The record ¥97.7 trillion general account budget for fiscal 2018, approved by Prime Minister Shinzo Abe’s Cabinet last week, features insufficient efforts to put the nation on a steady path for fiscal consolidation. While the government expects tax revenue next year to recover to the levels at the height of the early 1990s bubble boom on the strength of continued growth of the economy and robust corporate earnings, a reduction in its dependency on debt to finance its spending was kept to a minimum as not enough measures were taken to curb spending. Following its recent decision to shelve the target of achieving a primary balance surplus by fiscal 2020, the Abe administration is urged to quickly come up with a credible scenario for fiscal rehabilitation.
The government is under pressure to pursue fiscal consolidation while coping with the mounting policy challenges of the nation’s rapidly graying population and its changing security environment. Social security spending including the cost of medical and nursing care services of the expanding ranks of the elderly population, which occupies more than a third of annual expenditures, grew 1.5 percent to a record ¥32.9 trillion, while the defense budget, featuring more spending on missile defense systems in the face of the growing threat posed by North Korea’s nuclear and ballistic missile programs, rose 1.3 percent to another record ¥5.19 trillion for the sixth year-on-year increase in a row.
Since taking office five years ago, the Abe administration has emphasized the economy’s growth as key to rebuilding the government’s fiscal health, in which outstanding public debt has topped 230 percent of the gross domestic product. It has stressed flexible fiscal spending in its efforts to pull the nation out of deflation. The general account expenditures kept hitting record highs for six years under Abe’s watch.
With the Japanese economy now indeed in an extended cycle of expansion, the government estimates tax income in fiscal 2018 to rise 2.4 percent from the previous year to hit ¥59.79 trillion — the highest in 27 years since the ¥59.8 trillion recorded in fiscal 1991. In addition, ultra-low market interest rates, under the Bank of Japan’s massive monetary easing operation that has been maintained as a key pillar of Abenomics since 2013, help the government cut its debt-servicing expenses by reducing the cost of borrowing — a condition that critics say reduces the government’s sense of crisis over its fiscal health.
Such a favorable environment could have provided the government with more leeway toward fiscal consolidation by cutting back on its debt. Despite the projected ¥1.36 trillion increase in tax revenue, however, the primary balance deficit — under which the government’s tax and other income cannot cover its expenses (excluding debt-servicing costs) without incurring new debt — will improve by only ¥451 billion in fiscal 2018 as the policy expenses also increase by ¥484 billion. While the issuance of new government bonds will fall by 2 percent to ¥33.7 trillion for the eighth consecutive annual decline, the overall picture of the government relying on new debt for about a third of its revenue continues.
The fact that the government’s brisk tax revenue estimate is based on a projection of robust economic growth — 1.8 percent in real terms and 2.5 percent in nominal terms, well above the forecasts by many private-sector economists — is another source of concern. If the economy fails to grow as strong as forecast and tax revenue falls short, the government will be forced into issuing more debt to cover spending.
The Abe administration effectively gave up on its target of achieving a primary balance surplus in fiscal 2020 — deemed a landmark in the efforts for fiscal consolidation — when it decided this fall to divert part of the additional revenue from the next consumption tax hike in 2019, originally reserved for paying off the debt, to increase public spending on education. The government expects the primary balance to remain ¥10.4 trillion in the red in fiscal 2018, and the path toward achieving a surplus remains murky. It needs to set out a clear and credible path for fiscal consolidation when it comes up with a new target, scheduled in mid-2018, for a primary balance surplus. There’s no time to lose in such efforts, as social security expenses are set to expand further as the aging of the population accelerates — with all of the postwar baby boomer generation set to have turned 75 or older by 2025. Reforms of the social security system, including cuts in benefits for the wealthier elderly, will be inevitable.
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