Prime Minister Shinzo Abe’s decision to cut Japan’s high corporate tax rate may trigger unwelcome side effects along with bolstering foreign investment in the country.

Earlier this month, Abe pledged to reduce the 35 percent corporate tax rate to less than 30 percent within the next few years, aiming to attain his top economic goal of conquering nearly two decades of deflation.

But Abe, who took office in December 2012, was mum about how to cover the resulting decline in tax revenues after the tax cut, sparking fears that the country’s fiscal health, the worst among developed economies, may deteriorate even further.

Should the government try to collect taxes more broadly from companies or households, the world’s third-biggest economy could stall, some analysts warn. The April 1 consumption tax hike, the first in 17 years, has already dampened domestic demand.

A corporate tax cut is a pillar of Abe’s revamped growth strategy for stimulating private sector investment, the so-called third arrow of the “Abenomics” policy mix, following aggressive monetary easing and massive fiscal spending.

Economic and fiscal policy minister Akira Amari, Abe’s close ally and the linchpin in implementing the prime minister’s economic policies, has expressed hope that reducing the corporate tax rate will help invigorate the economy and eventually boost overall tax revenues.

“It’s important to use the fruits of Abenomics for promotion of fiscal rehabilitation and structural reform,” Amari said.

Amari has said the corporate tax rate should be cut in stages from the next fiscal year to around 29 percent, equivalent to the level in Germany, an economic rival of Japan as both are driven by the automotive and machinery industries.

Indeed, many experts agree that a corporate tax cut will have beneficial effects on Japan’s economy. If the effective corporate income tax is cut by 1 percentage point, direct investment in Japan from other nations is forecast to expand 3.5 percent, said Keiji Kanda, an economist at the Daiwa Institute of Research.

As cutting the corporate tax will make Japan more attractive as a market for global firms, “domestic capital spending, mergers and acquisitions, and new businesses may increase,” Kanda said.

The Ministry of Economy, Trade and Industry, a proponent of cutting the corporate tax rate, said in late April that Japan’s gross domestic product is projected to grow by at least ¥7 trillion ($68.7 billion) if the corporate tax rate is slashed to 25 percent, the same as in China and South Korea.

Japan’s nominal GDP in 2013 was about ¥478 trillion, according to data released June 9 by the Cabinet Office.

Some economists, however, said the positive impact of the proposed tax cut will be limited and thwart the government’s attempt to restore Japan’s precarious fiscal health.

“Abe’s government will say that it can achieve fiscal consolidation by beating deflation and successfully implementing the growth strategy,” said Ryutaro Kono, chief economist at BNP Paribas Securities (Japan) Ltd. Yet, a corporate tax cut is “unlikely to have a drastic effect,” given that it may take a “long time” before the economy embarks on a sustainable growth path, Kono added.

Japan’s public debt is more than 200 percent of its GDP, and the national debt has topped ¥1 quadrillion. A 1 percentage point cut in the corporate tax rate is expected to reduce tax revenues by about ¥470 billion, the Finance Ministry said.

The government and Abe’s ruling Liberal Democratic Party have reiterated that it will keep pursuing its goal of turning the primary balance — annual tax and nontax revenues minus outlays other than debt-servicing costs — into a surplus by fiscal 2020.

To attain the target, many LDP lawmakers have called for broadening the corporate tax base, as only about 30 percent of Japanese companies pay corporate taxes currently, with the rest exempt due to poor business performance.

If Abe’s administration does cut the corporate tax rate, it will deal a heavy blow to smaller firms at home, some of which have experienced low profitability, in turn weighing on the economy across the board.

This is because the government is giving preferential treatment to big companies while increasing the burden on small and midsize enterprises, Banri Kaieda, the head of the main opposition Democratic Party of Japan, said recently.

“In Japan, 70 percent of people are working for small and midsize enterprises. Higher burdens on them are sure to take a toll on workers there,” said Kaieda, a well-known economist before entering politics.

Some government officials are also considering cutting or doing away with tax breaks for households, such as the spousal tax deduction system, to finance a corporate tax cut.

In a time of both misinformation and too much information, quality journalism is more crucial than ever.
By subscribing, you can help us get the story right.