Tax

April 2002

Despite showing signs of improvement, the domestic economy remains trapped in its worst postwar deflationary period. The government should focus on anti-deflation measures by prioritizing active tax reforms. Due to draw up reform proposals in June, the government must first of all recognize that measures should aim at re-energizing economic activity on behalf of companies and consumers. The government tax reform debate has stalled because of disagreement over who is responsible, while many Finance Ministry officials, the government Tax Commission and the ruling Liberal Democratic Party's tax panel appear to be losing sight of the overall macroeconomic picture. The Tax Commission agenda is dominated by tax increases even though economic revival should be the top priority. Committed to engineering an economic revival, the Council on Economic and Fiscal Policy is very much under the thumb of the Finance Ministry. The council's proposal to prioritize tax cuts over reduction of the budget deficit would not help much to revitalize the economy, if it relies solely on spending cuts and sales of government assets. Meanwhile, Prime Minister Koizumi is not demonstrating strong leadership, as he did when pushing reform of the postal system and government-affiliated corporations. His priority is misplaced, as tax reform should take precedence over admission of private companies into the mail-delivery service. The corporate tax rate should be reformed to stimulate capital and R&D investment and encourage the activities of entrepreneurs in new growth areas to help companies cope with intensifying global competition. The income tax structure should be revised in a way that rewards hard work. Any such measure would require a flattening of the progressive tax rate and a lowering of the minimum taxable income. Reforms are also necessary to lure individual investors' money into the securities market and promote trades in land. The successive downgrading of Japan's sovereign credit rating has made it vital to turn around government finances. The government can no longer rely on public works projects to jump-start the economy. The deficit-ridden social security system also needs to be revamped in order to dispel worker anxiety. A further increase in the consumption tax appears inevitable with the rapid aging population. But any tax increase will have to be put on hold since there is no hope for improvement of government finances unless the economy is strengthened to bolster the tax base. In order to achieve these objectives, the cabinet and the Council on Economic and Fiscal Policy should take the lead. The Finance Ministry and the Tax Commission, therefore, should focus the policy decisions made by the council. (April 30, the Nihon Keizai Shimbun)

The tax reform debate is heading in two opposite directions, as the roles and the hierarchy of the Tax Commission and the Council on Economic and Fiscal Policy (CEFP) have not been clearly identified. Overseeing economic stimulus measures under the guidance of Prime Minister Koizumi, the council targets the tax reforms for boosting the ailing economy. However, the Tax Commission released an outline calling for measures that effectively raise tax revenues, diverging from the prime minister's insistence that tax reforms are vital to lifting the economy. Critics call the commission's outline self-righteous measures by experts focusing more on the principles of the tax system. Although the CEFP released a tax reform outline in late March, the commission largely dismissed it, saying taxes should not be used as a policy tool. A Tax Bureau official says debate at the commission is separate from that of the CEFP, and that the commission is not to be bound by the council's proposals. The commission treats the CEFP's outlines as if they were tax reform requests submitted every year by government agencies and interest groups. But the outlines serve a different purpose. Recognizing Japan's deteriorating competitiveness, the CEFP aims to devise economy-boosting measures that would increase tax revenues over the long run. It believes that providing tax relief for R&D and investments is an effective tool to nurture businesses to strengthen Japanese industry. Tax Commission Chairman Hiromitsu Ishi doubts that there is any such thing as effective tax cuts that can boost economic activity, and continues to stick to his principle that the tax system should be neutral not favoring certain economic activities. There is a view that the Tax Commission should finalize details based on the general guidelines formulated by the CEFP, considered the command center for broad economic measures. The CEFP and the Tax Commission aim to separately compile basic outlines in June. Unless the hierarchy between the two parties is clarified, the reforms may become a diluted version of both concepts. Yet, as long as the Tax Commission is responsible for building final tax measures, there is no denying the possibility that the current tax reform work could end up devising more measures that will increase taxes. (April 30, the Nihon Keizai Shimbun)

