A tax issue that would directly affect people’s pocketbooks is pitting the Democratic Party of Japan, the largest opposition group, against other parties, especially the Liberal Democratic Party, in the current campaigning for the June 25 Lower House election. The DPJ is calling for a lowering of the minimum taxable threshold, while the LDP and other parties are criticizing the proposal as a de facto tax increase that would hit low-income earners hard.

This issue has long been a key topic of tax reform, but so far no parties have tackled it head-on. The DPJ proposal has not sparked the vigorous and productive debate that it had desired because other parties and candidates apparently do not want to see tax issues become politicized at election time.

The LDP, however, can and should deal positively with the DPJ plan in ways that would at least lay the groundwork for an overhaul of the personal income tax system. In fact, some LDP members have long expressed support for a lowering of the tax threshold, while the government’s tax commission has given it favorable consideration.

The lowest level of annual income subject to taxation depends on deductions from gross income. In Japan’s case, 16 different deductions are allowed, including the basic deduction as well as those for the spouse, dependents and social-security contributions. So far, these deductions have been increased or decreased in lieu of tax cuts or tax hikes, because that is easier than changing the tax rates.

Currently, the tax threshold for a “standard” worker family of four (a couple with two children) is set at 3.68 million yen, a sum equal to the total amount of deductions that the family is entitled to. It must begin to pay tax when its annual income exceeds this level. The minimum taxable income in other industrialized nations is much lower. For example, it is 2.45 million yen in the United States and 1.11 million yen in Britain.

The number of taxpayers in Japan — counting only those employed in the private sector — has dropped by an estimated 2 million in the past 10 years. With the tax base shrinking, the per capita tax burden has increased. The DPJ plan would lower the threshold to 2.67 million yen by abolishing the deductions for juvenile dependents (380,000 yen for a younger child and 630,000 yen for an older child).

The question here is whether scrapping these deductions would unfairly squeeze low-income people or whether it should be accepted by them as a way of sharing the tax burden more broadly. The answer is not as easy as it may seem, for the DPJ proposes increases in child allowances to make up for the abolition of these deductions.

Currently, a family that makes no more than 6.7 million yen a year is paid 5,000 yen a month each for its first and second children and 10,000 yen for a third child before they enter elementary school. The DPJ plan would raise the income limit for these allowances to 8 million yen. Additionally, dependent college students would be eligible for child allowances.

Thus a reduction in the minimum taxable income would mean a de facto tax cut for families receiving child allowances that more than offsets the canceled deductions. But it would mean a de facto tax hike for those families with an annual income of over 8 million yen that receive no child allowances yet have to take cuts in deductions. In other words, new revenue generated by shedding the deductions for children would be used to expand allowances for low-income households. Thus the DPJ plan amounts to income redistribution.

Public finance in Japan is reaching crisis proportions, and putting the nation’s fiscal house in order is a long-term policy priority. Getting higher-income people to accept a greater share of this burden therefore stands to reason, as many members of the coalition parties would probably agree. It should be possible for the DPJ and the coalition parties to explore common ground from the broad perspective of tax reform.

The sticking point for the DPJ plan is that it remains unclear how much, or even whether, it will contribute to fiscal reform. It is possible that increases in child allowances might exceed tax revenue from a cut in the minimum threshold. The result, from the viewpoint of fiscal reform, would be counterproductive: The deficit would grow, pushing the goal of a healthy budget further into the future.

As the DPJ points out, delays in budget reform are casting dark clouds over the future of the Japanese economy and putting a damper on economic recovery. Japan must start planning for needed changes, however painful, including overhauls of the spending structure as well as the tax system. The debate on the minimum taxable income should serve as a good start.

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