Monday’s decision by the government to cut spending and aim for a primary surplus by 2011 is a step in the right direction, but more drastic reforms are needed to whip the books back into shape, experts say.

The government and the ruling coalition agreed to cut spending by 11.4 trillion yen to 14.3 trillion yen over the next five years.

The cuts, which include slashing the social security budget by 1.6 trillion yen, are estimated to cover more than 70 percent of the 16.5 trillion yen shortfall the government believes it must find to achieve a primary surplus in the combined central and local government budget by 2011.

A primary surplus excludes the cost of interest payments on government debt and new debt issues.

Naoki Iizuka, chief economist at Dai-ichi Life Research Institute Inc., said that although the spending cuts are a good move, a more fundamental reform of the social security system is necessary.

“I assume the cut in social security costs will come from money allocated to the elderly, such as medical care and pension (spending). But with the aging of society, social security costs are snowballing,” he said.

“If the government really wants to do something about the debt and . . . the low birthrate, the social security scheme needs to be fundamentally changed to shift money to youth, for example, in the form of child care or education.”

Among other spending reductions, 2.6 trillion yen will be pared by reducing the number of civil servants, and an additional 3.9 trillion yen to 5.6 trillion yen is to come from reduced public works spending, according to Monday’s announcement.

The remaining shortfall of 2.2 trillion yen to 5.1 trillion yen will have to be made up by raising taxes. If the consumption tax is to plug the hole, it would have to go up by 1 to 2 percentage points.

However, with an election coming soon, the ruling coalition is reluctant to raise taxes and it would like to hold cuts in local government grants to a minimum.

A consumption tax hike is unlikely to be mentioned in the government’s 2006 economic policy guidelines, scheduled to be adopted next month by the Cabinet.

Still, a document issued by the ministry Monday said the consumption tax could be used as “a source to cover social security costs.”

When asked about the social security issue, Kaoru Yosano, state minister in charge of economic and fiscal affairs, declined to give specifics.

“The ruling party decided last year to consider reform of the entire taxation policy, including the consumption tax,” he said.

Iizuka of Dai-ichi Life said a modest rise of 1 to 2 points in the consumption tax appears to be enough to meet the 2011 budget surplus target, but a bigger hike will be necessary if the government wants to clear its huge debts.

As of the end of fiscal 2006, the combined long-term debt for the central and local governments is expected to reach some 775 trillion yen.

Iizuka said with such a colossal debt, equivalent to 1.5 times GDP, the fiscal instability will increase as interest rates rise.

Even now, with rock-bottom interest rates, the central government spends 18.7 trillion yen, or 23.5 percent of all spending, on debt financing.

But over the short term, Iizuka said now is a good time to move workers from the public to the private sector as the economic recovery takes hold.

“Many big companies are booming and there are lots of jobs available. By accelerating the shift in manpower from civil servants to private companies, tax revenue will rise, and such a drastic tax hike may not be necessary anymore,” Iizuka said.

Masaru Takagi, a professor of economics at Meiji University, stressed the need for the government to overhaul the ailing social security system.

But for the upcoming budget, apart from the main issues such as cuts in public works projects, Takagi said official development assistance, for example, should be curtailed.

“Japan cannot afford to give so much abroad when it has gone totally broke in financing its own (spending).”

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