Tax cuts to help stimulate the economy are acceptable if they are balanced with future tax hikes to make up for the fall in revenue, according to Finance Minister Shiokawa. If there are both tax cuts and tax hikes conducted over a set period of time, then using taxes to revitalize the economy is worth considering. The Finance Minister said that it would be acceptable to conduct tax cuts first, and then follow up with tax hikes or other ways to increase revenue if such methods are specified at the time of the tax cuts. He added that any cuts ought to be offset by fiscal 2010, when the government hopes to achieve a "primary balance" where expenditures are balanced by tax revenue. The Finance Ministry and the government's Tax Commission had maintained the view that any tax cuts ought to be balanced out by tax hikes within the same fiscal year, in order to keep the effects on tax revenue neutral on a single-year basis. However, Shiokawa has recently said that tax cuts could be followed by hikes to offset revenue within "a set period of time," leaving the timing of future tax hikes vague. His comments today indicate tax hikes may be carried out over a relatively long period of time. He added the government will also consider opposite ways in which to offset a decline in tax revenue besides tax hikes, such as scaling back wasteful spending. But he expressed caution over relying on a natural increase in tax revenue, which may occur if the economy recovers. Shiokawa said that if natural revenue growth is to be counted on, numerical targets ought to be set for ensuring that there will be no shortfall in medium- to longer-term tax revenue. The government is currently working to map out a direction for comprehensive tax reform in June. While the reforms are essentially planned for next fiscal year on, some members of the ruling Liberal Democratic Party are calling for the tax cuts to be front-loaded to the current fiscal year. (April 24, Dow Jones)

Japanese taxpayers are increasingly frustrated with the Tax Commission's focus on tax hikes, with many public hearing attendees calling on the government to streamline its own spending before asking them to shoulder a heavier burden. The commission concluded its series of six public hearings, with the last one held in Matsuyama, Ehime Prefecture. It was put on the defensive by angry taxpayers at its first hearing in Chiba, who quickly dubbed the gathering a "tax hike meeting." This was because the Tax Commission tried to explain the necessity of tax hikes by citing figures suggesting that one out of four taxpayers does not pay income taxes. The prevailing view among attendees was that the fact that Japan's expenditures exceed 80 trillion Yen on tax revenues of less than 47 trillion Yen does not automatically justify increasing taxes. Surveyed on several tax questions, as many as 20-30% of participants at each meeting said they distrust the government on the use of tax revenues. And when questioned about solutions to the budget deficit, most called for spending cuts, possibly paired with tax hikes. They also said a review of income tax deductions should be conducted with consideration to the social security system as a whole. As for reviewing social security, special road construction revenues and local-allocation tax grants, Ishi only said that he hopes the Council on Economic and Fiscal Policy will come up with proposals. Summarizing the meetings' outcome, Ishi said that tax reforms should aim for a "fair and easy-to-understand tax system." Although taxpayers at first did not oppose to the commission's plan to broaden the tax base while reducing income tax rates, they disagreed on how specifically to review the current income tax deductions. Many participants also called for reducing the gift and inheritance taxes to make effective use of individuals' financial assets, most of which are now owned by the elderly. Many attendees also called for a taxpayer identification number system (taboo for privacy reasons in previous tax discussions) to make it harder for anyone to skip paying taxes as well as reduce the government's tax collection costs. Ishi said his commission will take one step forward in considering implementing such a system. (April 24, the Nihon Keizai Shimbun)

The Japan Chamber of Commerce and Industry (JCCI) supports increasing the consumption tax rate as part of the government's planned tax system reforms, an abrupt turnaround from its previous opposition to the idea. Japan's four major business groups all currently favor a hike in the consumption tax rate. Representing small- and medium-size businesses, JCCI has a different reason for advocating the move versus the other three groups, such as the Japan Federation of Economic Organizations (Keidanren) and Japan Association of Corporate Executives (Keizai Doyukai), which mostly comprise large companies. Keidanren and Keizai Doyukai are ready to accept a higher consumption tax rate. They believe that otherwise they will incur a higher corporate tax and a greater burden of social insurance premium payments, as the government will need more tax revenue to handle an increase in social security costs amid a graying society. In contrast, JCCI had opposed the introduction of the consumption tax, saying that smaller businesses would find it difficult to pass on the tax to product and service prices. In addition, the tax, or the higher tax rate, would have a major negative impact on the economy. However, for the JCCI, which is calling for a cut in corporate and other taxes as a way to boost the economy and strongly opposes the introduction of a new, comprehensive corporate tax imposed on factors other than profit, the consumption tax rate increase may be the only step it can compromise. Keidanaren and Keizai Doyukai accept the consumption tax hike on condition that the threshold for exempting firms from forwarding the consumption tax to the government should be lowered. Currently, firms with annual sales of about 300 million　Yen enjoy this privilege. However, the JCCI is reluctant to discuss this issue, as the issue to pay the consumption tax could prove to be an important matter for smaller businesses. (April 21, the Nihon Keizai Shimbun)

