TAX NEWS - JUNE 2010

Japan Tax: DPJ faces serious intraparty differences over consumption tax hike

Tough battle on fiscal changes

05 June 2010 -- With Naoto Kan elected the next prime minister and president of the ruling Democratic Party of Japan on Friday, the likelihood has increased that the Democratic Party of Japan will include a hike in the consumption tax rate in its manifesto for the upcoming House of Councillors election.

However, a number of DPJ lawmakers--particularly outgoing Secretary General Ichiro Ozawa--oppose a tax increase. As a result, reaching consensus on the issue within the party is expected to be very difficult.

Kan named fiscal reconstruction as one of his key objectives when he became finance minister under Prime Minister Yukio Hatoyama. As one measure, he aimed to cap issuance of government bonds, which has swollen to a record 44.3 trillion yen in the initial fiscal 2010 budget.

"As tax revenues dropped sharply after the 'Lehman shock,' we were unable to cut wasteful [government] spending as quickly as we hoped," Kan told reporters Thursday evening.

By saying this, he acknowledged that the prediction made in the party's manifesto for the House of Representatives election last summer--that the financial resources for realizing its key policy pledges could be secured by chopping wasteful spending--was too rosy.

Kan said he could rectify the current course whereby the government's debts would only rise by increasing the issuance of government bonds.

The prevalent belief in the party is apparently that "Kan has shown his determination to tackle revenue reform, including of the consumption tax, as [the next] prime minister," in the words of a midranking Democratic Party of Japan member.

Kan initially was not so keen on raising the consumption tax rate. After he became finance minister in January, however, he acquired experience in economic matters by attending international conferences, including one concerning Greece's sovereign debt crisis. He thereby deepened his understanding of the need for fiscal reconstruction and a higher consumption tax rate, according to a senior Finance Ministry official.

In February, Kan effectively changed his stance on the consumption tax by expressing his intention to move up discussion on the issue. Earlier Kan had said the issue should be discussed "in fiscal 2011 or later."

In May, Kan proposed holding down the new issuance of government bonds for fiscal 2011 to no more than 44.3 trillion yen.

Should this happen, it would be difficult for the DPJ-led coalition government to realize all the DPJ policies, including the provision of child-rearing allowances, touted in its manifesto. This could lead to opposition within the party, particularly among upper house members whose current six-year terms expire in July.

Of those in favor of pursuing fiscal reconstruction, many are lawmakers who distanced themselves from Ozawa and supported Kan's becoming party leader. They include Yoshito Sengoku, state minister in charge of national policy, and Koichiro Genba, chairman of the lower house Financial Affairs Committee.

Ozawa's standpoint is: "The first thing we must do is end wasteful spending."

Some believe these different standpoints on fiscal reconstruction may lead to conflict between "pro-Ozawa" and "anti-Ozawa" forces inside the party.

The DPJ plans to finalize its manifesto for the upper house election early next week. It is likely the party will have to make a difficult decision as to whether it should prioritize intraparty harmony and put a lid on discussions of a tax hike, or modify the manifesto and come up with a plan to raise the consumption tax.