The tax proposals by the ruling Liberal Democratic Party and Komeito included in the fiscal 2007 draft budget reflect Prime Minister Shinzo Abe’s idea that there will be no financial reconstruction without high economic growth. He envisages the following path: Tax cuts for the corporate sector will energize economic activities, which then will lead to an increase in tax revenues and contribute to financial reconstruction. The tax measures will benefit the corporate sector, but will not necessarily lead to a strengthening of the whole economy, the basis for a stronger tax base.

The proposals represent 450 billion yen tax cuts in fiscal 2007, mostly for the corporate sector. Companies will be allowed to fully write off capital investment and the depreciation period will be shortened. The proposals also include a year extension of the tax breaks on capital gains from stock sales and dividend income.

Mr. Abe and the ruling coalition hope that enlivened corporate activities through tax cuts will spill over to the household sector in the form of higher wages and thus help the economy grow. But despite the prolonging economic boom, the corporate sector’s total personal cost decreased by 7 percent in the past five years. Earlier, it was also decided that all tax breaks for income tax and residential tax would be abolished, resulting in a tax increase of about 1 trillion yen. Thus the tax burden on the household sector will increase and the people will not loosen their purse strings. If personal consumption does not ignite the economy, tax revenues may not increase as expected. The coalition should consider using a tax system to realize a balanced income distribution among different sectors.

The coalition hinted that it will discuss overhauling the tax system, including the consumption tax, in late 2007. The consumption tax could be a major source for social welfare spending. But since the coalition has prioritized reducing corporate tax burdens, and since the personal tax burden will become heavier, the people will likely resist the idea of raising the consumption tax.

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