Defying calls for prompt action by some lawmakers, members of the Liberal Democratic Party's powerful tax research panel agreed not to move up the tax cuts proposed in the ruling coalition's anti-deflation measures. The LDP's Research Commission on the Tax System, chaired by Hideyuki Aizawa, held a general meeting that day to discuss its policy on tax cuts. The plan to impose a 2% surcharge tax on firms using the group taxation structure will be submitted to the Diet in May as scheduled. While some critics have called for changes to the application of the surcharge, it is unlikely to reduce the time frame for its application. The proposed anti-deflation measures compiled by the ruling parties April 2 call for tax cuts to encourage investment and reductions in land-related taxes to improve the liquidity of such assets. Some lawmakers called for realizing tax revisions that can be made in the current Diet session. But many senior LDP tax panel members expressed caution about quick revision of the tax code. (April 19, the Nihon Keizai Shimbun)

The Tax commission subcommittee agreed to propose abolishing and consolidating some income tax deductions, including the spousal deduction, during ongoing discussions on comprehensive tax reforms. The subcommittee on basic tax issues also agreed to review increasing the basic exemption amount from the current 380,000 Yen and lowering income tax rates to alleviate possible increases in tax burdens after the abolition of some tax deductions. The tax panel has been seeking to abolish some outdated tax exemptions, such as the spouse deduction, to meet the needs of a changing society. The panel members also agreed to propose the lowering of tax exemptions on earned income for salaried workers as well as encouraging them to file a tax return by allowing them to deduct expenses such as transportation. (April 17, the Nihon Keizai Shimbun, the Japan Times)

The government's Tax Commission is considering reducing the minimum income tax rate as part of a broad reform designed to simplify the tax system. Although the commission reached a consensus to shrink as much as possible a whole range of deductions that reduce taxable income, the problem is that curbing deductions without lowering marginal tax rates will result in a larger tax burden for many people. The commission will work out the details with particular attention to the impact on low-income households. A commission panel focusing on basic tax issues discussed sweeping reform of income taxation and agreed to expand deductions that individuals calculate on their own based on actual expenses, such as commuting costs, while reducing deductions based on some automatic formula to approximate expenses, when employers file on behalf of their employees. The aim is to encourage individuals to take personal responsibility for filing taxes on their own and not leave the paperwork to their employers, which is now the common practice in Japan. The panel also confirmed the direction mapped out to reduce several tax deductions, including a special 630,000 Yen deduction for dependents aged 16 and up to 22, as well as the standard spousal tax deduction of 380,000 Yen, which is often blamed for giving women an incentive to stay out of the work force. Although pruning the tangle of various deductions will clear a path toward simplifying income taxation, it remains concerned that merely shrinking deductions will raise the burden of income taxes. The commission is especially worried about the possibility that households headed by a salaried worker whose income after deductions now falls under the minimum taxable threshold of 3.84 million Yen could suddenly face taxation at the bottom marginal rate of 10%. As a result, the panel agreed to consider options to avoid a heavier burden on low-income households, such as raising the standard income tax deduction (currently at 380,000 Yen), or lowering the tax rates. The Tax Commission had previously focused on lowering the top marginal tax rate (current 37%) in order to unleash the productive vitality of individuals with higher incomes. (April 17, the Nihon Keizai Shimbun)

