TAX NEWS - 2010

Japan Tax: Is Japan ready to pay?

Prime Minister Naoto Kan's proposals on tax reform didn't come out of thin air.

He got advice from an economics professor who champions the Swedish example of a very high tax burden in exchange for social security benefits that allow retirees to live comfortably.

Sweden's consumption tax rate is 25 percent overall. A 12-percent tax is levied on foodstuffs.

Kan, who at the time was deputy prime minister with the Finance Ministry portfolio, convened a meeting May 17 with Naohiko Jinno, a professor emeritus of economics at the University of Tokyo.

Also present were Yoshito Sengoku, then state minister in charge of national policy and now chief Cabinet secretary, and Kazuhiro Haraguchi, minister of internal affairs and communications.

The meeting was held in Tokyo's administrative heartland of Kasumigasaki. As the key member of the government's Tax Commission, Jinno explained the direction he thought Japan should take to address its fiscal woes and create a solid social security net.

"Here's why I think we need to impose a heavier tax burden," Jinno said. "It would create a solid welfare system and a strong economy. Those two points will ensure that domestic consumption remains strong as people will be able to spend."

His proposal reflected the experience of the Swedish model coupled with his own ideas.

Kan, Sengoku and Hara-guchi listened intently as Jinno outlined a radical restructuring of Japan's tax system. "It's a good idea," Sengoku said. Kan bowed his head in assent.

Two weeks later, Yukio Hatoyama abruptly resigned as prime minister. Kan immediately threw his hat into the ring for the election for a new president of the ruling Democratic Party of Japan.

In a news conference held to express his candidacy, Kan said, "I plan to achieve a strong economy, strong public finances and a strong social security system all acting in tandem."

Kan clearly borrowed part of Jinno's explanation to make this public pledge.

Economic theory, according to Kan, centers on the following: Japan has no time to waste in implementing fiscal reconstruction. To do that, tax increases are indispensable. But simply raising taxes will cool the economy. If the government uses the additional tax revenue to fund improved social security programs, gloom about the future will evaporate, and, as a result, people will start spending again. Based on this idea, if the government pumps money into medical services and nursing care, areas where demand is expected to grow sharply due to the aging population, economic growth will follow.

As a first step, Kan is leaning toward raising the consumption tax rate, now at 5 percent.

In a news conference held to announce DPJ's manifesto for the Upper House election, Kan hinted at doubling the rate, saying the 10 percent proposed by the main opposition Liberal Democratic Party was "a reference material."

Kan previously had been wary about raising the consumption tax rate because it would be an unpopular move. However, he had a change of heart after attending Group of Seven meetings of finance ministers and central bank governors in Canada in February, according to senior Finance Ministry officials.

It was at the gathering, the officials said, that Kan realized the seriousness of the fiscal crisis in Greece and its ramifications for the global economy. He then began to think about Japan's fiscal ills in light of the Greek situation. He became alarmed.

Kan also began marshalling his thoughts on tax reform during the chaotic period that preceded compilation of the 2010 budget plan under his predecessor, Hatoyama, said another source.

"There was a lot of confusion late last year about how to secure financial resources for child allowances. At that time, Kan felt a growing sense of crisis that it was impossible (without tax increase)," the source said.

Tax increases, for obvious reasons, are not undertaken lightly. Squeezing working people too tightly can be perilous for a government.

Kan was originally weak on economic issues.

However, he put his faith in the likes of Jinno and Yoshiyasu Ono, director of the Institute of Social and Economic Research (ISER) of Osaka University.

They provided the "wisdom" that tax increases and economic growth can co-exist, sources said.

The government has yet to decide on which course to take. One would require people to shoulder a higher financial burden in exchange for improved social welfare programs. The other is a course that offers social welfare programs that are lacking but which do not oblige people to shoulder a high financial burden.

Among developed nations, Japan's welfare programs are rated as mid-level. The problem is that tax revenue does not cover the costs for those programs. As a result, the government's fiscal deficits are rising.

"Japan should move toward a welfare society (where the people's financial burden is high)," Jinno said, citing Sweden's example.

Kan knows that tax increases could plunge Japan back into recession if the government errs in implementing the new policies.

That, in a nutshell, is Ono's economic theory. If people keep a tight hold on their pocketbooks, consumption drops and the economy falls into recession. Thus, the government should use any new tax revenue to create jobs.

Ono is against using the money for public works projects. Instead, he favors "meaningful jobs" in the "fields that heighten the quality of people's lives."

Other scholars and economists were dismissive of the advice Kan is getting.

As for Ono's theory, one said, "Is the condition that the government is infallible and does not make mistakes in its use of tax money really met?"

Wataru Suzuki, a professor of economics at Gakushuin University, cast doubts on the idea of using medical services and nursing care to stimulate the economy.

In the case of social security, once the government increases expenditures for those fields, it will be difficult for the government to decrease the services even if the economic situation improves.

Public involvement in social security is huge. Can such a field really become a "growing field"?

In Japan, about 40 percent of medical services and about 60 percent of nursing care services are covered with public funds.

Major fees are decided by the government.

There is little room for new players, such as private companies, to make inroads into the market and make profits with their ideas. Because of that, the field lacks "attractiveness as an industry" that promote investments, Suzuki said.