An finance advisory panel Friday recommended the government drastically cut spending and increase revenue by raising taxes in order to restore Japan's fiscal health -- a prerequisite to ensuring a sustained domestic demand-led economic recovery.

It is rare for the Fiscal System Council to call for tax hikes in its proposals for the government's budget.

Panel members said the proposal is an indication of the need to raise taxes to cope with inevitable rises in spending for the rapidly aging population.

The recommendation was given to Finance Minister Sadakazu Tanigaki, who responded by saying his ministry "will study it and take it into consideration in the budget compilation" process for fiscal 2005. A draft budget will be unveiled in late December.

Japan's fiscal situation is the worst among major industrialized countries, with government bonds currently covering 44.6 percent of state expenditures.

The ratio of national debt to gross domestic product stands at 160 percent, compared with 64.1 percent for the United States and 66.9 percent for Germany.

In the recommendation, the panel stressed the need to curb spending in defense and official development assistance, calling for "structural reforms" in defense outlays and "efficiency" in ODA.

It also outlined a plan to give greater incentives to farmers striving to boost production efficiency, in a move to rev up competitiveness in the agricultural sector so that Japan can play a more active role in bilateral free-trade negotiations or in trade liberalization talks under the World Trade Organization.

One panel member urged the government to consider restructuring defense outlays, saying that spending on defense equipment, including tanks and destroyers, is still based Cold War views.

"No one except the Defense Agency would be annoyed by changing the way the state budget is earmarked for such equipment," he said.

Another panel member said the central and local governments should cut personnel costs and reduce the number of employees by promoting administrative efficiency. The member also called for flexibility in the working styles of government employees, including increasing the number of part-timers.

The Fiscal System Council has warned that government spending would snowball to 119.4 trillion yen in fiscal 2014 from 82.1 trillion yen in fiscal 2004 if the government fails to curb expected rises in social security expenditures and to raise taxes.