Japan faces a clear and present danger in public finance, epitomized by a crushing debt load equal to 140 percent of its gross national product. In this light, changes to the tax code for fiscal 2003, proposed by the ruling coalition last week, fall far short of expectations. It is essentially a patchwork of tax cuts and tax hikes that, on balance, fails to convey a clear message.
What is lacking is a long-term vision for revamping the tax system. The coalition parties would have done well to tell the nation forthrightly about the gravity of the crisis and present a credible game plan to combat it. Specific tax changes for the next fiscal year and beyond should have been proposed along the lines of such a long-range strategy.
The tax package was originally aimed at keeping the runaway budget deficit under control. To that end, tax cuts were to have been offset by tax hikes over five years. Now this policy of fiscal balancing has all but collapsed. The key reasons for this are conventional wisdom and weak leadership — Prime Minister Junichiro Koizumi has left almost everything to tax gurus in his party.
Generally, the package favors business over the consumer. For example, companies that spend for research and development will receive tax credits while the special spouse deduction for married workers will be scrapped. Also, taxes on tobacco and liquor (low-malt “happoshu” beer) will be raised. The proposed R&D tax break, designed to spur investment in growth-oriented sectors, is necessary. Scrapping the extra spouse deduction, although it means a de facto tax increase, makes sense in view of the need to streamline the convoluted system of income deductions and broaden the tax base. And raising the “sin tax” is no big deal.
These proposals, however, have one drawback in common: the lack of a coherent scenario for tax reform. The Finance Ministry’s long-term plan to balance tax cuts and hikes — a plan aimed at securing an essential degree of fiscal discipline — was conceived as part of such a scenario. Now it appears all but dead amid mounting calls for an economic stimulus.
The expectation is that the tax cuts will spur growth and boost tax revenue along the way. The question is how effective they really will be. The multiplier effect of a 1.8 trillion yen tax break in a 500 trillion yen economy will be a drop in the bucket, particularly when the economy is caught in a deflationary quagmire. The dilemma is that without a stimulus, however minimal, the slump will worsen, thus cutting further into tax revenue.
The budget gap is appalling. The fiscal 2002 general-account budget, including supplementary spending, is more than 80 trillion yen; by contrast, the revenue estimated for the same year is only 44 trillion yen. The revenue-to-spending ratio, now slightly above 50 percent, has continued to drop since 1990 when it peaked at 86 percent. In the United States and Britain, the ratio is more than 90 percent; in major European countries it is about 80 percent.
The severity of Japan’s fiscal crisis is also evidenced by the ratio of budget deficit to GDP. At about 7 percent, it is more than twice the figures for the U.S. and European states — where the ratio is less than 3 percent. Italy offers a successful example of deficit reduction. Italy slashed the share of the deficit to less than a third in five years — from more than 10 percent in 1993 to less than 3 percent in 1998 — through a combination of spending cuts (pension benefits, social security payments) and tax increases.
The problem for Japan is that it cannot follow Italy’s example. Italy could pursue budget austerity because its economy was inflationary. Japan’s deflationary economy does not allow for any major spending cut or tax increase. On the other hand, the bloated budget deficit precludes a major tax cut or a large increase in public investment. The prospect of fiscal bankruptcy would send government bond prices into a tailspin.
So what can be done to put the fiscal house in order? Certainly there is no panacea. The only sensible way would be to draw up a long-term program of fiscal reform and put it into action steadily. For that, politicians from the prime minister on down must tell the nation candidly that such a program inevitably includes bitter medicine — tax hikes — and do their best to win public acceptance.
The tax package, to be sure, includes plans to broaden the tax base and secure fairness in the tax burden, such as restructuring part of the corporate income tax as a size-based levy and closing loopholes in the consumption tax. These plans, however, represent only tiny steps toward addressing the ongoing crisis. There is still a long way to go before fiscal health can be restored.
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