The Japan Federation of Economic Organizations (Keidanren) urged the government to increase preferential tax treatment for people who invest in start-ups, in its proposals for creating new businesses. Japan's most influential business lobby is seeking a deduction of a similar amount. It is also proposing a 5-year carry forward of losses on stock trades regarding emerging firms. Under current Japanese tax law, 75% of the profit from selling the stock of start-ups can be tax-free if the stock is sold within a year of the listing. If investors lose money on such sales, the loss is allowed to be carried forward for three years. But in Japan, trading losses can only be canceled out against the income from other stock trades. Keidanren requested the tax system to be modified to offset losses from trading the stock of emerging firms against income from other sources. According to the organization, preferential treatment has been sought just 226 times since the new tax system for investment in start-ups was created in June 1997. (April 16, the Nihon Keizai Shimbun)

Twelve large cities have jointly compiled a tax proposal to be independently implemented, including taxes on commuters from outside the cities as well as on PET bottles. The cities intend to secure funds needed to solve urban problems via the taxes, which also include charges on industrial waste and tourists. The proposal will likely serve as a model when other municipalities introduce independently imposed levies. The proposals were compiled in a two-year project by a panel's working group on local taxes, with representatives from prefectures and the 12 major cities. The tax imposed on commuters, around 3,000 Yen a year, is aimed to even out tax burdens for all beneficiaries of administrative services. The cities plan to levy the tax either on companies or individuals. The tax on PET bottles will be imposed on retailers. Revenue from the tax would earn a city of about 300,000 households about 700 millionYen a year. However, the 12 cities are cautious about an early introduction of the taxes. They are concerned that the commuter tax will overlap with the existing business tax if it is charged on companies, and that the PET bottle tax will create a price gap with neighboring municipalities. With many companies hoping for tax cuts amid the economic downturn, the Home Affairs Ministry is growing critical of an increase in new taxes imposed by local governments at their discretion. But municipalities are trying to offset a decline in corporate tax revenue due to the economic slump. The city of Osaka plans to introduce a tax on hotel guests, and the city of Kitakyushu in Fukuoka Prefecture plans a tax on industrial waste.(April 13, the Nihon Keizai Shimbun)

The government and ruling coalition parties, which are considering the quick implementation of tax breaks aimed at revitalizing the economy, are now beginning to focus on a time frame for a decision as well as tax revenue alternatives. Indeed, some in the government are seeking a decision for such tax breaks even before the Council on Economic and Fiscal Policy compiles in June its basic guidelines for tax reform. Prime Minister Koizumi's instructions for tax reform have called for the presentation of an agenda for tax reform by June, with implementation starting fiscal 2003. But a growing chorus within the ruling coalition parties is voicing its support for tax reforms as a way to bolster the economy. During a cabinet-level meeting to discuss the monthly economic report for April, Liberal Democratic Party Secretary-General Taku Yamasaki and others urged the quick implementation of tax breaks for investments and other measures included in the government's anti-deflation measures. Yasuo Fukuda, Cabinet Chief Secretary referred the tax cuts for the anti-deflationary measures. But Fukuda's comments were followed by disclaimers that excessive emphasis on tax cuts would be a problem and that the government is not in a position to clearly state to make a decision before June about tax cuts. However, the government does appear to be warming up to the idea of presenting tax cuts as an anti-deflation measure before the Council on Economic and Fiscal Policy's basic guidelines are unveiled. Private-sector members of the Council on Economic and Fiscal Policy are also calling for tax breaks within the fiscal year to promote R&D investment. Those in charge of policy in the ruling coalition parties and the council appear to agree on the need for stimulating tax cuts aimed at reinvigorating the economy. A decision to implement quick tax cuts would leave little time for pertinent bills to be passed during the current Diet session. If they are carried over into the extraordinary Diet session in the fall, the actual practice of the tax cuts is likely to begin in January 2003. Prime Minister Koizumi referred to the issue of additional anti-deflation measures. As for tax reform, Mr. Koizumi said that it would be addressed after the basic guidelines for tax reform are compiled in June. But obstacles such as finding alternative sources of revenue still need to be addressed, especially since Koizumi has pledged to cap new bond issuance at 30 trillion Yen this fiscal year. Finance Minister Shiokawa, who places importance on restoring Japan back to fiscal health, met with Chairman Takashi Imai of the Japan Federation of Economic Organizations (Keidanren) to discuss ways for covering the revenue drop that would accompany tax cuts, such as setting a policy to increase revenue in the future. (April 12, the Nihon Keizai Shimbun)

