Tax

January 2003

The revised medium-term reform outlook issued by the Council on Economic and Fiscal Policy (CEFP) highlights the fiscal and economic impasse. The reform outline, which maps out economic and fiscal management over the next five years, pushes back several key targets. The target dates for both bringing deflation under control and achieving stable economic growth have been delayed by at least two years. With efforts to restrain government spending making little progress, the CEFP also concedes that new government bond issuance will top 40 trillion yen in fiscal 2004 and beyond. Meanwhile, the idea of raising the nation's consumption tax is now on the table. With economic and fiscal policy hobbled, the tangible impact of structural reform has yet to emerge. A closer look at some of the problem areas follows. Finance Minister Shiokawa used the metaphor of drug addiction to stress the importance of breaking free of a dependence on government bond issuance in managing fiscal policy. But the road to fiscal health will be rough going. Mired in a protracted economic slump, Japan now faces chronic tax revenue shortfalls. At the start of the year, Shiokawa touched on the necessity of correcting an imbalance between direct and indirect taxation, dropping a not-so-subtle hint at the possibility of a consumption tax hike. The fact that Shiokawa would take this step reflects an admission that no substantial recovery in tax revenue can be expected. The original medium-term reform blueprint last year, assumed a 1 percentage point hike in the consumption tax. Even so, the revised version projects that government bond issuance will increase much more than forecast in January 2002, assuming that annual issuance of more than 40 trillion yen will become the norm. The problem is that the reform of government expenditures, which by all rights should be tackled before taxes are raised, is proceeding at a snail's pace. Although the CEFP has pushed for priority budgetary allocations in urban redevelopment and other areas expected to have a wider economic impact, the old vertical barriers dividing the various ministries and agencies are proving resistant to change. The government had originally forecast a return of stable economic growth in fiscal 2004, with nominal growth of at least 2.5% and real growth of at least 1.5%. But the Cabinet Office's latest provisional forecast, which serves as the baseline for the CEFP's revised reform outline, now calls for nominal growth of only 0.8% and real growth of only 0.9% in fiscal 2004. The nominal growth figure is particularly weak, largely because the government has failed to tame deflationary pressures so far. The effort to accelerate the cleanup of nonperforming loans in the banking system appears to be letting up, while a deregulation initiative aimed at unleashing private-sector demand lags. Moreover, the impact of anti-deflation policies now on the table remains unclear. In fact, the only fresh note in the revised reform blueprint is a strong call for the Bank of Japan to take additional monetary steps to combat deflation. If nominal economic growth rates are not raised by eradicating deflation, neither consumer nor business sentiment will improve significantly, if at all. The Cabinet Office's latest forecast puts the economy on a sustained growth track starting in fiscal 2006, but the foundation for this prediction remains shaky. (January 21, the Nihon Keizai Shimbun)

The Tax Commission began tax reform discussions recently that will last throughout the year, with the aim of hammering out plans for fiscal 2004 pension system reform. The tax panel's intention to take up the unpopular topic is due in part to the growing acceptance of the idea among business leaders, who believe a higher consumption tax is unavoidable to support the national pension system amid a falling birth rate. But the ruling coalition sees the issue of a consumption tax hike as an optimum political tool. They are forcing the tax panel to consider the matter putting pressure on Prime Minister Koizumi. Alarmed by the underlying intentions of ruling coalition lawmakers, the Ministry of Finance hopes to discuss a consumption tax hike as part of a major pension system overhaul. The Ministry of Health, Labor and Welfare plans to finalize proposals on pension reform this autumn, with the aim of submitting the pertinent legislation to the ordinary Diet session next year. The government must come up with ways to finance the reform by fall this year. The key element of the upcoming pension reform is the introduction of an upper limit on future pension premiums that will determine future pension payments. According to a test calculation by the Welfare Ministry, if pension premiums for salaried workers are capped at 20% of annual income, benefit payouts would be reduced by 12% from the current level in 30 years, even if the government's share of the public pension programs is raised to one-half from the current one-third. Many in the ruling coalition are strongly opposed to lowering pension benefits, and the Tax Commission has yet to discuss how the 2.7 trillion yen increase in the government's contribution will be financed. (January 18, the Nihon Keizai Shimbun)

