TAX NEWS - June 2010

Kan Plans May Require $76 Billion Japan Tax Increase

Japanese Prime Minister Naoto Kan may have to raise taxes by as much as 7 trillion yen ($76 billion) to fulfill his pledge to cap bond sales in coming years, according to an independent adviser to the government.

Kan has committed to holding new bond sales to 44.3 trillion yen through the year to March 2012. At the same time, his administration is considering an annual public-spending limit of 71 trillion yen over the coming three years, according to two government officials familiar with the deliberations.

"The two targets are inconsistent," Toshiki Tomita, who has advised the government on a midterm fiscal plan that is scheduled for release this month, said in an interview today in Tokyo. "There would be a gap between revenue and spending of 6 or 7 trillion yen."

The shortfall underscores the challenge for Kan as he seeks to contain the world's largest public debt and end what he calls Japan's "unsustainable" dependency on borrowing. Standard & Poor's and Moody's Investors Service have said they will closely watch the budget strategy as Europe's fiscal woes increase global scrutiny of sovereign debt.

"It seems the government is going to make a tough target," said Kiichi Murashima, chief economist at Citigroup Global Markets Japan Inc. in Tokyo. "We need to keep an eye on their level of commitment to this and how successful they will be."

Media including the Mainichi and Nikkei newspapers had previously reported the proposed spending ceiling.

The Ministry of Finance declined to comment on the fiscal plan prior to its release.


Sales Tax

Kan, as finance minister under predecessor Yukio Hatoyama, urged the government to contemplate an increase in the country's sales tax as part of efforts to restore fiscal health. He replaced Hatoyama as premier this month.

A 1 percentage point increase in the sales tax would generate revenue of about 2.5 trillion yen, according to the ministry. That means an increase in the tax to 8 percent from the current 5 percent would plug the 7 trillion yen hole.

Tomita, who is a member of the government's Fiscal Policy Committee, said Japan could raise taxes to fill the gap, though any increase in the next fiscal year would be "challenging." Further spending cuts may also be tough as the country faces increasing costs such as for social welfare, he said.


Difficult Task

"The more seriously I think about it, the more difficult I think it will be," said Tomita, 62, an economics professor at Chuo University in Tokyo. Unless taxes increase, "bond sales could end up at around 50 trillion yen," he said.

Newly appointed Finance Minister Yoshihiko Noda said as deputy finance chief last month that Japan is "lucky" bond yields have stayed around 1.3 percent. Borrowing costs could jump "if we let our guard down," he said in an interview on May 13. Japan's 10-year bond yielded 1.235 percent today.

A key government tax panel may underscore the need to raise taxes in recommendations this month, the Asahi newspaper reported today, without saying where it got the information. The proposal doesn't say when or by how much the sales levy should increase, the report said. The group will also propose increasing the maximum income tax rate, the newspaper said.

Should policy makers delay raising the sales tax, an increase to as high as even 20 percent in the longer run will be insufficient to restore fiscal health, Asahi said, citing an unidentified Finance Ministry official. The International Monetary Fund said last month that the tax may need to climb to 22 percent if the government doesn't rein in spending.


Voter Support

Voters are growing open to the possibility of a higher consumption tax as Japan's coffers become more strained. A Nikkei newspaper survey taken in May showed that 49 percent of respondents opposed Hatoyama's plan to delay raising the levy.

Any multiyear pledge to cap spending would be the first since 2006, when then-Prime Minister Junichiro Koizumi announced a target of balancing the budget in five years.

The fiscal plan will include a goal of eliminating the primary budget deficit by 2020, the two officials said. The shortfall, which excludes interest payments on bonds, is 7.1 percent of gross domestic product, or 33.5 trillion yen, for the year ending March 31, the Cabinet Office estimates.

Tomita said the primary-balance goal "won't be enough to reduce outstanding debt" because of expenditure such as debt- servicing costs, and a 4 percent surplus is required.

National Strategy Minister Satoshi Arai said last week that the fiscal plans "need to keep a pay-as-you-go principle," and will be based on Kan's pledge to limit new bond sales.

This year's budget was compiled using 10 trillion yen of funds from special accounts, and it's hard to expect Kan to secure the same amount from those sources next year, said Tomita, who is a senior independent fellow at an institute that provides policy research for the Finance Ministry.

"If we rely on hidden money or just manipulating figures within the account, it's possible we will be seen as another Greece," he said.