Tax system overhaul must ensure economic vigor for a dwindling population


The ruling coalition released its tax reform proposals for fiscal 2006 on Dec. 15. Despite the tight fiscal conditions, it is laudable the ruling parties recommended measures aimed at boosting economic activity — such as those that encourage corporate investment in research and development, expenditures for information technology and spending on housing.

Meanwhile, expectations are rising that the government and the ruling coalition will start a fundamental review next year of the structure of state expenditures and revenue, including the tax system.

The Council on Economic and Fiscal Policy is expected to specify options and timetables for the review by June 2006. The Liberal Democratic Party’s tax commission will likely resume debate on the issue early next year, while the government’s tax panel is scheduled to compile its triennial, medium-term report on tax reforms next year.

Under the Koizumi administration, large tax cuts aimed at improving corporate competitiveness and pulling the nation out of deflation were introduced in fiscal 2003. Some of these tax breaks will be carried over to the next year and onward.

Meanwhile, the government has decided to make a major shift in focus from income tax to residential tax, in terms of taxing individual income. This is consistent with Prime Minister Junichiro Koizumi’s desire to redistribute sources of tax revenue to local governments and promote decentralization.

Meanwhile, the fixed-rate tax breaks introduced as an emergency measure to boost the economy are set to be scrapped within two years.

Collectively, these steps are gradually setting the stage for a fundamental overhaul of the tax system.

The most important point to consider when discussing an overhaul of fiscal policy, including the tax system, is that Japan, as it braces for an era of population decline, must pursue a small and efficient government so it can maintain its economic vigor.

Specifically, the so-called potential burden rate — the combined ratio of tax and social security premiums to people’s income — needs to be kept at around 50 percent over the medium to long term.

Fiscal needs that cannot be met by higher tax revenue resulting from a positive economic cycle, plus far-reaching cuts in government expenditures, should be countered by an increase in the consumption tax.

However, the government needs to examine whether it really has made sufficient progress on spending cuts before attempting a consumption tax hike.

Furthermore, the corporate tax system needs to be reviewed constantly from the viewpoint of attaining equal footing with other countries and improving the competitiveness of Japanese companies. In Japan, the effective corporate tax rate is still higher than in many European and Asian nations where Japanese firms face increasingly tough competition.

The corporate tax system should be reviewed as part of any upcoming tax system overhaul.