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It appears that Prime Minister Junichiro Koizumi is pushing the consumption-tax issue onto the political agenda. During a Lower House plenary session earlier this month, he said, in effect, that the value-added tax should be increased as part of overall social security reform. Until recently, Koizumi had consistently avoided this issue since taking office nearly four years ago, vowing that he would not raise the tax while in office.

The government’s Tax Commission is also taking a positive stance toward an increase. At a press conference immediately after Mr. Koizumi’s statement, Mr. Hiromitsu Ishi, head of the panel, suggested that he would announce, perhaps as early as this autumn, a detailed proposal spelling out how much the tax rate should be raised and when.

The Liberal Democratic Party, meanwhile, is moving toward boosting the tax in or after fiscal 2007 — sometime after Mr. Koizumi’s tenure as LDP president expires in September 2006. To that end, the party is planning to set up an in-house council. Thus a consumption-tax increase linked to social security and fiscal reconstruction looms as the biggest policy issue after postal privatization.

The health ministry estimates that social security benefits — the sum of pension, health-care and welfare payments — will double in the next 20 years to 176 trillion yen, assuming that the government share of basic-pension contributions will increase to one-half. As a result, social security spending by the central and local governments will rise to 64 trillion yen from the present 26 trillion yen.

The question is where the money will come from. There are no easy answers. Tax revenues for fiscal 2005, estimated at 44 trillion yen, make up only slightly more than half of the 82 trillion yen government budget. The balance of outstanding government bonds at the end of March will total an estimated 483 trillion yen, or 11 times the current annual tax intake. This rising debtload — the result of massive borrowing since the collapse of the asset-price bubble in 1990 — threatens fiscal viability.

In the meantime, the makeup of tax revenues has changed significantly. While individual and corporate income-tax payments have diminished markedly, revenue from the consumption tax — which was introduced in fiscal 1989 at the rate of 3 percent — has expanded steadily following a rate increase to 5 percent in 1997 and a broadening of the tax base. In fiscal 2005, this levy is expected to yield more than 10 trillion yen at the national level and 2.5 trillion yen at the local level. The central-government intake represents more than 20 percent of the total tax yield in the 2005 budget — a share comparable to that of individual and corporate income-tax revenues.

The business community is also in favor of boosting the consumption tax. Nippon Keidanren (Japan Business Federation) and Keizai Doyukai (Japanese Association of Corporate Executives) have each published a policy statement calling for phased increases of up to nearly 20 percent to secure a stable revenue source.

The Democratic Party of Japan, the largest opposition group, also argues for an increase, on the condition that the revenue be used specifically for funding public pensions. Both the party and the business community note that value-added taxes in European Union states already exceed 15 percent.

Some members of the Tax Commission counsel caution, however, saying that problems in the social security system should be addressed first. That is reasonable. Problems are many, including those carried over from last year’s pension reform. What is needed is a systemic redesign that deals squarely with the realities of Japan’s aging society. The revenue issue ought to be discussed on that basis.

Systemic reform is also required of the consumption tax, although the tax itself has taken root in the daily lives of Japanese consumers over the past 15 years. A rate increase should be discussed as an integral part of such reform.

One area of reform involves the tax privileges enjoyed by small businesses — tax exemptions and deductions that effectively allow them to keep some of the tax paid by consumers. These privileges, which have been widely criticized as “sweeteners” for small businesses, were curtailed, not abolished, beginning in April 2004. The number of small-business taxpayers is said to have increased by approximately 1.3 million.

Another problem is the regressive nature of the consumption tax. Because it is levied on a broad range of goods and services, the tax tends to impose a greater burden on low-income people. To correct this defect, the system must be redesigned. One way would be to apply a lower tax rate to food and daily goods, as is done in European nations.

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