Japan’s Struggle for Tax Reform


Japan has struggled to find a satisfactory tax code for several decades but with little success.
The problem for governments is to find a tax system that helps the economy and at the same time raises enough revenue to support government program spending. Ishi argues that: “Since 1985, the question of tax reform has become the most important political issue for the general public.” (Ishi, 1989, 277) It would appear that the dream of perpetual economic growth for Japan has come to an end. Japan placed a heavy accent on mass production after the War and in today’s economic climate, its costs of production and a high priced Yen are making production in Japan expensive. Accordingly, governments now need to look towards alternative taxation policies in order to raise funding for an ailing economy. The purpose of this essay is to review the causes of taxation reform problem and to argue that Japan needs to restructure its tax system in order to improve both its revenue raising mechanisms and spending mechanisms and thereby influence the direction of its economy and at the same time improve the welfare of its people.

The problem facing any Japanese government is that tax reform is needed to raise revenue into the Treasury but at the same time it is needed as a means of revving up domestic demand in the economy. This has proved to be a very difficult task as several consecutive governments have discovered. Chairman of the Tax Commission, Kato Hiroshi, in an interview in 1994, suggested that; “The way things are going, Japan will soon find itself in a swamp.” (Hiroshi, 1994, 39) The consensus seems to be that changes in fiscal policy are the way to go and that the right mix of revenue raising and government spending will bring improvement. This approach, however, could spell continual and worsening problems if the effect upon the very structure of the Japanese economy is not considered. As Hiroshi points out; “... simply spreading some money around doesn’t translate into a reform of Japan’s structure.” (Hiroshi, p.37) Fiscal policy reform in the guise of tax reform, needs to address social need as well as the need for economic growth. It is juggling these imperatives in the context of political expediency which is causing Japan’s stress.

Japan’s fiscal problems have come about because of a decline in the private sector and manufacturing. In 1994, Jonathan Friedland reports that the profits of Japans top 142 top companies had fallen by 43.6% in the first quarter and industrial production had fallen by 13.9%. Unemployment had risen to 3% and the inability of businesses to pay interest on their loans has led to Y13.7 trillion in non performing loans. (Friedland, p.56) Japan’s domestic consumption does not make up a significant proportion of it's GDP and it’s economy is further frustrated by other emerging Asian and South East Asian countries competing for mass production markets. It's like the country has stagnated in its dependency on mass production and is unable to successfully move into a new phase of economic leadership. Even America, once a great dumping ground for Japanese products, is reclaiming ground in technological areas of production and moving away from its high dependency of Japanese products. (Japan Echo p. 32)

Still, Japan has suffered because it has failed to pace with the changes in the international market. Since the 1973 oil crisis, Japan has been experiencing changes to its economy and has been slow to find a way to make appropriate adjustments. In some ways, it has been a matter of attitude or approach as much as international demand. Kawamoto Nobuhiko, President of Honda Motor, in an interview in 1994 said that Japanese car makers have had their sights set on matching the quality of Mercedes-Benz but in Japan “...[t]here is no connection between potential car performance and the conditions of actual use. ...One has to wonder whether we really need more cars now that they have proliferated to the point where there is one car for every two Japanese.” (Japan Echo, Spring 1994, p.33) The economic growth rate has slowed but at the same time its trade surplus has grown: Now more than US$140 bil. world wide, reflecting a low level of domestic investment relative to savings. This is itself is a real problem as it drains capital and capital flow from the national economy. As Nakatan Iwao points out: “If more money was channelled into infrastructure at home and less into the acquisition of assets overseas, the quality of life would improve even as the surplus came down.” (Japan Echo, Spring 1994 p.33)