The government Tax Commission will study revising the tax system to grant companies a tax break even if their R&D spending does not increase, Commission Chairman Hiromitsu Ishi. Currently, companies are eligible for a corporate tax break only when R&D spending increases. The commission, which held a subcommittee meeting to discuss corporate-related tax reform on the same day, aims to strengthen the competitiveness of Japanese companies. Under the current system, Japanese companies that expand their R&D spending in a given year are eligible for a tax credit equivalent to 15% of the increase, when compared with outlays over the preceding two years. Once eligible, the actual tax credit is calculated by selecting the three years with the highest R&D spending out of the past five years and subtracting the average outlay for these three years from the amount spent on R&D in the most recent year. It is difficult for companies to increase R&D spending annually due to the economic downturn, and even companies that spend a large amount of money on R&D are ineligible for a tax credit if the amount of spending is smaller than that of the level seen in the previous year. In the U.S., a system under which companies are eligible for a tax break even if R&D spending does not increase was set up in 1996. According to the Ministry of Economy, Trade and Industry, private-sector R&D spending in Japan increased by only 20% in 2000 as compared to figures for 1994, while similar outlays rose by 70% in the U.S. Ishi said that the introduction of a system similar to the one in the U.S. is "possible." (April 12, the Nihon Keizai Shimbun)

LDP tax panel opposes tax cuts within current fiscal year. The Research Commission on the Tax System will not support a proposal from the coalition parties that tax cuts be implemented within this fiscal year as part of an anti-deflationary package. Some influential members of the ruling coalition have called for reductions in levies imposed on stock and land transactions, as well as cuts in inheritance and gift taxes, to spur the economy. Debate at a meeting of the LDP tax panel was dominated by criticism of the proposal. Tax cuts in our tax reform proposals should be included for next fiscal year to be released in December. A participant at the meeting suggested that the government should not change the tax system in the middle of a fiscal year. The panel also blasted tax reform proposals made by the government Council on Economic and Fiscal Policy, saying that private-sector members of the council seeking to cut specific taxes without concern for the overall framework of tax reform have overstepped their authority. (April 11, the Nihon Keizai Shimbun)

Tax Commission Chairman Hiromitsu Ishi expressed his intention to pursue a streamlining of government spending as an integral part of the government's tax reform initiative. He said at a press conference after a hearing that he would like to urge the Council on Economic and Fiscal Policy to lay out a clear direction on expenditure reform, including national tax revenues reallocated to local governments and gasoline tax now earmarked exclusively for road construction and maintenance. The hearing, the third in a series of meetings with local taxpayers around Japan sponsored by the government's Tax Commission, was held in Obihiro, Hokkaido. At the meeting, a number of participants requested that the government cut wasteful spending before asking taxpayers to shoulder a bigger burden. One member pointed out that legislators with ties to special interests are behind subsidies from the government and the waste is tremendous. Another participant said that if some real energy is put into administrative reform, there should be no need to raise taxes. Opinion appeared to be equally divided on a government proposal to expand the tax base by shrinking spousal deductions and other income deductions. Ishi stressed the need to consider a wider poll of public opinion on tax reform issues. Males middle-aged and older mainly represented the audience in Obihiro. (April 8, the Nihon Keizai Shimbun)

Aiming to inject renewed vitality into the Japanese economy and raise business competitiveness, the Ministry of Economy, Trade and Industry (METI) is poised to launch a plan for new tax incentives designed to jump-start business creation. METI convened a special study panel focused on taxation and economic revitalization, with several members calling for tax system revisions to support business creation. One of the key proposals being floated is to create a special incentive to allow "angel investors" to deduct a certain percentage of the investments they make in start-up companies. Another idea under consideration is to broaden a tax break that permits new companies to carry forward accumulated losses for tax purposes. METI's initiative comes in response to evidence that business creation is stagnating in Japan, weakening the process of regeneration that is necessary to a vibrant economy. In one disturbing sign, statistics suggest that Japan is losing businesses faster than it creates new ones. Newly created business as a percentage of total businesses reached only 3.5% in the 1996-99 period, well below the 5.6% figure for failed businesses as a percentage of total businesses. Under the current tax system, angel investors, who are individuals who provide start-up capital to fledgling entrepreneurial companies, are allowed to exclude from taxable gains 75% of any capital gains earned when the firms they support are taken public. Practically this break is not functioning as an incentive, largely because relatively few start-ups are able to go public quickly. Angel investors are also allowed to use capital losses incurred in selling investment stakes in start-ups to offset capital gains on other stocks. But the problem is that investors must have capital gains in the first place to take advantage of this break. According to METI, only 226 investors filed for angel tax breaks from 1997 through the end of March, compared with an annual figure of about 45,000 for a similar system of incentives in the U.K. METI also wants to expand an existing tax break that allows specially designated small and midsize businesses to carry forward accumulated losses for seven years. The rules for eligibility are restrictive, requiring new businesses to show that their research and development is innovative. (April 6, the Nihon Keizai Shimbun)

