• Kyodo

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The International Monetary Fund on Wednesday recommended Japan gradually lift its consumption tax to 15 percent, beginning in fiscal 2011, to restore the nation’s public finances amid ballooning public debts.

“Fiscal adjustment should start in fiscal 2011 beginning with a modest consumption tax hike,” the IMF said in a report after annual talks with the Japanese government and the Bank of Japan.

“A gradual increase of the consumption tax to 15 percent beginning in fiscal 2011 and distributed over several years, could generate 4 percent to 5 percent of gross domestic product of revenue,” it said.

Noting the importance of comprehensive tax reform, the IMF said the consumption tax hike could be combined with a reduction of personal income tax allowances and corporate tax reform to stimulate domestic investment.

Prime Minister Naoto Kan’s reference to a hike in the 5 percent consumption tax was seen as a major factor behind the setback suffered by his Democratic Party of Japan in Sunday’s House of Councilors election.

But the IMF’s message is likely to give a boost to those who want to push for debate on the consumption tax hike.

Stressing “the urgency of credible fiscal adjustment,” the IMF also called for curbing spending growth in areas other than social security and reforms to entitlement programs.

“The key challenge is to bring down public debt to more sustainable levels — through decisive and sustained fiscal action — while ensuring adequate support for the still nascent recovery and a more balanced economy,” the IMF said.

“Introducing a cap on public debt would help strengthen the credibility of the fiscal consolidation plans,” it said.

Japan’s overall fiscal deficit swelled to 10.25 percent of gross domestic product in 2009 and the net public debt ratio rose to 110 percent of GDP, one of the highest among developed economies, according to IMF data.

The Washington-based macroeconomic watchdog also said it looks forward to “agreement on specific measures” regarding a medium-term fiscal consolidation path that Tokyo announced last month.

The IMF also urged the BOJ to prepare for additional monetary easing steps, if necessary, to support the nation’s economic recovery and combat deflation.

The IMF called the BOJ’s accommodative monetary stance appropriate and welcomed various steps recently implemented by the central bank to fight deflation and boost growth.

On the overall assessment, the IMF said the Japanese economy is “gaining strength, helped by strong external demand and timely and sizable policy support.”

With domestic demand gradually improving and deflation easing, the recovery is expected to continue, albeit at a more moderate pace, it said.

But the IMF also expressed caution about the economic outlook, noting the recent turmoil in Europe “has heightened risks to the outlook and Japan’s vulnerability to sovereign risk.”

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