With the changes in the world economy and a need to improve domestic infrastructure and induce more domestic spending, Japan has moved into a period where it needs government intervention and a government led recovery to its economic and structural problems. This means a focus on domestic fiscal policies and, consequently, reform to tax policy. While there might be less money in the economy, the political reality is that there is less money in the Treasury. Japan’s current budget is about Y70 trillion, but its government debt is running at about Y200 trillion. To stimulate the domestic economy through fiscal policy, that is through changes in spending and revenue procedures rather than through monetary policy, means increasing consumer spending power. This can be done through providing more money in the economy through reducing taxes or increasing public works spending and welfare spending. But increased spending in reliant upon increased revenue or taxes. How then can a country spend without taxation, and without increasing the national debt? Here then is the basis of Japans fiscal gymnastics. As Friedland points out; “...consensus on where to go from here is clouded by the conflict between jump-starting the economy now and laying the groundwork for a fiscal sensible future.” (Friedland, Give and Take, p.82)

The economic problems of the country have made tax reform a political necessity but at the same time it is a political minefield. Trying to convince an electorate that raising taxes is a good idea is demonstrated well in the increase in the consumption tax levy from 3% to 7% by Prime Minister Morihiro Hosokawa in February, 1994. The problem for his Government was that with an election due later that year, the people would want to hear a message of tax cut and reduced government spending and debt, but the reality was the Government needed more revenue in order to give the economy its badly needed financial stimulus.

On February 2, 1994 the leaders of the 7 Parties, which made up the Coalition Government led by Morihiro, met and discussed fiscal issues. Having reached an agreement, and knowing of the fuss the media were making of the tax issue, Morihiro held a 1:00 AM press conference ( before the 2:00AM press deadline) to announce the creation of a “national welfare tax”, a change of name for the consumption tax, with a hick to 7%. (Hiroshi, p.33)

The next few days were to see violent reaction and agitation among the 7 Coalition Parties. Public opinion moved against the proposal. People didn’t appreciate the change of name for an old tax, nor did they like the size of the proposed increase. Yet, it would seem people were just as concerned about the revenue was to be used. (Hiroshi, p.34) With an inability to show a united and well presented and thought-out package, the government appeared inept. They quickly retreated to a safer political position and a compromise. The country would get tax cuts amounting to some Y6 trillion for 1 year only, and another bust of government spending of Y9 trillion. After the year, the government proposed to consider the consumption tax proposal again along with the issuance of more government bonds. In the end very little was achieved. (Friedland, Hosokawa’s Horse Trade, p.56)

While tax policy changes are unsavoury for any government in any country, the problems of acceptable tax reform are made worse in Japan by the political and bureaucratic factions within the government structure itself. Hiroshi points out that the problems of consensus of policy, or the lack of it, arise because of conflict between national and local tax authorities. The situation is compounded by a conflict of personalities. On the one hand, he tells us, was the Ministry of Finance with its lead player, Saito, Administrative Vice-Minister, and his ally Ozawa of the Japan Renewal Party and on the other hand was the Ministry of Home Affairs with its lead player Takemura, Chief Cabinet Secretary. The conflict in the bureaucracy over the Hosokawa “welfare tax” was caused because the Ministry of Finance didn’t consult with the Ministry of Home Affairs before the announcement of the 7% tax rate. (Hiroshi, p.34) Tax policy reform is as much to do with administrative co-operation as it is to do with electorate acceptance.

Give historical overview
Japan needs to revive its economy with a quick fix; and one that will comply with the demands of a balanced budget. But its economic, and indeed, its taxation problems are essentially structural problems that have grown over the years to cause the polarisation of opinions and interests that now exist.

“An Outline of Japanese Taxes, 1993” explains that for more than 30 years after World War II the taxation system was influenced by the United States early intervention and economic reconstruction, especially the work done by Professor Carl Shoup. From 1950 - 1969, Japan was marked by economic growth and from 1970 there has been an accent on improving national welfare and infrastructure. The Outline says:

In order to fulfil the urgent tasks of correcting various distortions in the Japanese economy, such as environmental pollution, and of improving the quality of life of the people, the economy is required to shift from one spearheaded, as in the past, by investment in the private sector to one led by public finance. (An Outline of Japanese Taxes, 1993 p.4)

