The latest report from the government’s Tax Commission has a sobering message: In the long run, taxes in Japan have nowhere to go but up. As the commission’s chairman, Mr. Hiromitsu Ishi, points out, there is no way to avoid tax increases in order to put the nation’s fiscal house in order.
For a start, the commission is calling for the phased abolition of the flat-rate income tax cut for individuals, beginning in fiscal 2005. Further down the road, perhaps beginning in fiscal 2007 at the earliest, a higher consumption tax (which is now 5 percent) is considered unavoidable.
The central problem is an enormous budget deficit resulting from chronic shortfalls in tax revenues. To close the budget gap, the government issues tens of trillions of yen of IOUs every year. The debt load — the balance of government bonds — is likely to exceed 600 trillion yen at the end of fiscal 2004. The national debt — the sum of central and local government debts — amounts to about 160 percent of the gross domestic product.
Clearly this borrow-and-spend policy is reaching its limit. In terms of public debt, Japan is already the most heavily indebted industrialized nation. At this rate, future generations will suffer as a big chunk of the bill is passed on to them. The massive debt also hurts efficiency in credit and capital markets as the public sector siphons off private-sector funds.
The corporate sector has tried hard, with considerable success, to improve balance sheets since the asset-price bubble burst in 1990. The household sector has also made painful efforts to make ends meet. By contrast, fiscal reform of the central and local governments has made little substantial progress. To reduce the debt in the long run, they will have to raise taxes, as the commission has recommended.
But a number of conditions must be met before taxes can be increased: First, reform must be initiated on the spending side. Second, the tax code must be revised in ways that correct inequalities. Third, but not the least important, a national consensus must be forged on how much of the national income should be earmarked for taxes and social security contributions.
According to the commission, the flat-rate tax cut would be phased out in two years, beginning in fiscal 2005. This across-the board reduction of the national income tax by 20 percent and the local income tax by 15 percent was put in place in 1999 when economic growth was threatened by a looming banking crisis. A phaseout of the tax cut would mean a de facto increase of 3.3 trillion yen in tax revenue.
Given its ad hoc nature, the tax cut should not be continued indefinitely. With the economy now showing some signs of weakness, however, the timing should be carefully considered. GDP growth for the third quarter ended Sept. 30 is estimated to have dropped below zero. The government’s latest monthly economic report has revised its forecast downward.
The business community believes it is premature to discontinue the tax cut. A similar belief is held by many members of the ruling parties. The tax panel itself says a decision should be made in consideration of the economic situation. The mistake of 1997, when premature tax hikes sent the economy back into recession, should not be repeated.
In the long term, though, the Japanese seem to have no choice but to accept a higher tax burden. For one thing, the progressive rates of income taxes here are among the lowest for industrialized nations.
It should be noted that past tax cuts intended for people in the middle-income brackets have tended to favor high-income taxpayers. So it is important to consider ways of raising the burden on high-bracket earners — such as changing the progressive tax rates or raising the estate tax. Such measures are considered necessary to ensure fairness in taxation. An abolition of the flat-rate cut will hit low-income people harder.
The Tax Commission takes a cautious stand on the proposed environment tax, also known as the carbon tax, saying the proposal should be “carefully considered” in the broader context of antiglobal warming measures. It remains unclear whether the gasoline tax, which is now used exclusively for road projects, will be allocated to environmental projects as well.
Prime Minister Junichiro Koizumi says he will not raise the consumption tax while he’s in office. That is seen widely as an admission that the value-added tax will be increased sometime after his tenure expires in the autumn of 2006. The questions that remain are, specifically, when and how much it will go up after his departure. One thing seems certain: Japan is heading for a period of higher taxes.
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