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With Japan’s economic recovery gaining momentum, the government appears set to increase taxes across a broad spectrum. The Tax Commission last week proposed a series of tax-code changes for fiscal 2006, including an abolition in 2007 of the flat-rate tax cuts for individual income taxes that had been introduced to shore up a flagging economy. The commission also called for eliminating special tax breaks for businesses, such as those designed to promote investment in information-technology (IT) projects.

The panel did not say whether the consumption tax would be raised, although it is almost certain that the question will be the central topic of the tax debate a year from now. The government must realize, however, that introducing a host of tax increases to reduce the budget deficit will smother the burgeoning economic recovery. It is also important not to reduce efforts to cut government spending.

The commission’s silence on the value-added tax is like the calm before a storm. With a vigorous debate looming over the horizon, the panel probably wanted to skirt this explosive issue. A boost in the tax rate, now 5 percent, is considered unavoidable down the road. The sticky questions are when it should be raised and by how much.

The proposed abolition of the flat-rate tax cuts is less controversial. Given their ad-hoc nature, they are destined to go sooner or later. Now that the economy appears to be emerging from a long spell of deflation, the proposal seems timely.

This temporary measure, adopted in 1999, deducts 20 percent of national income taxes and 15 percent of local income taxes (local residence taxes) for individuals. The amounts of reduction will be halved in 2006 as a result of the tax reform proposed at the end of last year. The latest proposal would eliminate the other half in 2007. This would mean a de facto tax increase of 82,000 yen for a four-member worker household (a couple with two children) with an annual income of 7 million yen.

The proposal to scrap the IT-related tax cuts, due to expire at the end of next March, also seems reasonable. The business community had pressed for an extension of these incentives, but the commission rejected the request, citing a robust recovery in corporate earnings. It would be unfair to keep these tax breaks for businesses while ending those for individuals.

If the flat-rate tax cuts are abolished, tax revenue will increase by an estimated 3.3 trillion yen. Removal of the IT tax cuts will bring in an estimated additional 600 billion yen. That will go a long way toward rebuilding the deficit-ridden public finances.

The Tax Commission made no specific proposals to levy higher taxes on “third beer” — a new, low-alcohol drink that is made from different ingredients than traditional beer but tastes similar. Because a lower tax is levied on such alcohol, the beer industry is developing such products to ease its tax burden. Meanwhile, the tax authorities are considering changing the liquor-tax system. The panel emphasized the need to simplify alcoholic-beverage tax classifications to reduce imbalances in the tax burden on different products.

Details are to be worked out this month in a debate with the ruling party’s Tax System Research Council. It is necessary to end the “tug-of-war” between the liquor industry and tax authorities, and to create a more integrated liquor-tax system.

The panel also proposed that the central government transfer more of its tax-collecting authority to local governments by reducing national income taxes and increasing local income taxes. Specifically, rates on individual residence taxes would be unified, while those on national income taxes would be made more progressive without changing the overall tax burden.

Generally, the proposed tax-code changes for fiscal 2006 are small in scale, yet the government appears increasingly determined to put its fiscal house in order through tax increases. It is worth noting, though, that a view is gaining hold that tax revenue decreases are bottoming out as the economic recovery becomes more stable.

As things now stand, fiscal 2005 tax receipts will likely exceed the original estimate (44 trillion yen) by more than 2 trillion yen, thanks largely to better-than-expected natural increases in personal and corporate income-tax revenues. Prime Minister Junichiro Koizumi reportedly intends to cut bond issuance for fiscal 2006 to nearly 30 trillion yen from 34 trillion yen for fiscal 2005.

A natural revenue increase of this order should help to achieve the borrowing target. To make a significant cut in bond issues, however, it is also necessary to slash spending. If tax increases are unavoidable, the government must first win public acceptance by introducing bold spending cuts in its budget-making process, which will soon enter the homestretch.

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