The oil crisis of 1973 was to become significant in the history of tax reform because it clearly revealed just how vulnerable the country was to international trade fluctuations and how poorly structured its own domestic economy had become. The government responded by increased spending and finance injection programs but to raise the revenue deficit-financing bonds were created. The Outline of Japanese Taxes explains that; “Tax revenue did not recover from this stagnation and the ration of bond issues to total expenditure in the national budget continued to be extraordinarily high since 1975, reaching 34.7% in FY 1989. (An Outline of Japanese Taxes, 1993 p.13) By 1994 the bond debt had risen to some Y60 trillion. This heavy reliance on borrowing coupled with poor revenue raising mechanism (taxes) has led to cry for a balanced budget. ( Ishu p. 272)

As early as 1979 there were suggestions that Japan should move away from its dependence upon direct taxes, mainly income tax, and move towards the introduction of indirect taxes, or a consumption tax as evidenced across Europe. But right from the start the proposal has been met with heavy resistance. Ishi argues that this resistance arose for two main reasons: Small traders feared that this new tax would force them to reveal all their transactions to the Tax office, and second, there was much popular protest over inequitable tax burdens and wasteful use of government expenditures. ( Ishu p. 273)

Tax reform was inevitable and a consumption remained on the agenda. it would take another 9 years, however, before a consumption tax was to be introduced under Prime Minister Takeshita. The tax was railroaded into law with something like 80% of the population opposing it. Again, the Government faced elections some few months later and again it suffered. Takeshita had tried to run on the examples being set by Thatcher and Reagan to reform taxation but his problem was that the country believed that the changes were not significant and that the tax system itself was unfair and needed overhauling. “The Takeshita reforms ... expand[ed] the tax base while leaving nearly all the loopholes in place.” says Nagaharu. He maintain that this is no accident and that these loopholes, mostly favouring top management were supported for political reasons. ( Nagaharu, A Tax Reform Fraud, p. 128)

There is no doubt that government intervention in the economy was overdue nor is there any doubt that fiscal policy was the only reasonable means of propping up the ailing domestic market but the populous had reached the end of its sufferance of inequality and favouritism. At the same time, Japan is very much aware that its population is aging and that by the end of the Century something like 23% of the population over the age of 65.

It is not that Japan needs an economic package, what it needs is a socio-economic package.

The Japanese individual income tax comprises nearly 40% of national tax revenue. It is a progressive system introduced by Shoup after the War. Yet, since that time, governments have taken to introducing tax concessions and inequalities as a means of aiding the private sector and private sector interests. “The introduction of such special tax measures,” says Ishi, “has contributed to the erosion of the tax base and has greatly reduced income tax revenue.” (Ishi p. 85) Nagaharu points out that under the Takeshita reforms; “Combined, businesses that are either tax exempt or entitled to lighter taxation will account for 97% of all business.” What is not stated obviously is that government appears to have a binding relationship with business, regardless of who is in power. Indeed, given the evidence, it would be reasonable to surmise that big business has control of the government. To use political jargon, it could be said that they are in bed together. Regardless of the strings may be attached, governments have been continually afraid to reform taxation with corporate taxation measures.

The people and the government know that socio-economic reform is necessary and more needs to be spent on social infrastructure. Schools, hospitals and age care all need attention. Ishi maintains that Japan’s social infrastructure remains low and in the late 1980s, “... the proportion of paved roads, the housing standards, the diffusion of sewage systems, and the availability of public parks still lags behind those of many Western countries.” ( Ishi p. 287)

The pressure is for Japan to move towards what is called a ‘social welfare state’ or a ‘guided democracy’ as seen in the US, UK and Australia where governments play a major role in influencing economic behaviour. It is this kind of logical necessity that led the Hosokawa Government to try to increase the consumption tax but by way of another name; the “welfare tax”.

Ishi maintains that what Japan needs is a tax system that restores “... fairness, neutrality, and simplicity while moving to increase the necessary tax burden in the future.” ( Ishi p. 285) While no one can be certain as to which tax reforms will improve the economy and give Japan the quick fix it needs, what ever the means, social factors as well as economic factors will need to be considered if a tax package, and the government that introduces it, is going to gain popular support.