The government's Tax Commission agreed to consider shrinking a spousal tax deduction originally designed to lighten the tax burden of households in which the husband works and the wife stays at home as a full-time homemaker. The idea of the overhaul is to make an adjustment to incentives so that the overall tax system is not affected by a wife's decision whether to join the work force or not. However, calls are expected to emerge to pair the adjustment with a cut in the income tax rate, since deduction shrinkage alone would raise the tax burden of households supported by a full-time housewife. A basic principle of income taxation in postwar Japan is that taxes are levied at the individual level, not at the household level. In actual practice, the current tax system also features a range of deductions in household income that takes into account the number of family dependents and other factors that affect the ability of a family unit to handle its tax burden. The spousal deduction is a classic example of one of these household deductions. It is actually two-tiered, with a standard deduction of 380,000 Yen for a spouse whose annual income is 1.03 million Yen or less. An additional special deduction of up to 380,000 Yen is given those earning from 1.03 million Yen to 1.41 million Yen, with the amount of the deduction decreasing as the income level rises. No such deductions are available for spouses with an annual income exceeding 1.41 million Yen. Those with no income or who earn 700,000 Yen or less are entitled to a total deduction of 760,000 Yen. The deductions are applied to the husband's income. Criticism has been mounting that the system works to reduce the incentives of women to work, making housewives with part-time jobs, loathe working more than a certain number of hours. The consensus at a commission panel meeting was that reducing the spousal deduction would encourage women to enter the work force by eliminating the discrepancies between the tax treatment of workingwomen and full-time housewives. According to a calculation by the Ministry of Finance, eliminating both tiers of the spousal deduction would generate an increase in tax revenue of more than 1 trillion Yen. (April 3, the Nihon Keizai Shimbun)

The coalition parties proposed a series of tax and other measures, including a plan to set up land-buying funds, as part of their antideflation package. Among the major proposals, policymakers proposed the establishment of urban revitalization funds that could be used to purchase unused land plots. The new antideflation measures follow similar policy packages announced by the government in late February. The three parties proposed drastic tax reforms, urging the government to consider implementing them this fiscal year in areas most likely to help revitalize the economy. The policy leaders also agreed to set up a project team to discuss a price target and a broadening of the functions of Banks' Shareholding Purchase Corp. The package includes tax measures intended to promote corporate investment in research, development and environment projects. (April 3, the Japan Times)

Government Council members discuss funding for tax cuts. Finance Minister Shiokawa emphasized the need for both tax cuts to spur the economy and steps to make up any resulting revenue shortfall in meeting with the council on Economic and Fiscal Policy covering tax reform. Minister Takenaka for economic and fiscal policy said that no one would say tax cuts should come first and funding be considered later. Takenaka went on to suggest that revenue be generated by means of expenditure cuts, administrative reform and the use of idle state assets. Hiroshi Okuda, a private-sector member of the council, also emphasized the importance of reducing expenditure as a means of securing revenue in order to afford tax cuts. Jiro Ushio, a council member, said that emergency measures should be taken to revitalize the economy, with tax increases becoming possible when economic growth is running at 4-5%. Also participating in the meeting was Hiromitsu Ishi, chairman of the government Tax Commission, who expressed approval of the direction of proposed changes to the tax system. Council chief Prime Minister Koizumi said that different views and opinions are acceptable. Continuing discussions will naturally lead to agreement (on the proper course of action)." (April 3, the Nihon Keizai Shimbun)