The government plans to offer tax breaks to banks that agree to help revive companies in cooperation with the Industrial Revitalization Corp., to be established this spring. The plan aims to accelerate bad-loan disposals by giving banks tax-deductible write-offs of loans sold to the revitalization entity and simplify the write-off procedures. The corporation will purchase loans extended to struggling companies from lenders other than major banks, and team up with the banks to help the firms rehabilitate. However, some banks complain that there is little advantage in selling loans to the revitalization body. Specifically, the government will grant tax-deductible write-offs to non-major banks when they sell loans extended to companies, breaks also granted to major banks that work with the revitalization body to help rehabilitate companies through debt waivers. The government will not require banks to obtain permission from the National Tax Administration when they use tax-deductible write-offs. Financial institutions are allowed to take advantage of these write-offs when corporate borrowers are liquidated through legal proceedings, or when the National Tax Administration approves debt waivers, procedures that usually take two to three months. (January 17，the Nihon Keizai Shimbun)

Some 55 companies will consider paying taxes under the consolidated taxation system if the current tax surcharge is eliminated, according to the latest survey by the Nihon Keizai Shimbun. The consolidated taxation system is presumed to assist in corporate restructuring efforts, allowing a corporate group to offset profits and losses of the parent company and wholly owned domestic subsidiaries in paying taxes. The government decided to levy a 2% tax surcharge for two years to prevent sharp drop of tax revenues. That has deterred many companies from using the new tax system. Only seven of the companies polled said that they will pay taxes under the consolidated system, such as Itochu Corp., All Nippon Airways Co., Taisei Corp., Hitachi Ltd., Marubeni Corp. and Mitsubishi Chemical Corp. A total of 11 firms, such as Sony Corp., Toshiba Corp., Japan Airlines System Corp. and Kobe Steel Ltd. will do so from fiscal 2003. 16 will not do consolidated taxation, if the surcharge is abolished. (January 6, the Nihon Keizai Shimbun)

The Japan Business Federation (Nippon Keidanren) has drafted economic reform proposals to increase 1 point annual consumption tax from fiscal 2004. Japan's most influential business lobby argues that the proposed tax hike is necessary to finance the increasing costs of pension benefits and health care. Concerning consumption tax, Keidanren's report argues that the rate should be gradually increased every year until it reaches 16% in 2014. The government must keep security benefits and increase the consumption tax in order to ensure viability of programs and vitality of the economy. The report estimates that if the birthrate continues to decline at the current pace, social security costs and taxes that individuals have to pay will rise to as much as 57% of their personal income, up from the current 38%. Keidanren claims taxation and other levies could be limited to 47.2% of income if its proposals are implemented. Prime Minister Koizumi expressed no intention to raise the consumption tax while he is in office. But Keidanren Chairman Hiroshi Okuda says that other comments the prime minister has made about the consumption tax suggests he has not entirely ruled out a hike, indicating a tax increase could take place by the end of fiscal 2004. Another of Keidanren's proposals calls on the government to devise concrete measures to admit more foreign workers. The report points out that since the working population is projected to decrease by 6.1 million by 2025, a dwindling number of workers will be forced to bear the increased burden of social security costs, which it argues would dampen demand and slow the economy. There will continue to be excess labor for a while as the unemployment rate rises, but the long-term trend points to a shortage, according to Okuda. The first thing to do is create an environment that makes it easy for women and senior citizens to work. But since even that is unlikely to sufficiently finance the growing costs of health care and pensions, measures should be taken to admit more foreign workers, allowing some of them to reside in Japan permanently. The report also states that Keidanren plans to draw up guidelines by which to assess the policies and achievements of both the ruling and opposition political parties. Such assessments will be used when Keidanren decides whether to donate funds to parties or politicians. Although the report does not say that Keidanren will collect political donations from companies and distribute them as it did in the past, the group is expected to begin playing a role in political fund-raising for the first time in 10 years. It is quite possible that politicians will score high in the assessment if they call for an increase in the consumption tax (in line with Keidanren's proposal). The amount of donations individual politicians receive might depend on how much they work to help turn the group's vision into reality. (January 1, the Nihon Keizai Shimbun)