Most banks have shed their burden of bad loans. The Nikkei 225 average has recovered from rock bottom and the economy is finally picking up. But what about Japan’s debt-ridden finances?

With only three months to go before Prime Minister Junichiro Koizumi leaves office, his successor will inherit many pending or unfinished tasks, including the onus of raising taxes to whittle away at a government debt expected to reach 827.5 trillion yen at the end of fiscal 2006 next March, vs. some 46 trillion yen in annual tax revenue.

Of several pledges Koizumi made soon after he took office in April 2001, that of promoting structural reform via government budgetary belt-tightening perhaps drew the most praise from experts.

Despite strong opposition from conservative lawmakers in Koizumi’s own Liberal Democratic Party, the government began cutting public works spending in fiscal 2002.

His attempts to upset the pork barrel clearly went against the norm in a country long heavily dependent on public works projects to stimulate the economy.

“He cut public works investment from what was 8 percent to 9 percent of the GDP to 4 percent, and began evaluating each project — something other politicians didn’t do,” said Kazuyoshi Kurokawa, a professor of economics at Hosei University and a member of the government’s Fiscal System Council.

As a result, the fiscal 2006 budget allocation for public works stood at 7.2 trillion yen, compared with a 15 trillion yen peak in 1998.

Koizumi also strove to slash government spending and stimulate the economy by privatizing public entities, including universities, and shifting work from the public to private sector.

He tried to increase regional autonomy by cutting subsidies to local governments and making them draw up their own balance sheets, Hosei’s Kurokawa said.

The government set up 847 special economic zones in municipalities, and in the process transferred various jobs from the public sector to the private.

Management of a new prison to be built in Yamaguchi Prefecture in 2007, for example, will be outsourced to the security firm Secom Co., which will use integrated circuit tags to monitor inmates.

“Although many changes are still needed, Koizumi made structural changes — something other prime ministers couldn’t do,” Kurokawa said. “Although it is hard to see the impact of those changes right away, their effect will appear later.”

Thanks to his reforms, the economy, in bad shape five years ago, is getting back on track, with GDP growing 3.2 percent in fiscal 2005.

Although they praise Koizumi’s efforts, some experts say he has failed to fulfill key pledges and shelved many issues for the next administration, including his vow to cap the annual issuance of government bonds at 30 trillion yen.

The government met the pledge in fiscal 2001, Koizumi’s initial year in office, but the amount subsequently hit 35 trillion yen in fiscal 2002, 35.3 trillion yen in 2003, 35.5 trillion yen in 2004 and 33.5 trillion yen in fiscal 2005.

“Koizumi said from the beginning that he wants a small government and vowed to tamp down government bond issues. But neither has been accomplished, and the long-term debt just keeps growing,” Meiji University economics professor Masaru Takagi said, predicting the bond target won’t be met again this fiscal year.

But worst of all is that Koizumi himself downplayed the vow, Takagi said.

When asked in the Diet in January 2003 by then Democratic Party of Japan leader Naoto Kan why the 30 trillion yen cap was not achieved, Koizumi replied, “Not fulfilling the pledge is not such a big deal.”

“This is not good, since he had pledged it so strongly,” Takagi said.

Koizumi was inflexible on cutting government expenditures, especially for public works projects, causing the economy to suffer a setback, Takagi argued.

“It was a mistake to tighten the economy early on,” he said, adding that the government should have gauged the current situation before setting policy.

The Nikkei stock average, which closed at 13,934.32 yen on the last day of April 2001, hit its nadir — 7831.42 yen — in April 2003, reportedly due largely to the Koizumi administration’s pressure on banks to dispose of their bad loans.

Koizumi never entertained the unpopular but fundamental revenue reform of hiking the consumption tax.

Apart from a few tax hikes on alcohol and tobacco, and the easing of certain exemptions, Koizumi didn’t touch taxes and always promised a hike in the sales levy would not happen on his watch.

“Koizumi needed to remain popular” to stay in power, Kurokawa said.

But rising social security costs are preventing the nation’s fiscal health from improving.

According to the latest report by the Finance Ministry on June 23, the nation’s debt will stand at 827.5 trillion yen at the end of fiscal 2006. Together with the debts of local governments, the total is expected to reach almost 1 quadrillion yen. But the yearly tax revenue is only 46 trillion yen.

An earlier government report said that between fiscal 1990 and 2006, the issuance of government bonds increased by 380 trillion yen.

Roughly 90 trillion yen of that amount was due to an increase in social security costs, and 60 trillion yen covered a rise in public works costs, the report said. But 140 trillion yen was to cover a tax revenue shortfall.

Shinshu University economics professor Akio Makabe said the government’s financial situation did improve along with the economic recovery and Koizumi’s reforms, including the cut in public investment in the past five years.

But if social security costs are not remedied, the nation’s finances will become irreparable, Makabe warned.

“In the early 1990s, the main cause of the government deficit was public investment. But now it is social security costs, which are snowballing with the aging population and declining birthrate,” he said.

Takagi said it is vital for the economy to achieve a surplus in the primary balance for the central and local governments by 2011, as now being pushed by the government and ruling coalition.

According to the latest estimate by the government, 16.5 trillion yen will be needed to eliminate revenue shortfalls.

“If the cut in expenditures and a tax increase are carried out gradually, the goal of 2011 may not be so difficult to achieve,” Takagi said.

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