TAX NEWS - 2010

Japan Tax: Consumption tax rate is gathering attention

As the main combatants in the Upper House election stress the need to increase the consumption tax rate to solve Japan's debt woes, doubts are rising over whether the measure will be enough.

Soaring social security costs, coupled with stagnant economic growth, could render the expected tax hike impotent in putting Japan on solid fiscal footing.

Some experts already say it would be wrong to think that a tax increase alone will serve as a cure-all for the nation's ills.

"As fiscal reconstruction measures go, only the consumption tax rate is gathering attention," said Yasunari Ueno, chief market economist at Mizuho Securities Co. "More deep policy discussions are necessary."

Indeed, the consumption tax rate has become the key topic in campaigns for the July 11 Upper House election.

Both the ruling Democratic Party of Japan and the Liberal Democratic Party, the largest opposition party, are in favor of raising the tax rate. They are generally battling for recognition as the more responsible party that can prevent Japan from following Greece's path to fiscal disaster.

The LDP pledged to raise the tax rate from the current 5 percent to 10 percent as a tentative measure. Prime Minister Naoto Kan, the DPJ president, said his government will use the LDP's 10-percent proposal as reference material.

Other opposition parties are calling for a consumption tax hike, a topic that had been avoided recently until Japan's debt--now at 862 trillion yen, or 181 percent of gross domestic product--became too big to ignore.

The Sunrise Party of Japan is proposing a tax rate of 8 percent in fiscal 2012. The New Renaissance Party says the rate should be increased to at least 10 percent around 2020, with certain preconditions.

New Komeito is urging drastic reforms of the tax system, including the consumption tax rate.

But the Japanese Communist Party, the Social Democratic Party and even the DPJ's junior coalition partner, the People's New Party (PNP), are opposed to a tax hike.

Your Party is advocating fiscal reconstruction without raising the consumption tax rate.

One big problem facing the country is social security, the cost of which is rising by about 1 trillion yen (about $11.2 billion) every year as the population ages and the birthrate declines.

This fiscal year, social security costs will total 27.3 trillion yen, or about 30 percent of the general account of the government's budget.

Consumption tax revenue has already been used for health care, public pension programs and nursing care. However, the amount spent is only 6.8 trillion yen.

"The consumption tax revenue used for social security costs is insufficient, so the government has been covering the shortage with deficit-financing bonds," Kan warned.

Kan's apparent thinking is that increased revenue from a higher consumption tax rate would cover part of the shortage and reduce the issuance of new government bonds.

The LDP has similar ideas on using the increased tax revenue.

But the LDP's calculations show that the primary budget balance would still fall 1.9 trillion yen into the red in fiscal 2020 even if the tax rate is raised to 10 percent and personnel costs of the central and local governments are slashed by 20 percent, both in fiscal 2011.

"It will be necessary to raise the consumption tax rate to around 20 percent," a senior Finance Ministry official said.

Political parties advocating a consumption tax rate hike are banking on high economic growth to bring in more tax revenue for social security costs.

The DPJ is targeting an annual nominal economic growth rate of 3 percent to fiscal 2020.

The LDP's growth target is 4 percent over the next three years, while the PNP has gone as high as 5 percent.

Ueno of Mizuho Securities said these forecasts are far-fetched.

"In the past 10 years, even a growth rate of 2 percent has not been achieved. Therefore, a growth rate of 3 to 5 percent is unrealistic," he said.