No. 17 — April 28, 2000

Feature Article


Jon Choy

Issue Index aaaa 2000 Archive Index aaaa Subscriber Area aaaa Home


In the 1990s, successive Japanese cabinets attacked the domestic economy's ills using a tried-and-true approach: compensate for flagging private-sector demand by expanding budgets for public works projects and implementing targeted tax breaks. Politicians believed that pump-priming was effective both economically and politically — not-insignificant considerations during a decade of discontent — and so fiscal stimulus was their tonic of choice.

As the final decade of the 20th century unfolded, however, it became increasingly apparent that the large sums of money being thrown into public works were not producing the desired macroeconomic result. Growth remained anemic despite a string of record-setting stimulus packages. Chastened by this experience and envious of the booming U.S. economy, political, bureaucratic, business and academic leaders grudgingly realized that Japan's corporate, financial and regulatory structures needed to be reformed and updated so that new industries and economic activities could take root and thrive.

This epiphany, however, by no means relegated fiscal policy to the dust bin. As Japan entered the new century, the cumulative effects of Tokyo's decade-long spending spree coupled with restructuring and deregulation began to show results in the form of positive — if hesitant — economic growth. The government's spending and tax plans for FY 2000 were crafted to at least maintain the momentum of public works spending established the previous year.

Although it is not yet certain that the economy is back on a sure growth track, the debate already is shifting to address the ballooning national debt created by a decade of pump-priming. The impending elections for the Diet lower house make it an impolitic time to propose new or increased taxes. Nevertheless, tax policy is coming to the forefront as a two-pronged tool to boost economic activity while also holding down the debt. Wary of repeating the April 1997 mistake of raising taxes before solid growth was established, a decision that pushed the economy back into recession and contributed to the downfall of a prime minister, policymakers are considering very carefully their near-term as well as long-range options.


Overdosed On Fiscal Stimulus

Between August 1992 and December 1999, Tokyo unveiled 14 economic stimulus packages worth, by the government's calculations, ¥125.4 trillion ($1.1 trillion at ¥110=$1.00) in added final demand (see Table 1). Stimulative spending had the lead role in 10 of these packages, with tax cuts costarring in three. Two were aimed at resolving the banking industry's nonperforming-loan crisis, and the remaining two were composed of deregulatory and other measures for which a monetary value was not given.

Table 1: Economic Stimulus Packages, FY 1990-FY 1999

(in trillions of yen)



August 1992


April 1993


September 1993


February 1994


April 1995


September 1995


October 1997


December 1997


February 1998


April 1998


October 1998


November 1998


July 1999


December 1999




*No exact value given for proposed deregulatory and other measures.
**Bank recapitalization plan worth up to ¥30 trillion also announced.
***Bank restructuring and recapitalization plans worth 43 trillion announced (replaced December 1997 plan).

Source: Ministry of Finance

FY 1999's two packages each had notable points. Although a value of just ¥542 billion ($4.9 billion) was attached to the July measure, it went down in history as the first stimulus package to contain direct government action to counter unemployment, with money earmarked for local authorities to create jobs for displaced workers, particularly middle-aged workers targeted by corporate downsizing efforts (see JEI Report No. 23B, June 18, 1999). Previous efforts at employment promotion had been in the form of tax breaks or indirect subsidies to employers. The December stimulus plan broke with tradition by relying on new issues of bonds for almost all its funding. While borrowing had been a central feature of earlier plans, it usually had been coupled with spending cuts and tax changes.

An injection of ¥125.4 trillion ($1.1 trillion) into the economy over seven years and four months might have been expected to kick growth into high gear. A comparison of the announced value of the economic stimulus plans with the supplementary budgets backing them up makes it clear that Tokyo expected its pump-priming to ripple through the economy with great effect. When the supplemental budgets from FY 1990 through FY 1999 are summed (see Table 2), the grand total comes to just over ¥36.7 trillion ($333.6 billion), or a little more than a quarter of the total value of the announced stimulus plans.

Table 2: Supplemental Budgets to the General Account Budget,
FY 1990-FY 1998

(in billions of yen)



FY 1990

aa December 1990


aa March 1991*


aa aa Subtotal


FY 1991

aa December 1991


FY 1992

aa December 1992


FY 1993

aa June 1993


aa December 1993


aa February 1994


aa aa Subtotal


FY 1994

aa February 1995


aa March 1995


aa aa Subtotal


FY 1995

aa May 1995


aa October 1995


aa February 1996


aa aa Subtotal


FY 1996

aa January 1997


FY 1997

aa March 1998


FY 1998

aa June 1998


aa (October 1998**


aa December 1998


aa aa Subtotal


FY 1998

aa July 1999


aa November 1999


aa aa Subtotal


Net Total


*Primarily to fund Japan's contribution to the allied Persian Gulf War effort.
**Authorization for government bond guarantees related to the restructuring and the recapitalization of Japan's banking industry that was not an actual expenditure.

Source: Ministry of Finance

Domestic and foreign critics of Japan's fiscal policy seized on the large gap between the announced impact of stimulus packages and the supplemental budgets as evidence that Japanese political and bureaucratic leaders were trying to talk up the economy in order to avoid tough choices on deregulation and restructuring. According to these analysts, Tokyo's fiscal initiatives were flawed for three reasons:

  • The measures were not truly stimulative because they were too small or did not yield a net increase in public-sector outlays. Given a nominal gross domestic product that has ranged between ¥475 trillion and ¥500 trillion ($4.3 trillion to $4.5 trillion), even the record-setting ¥23.9 trillion ($217.3 billion) November 1998 package looks like small change. Since the implementing supplemental budgets are worth only a fraction of the packages' announced values, the cabinet's actions seemed not to support its words.

    More important from the critics' standpoint was the fact that most of the supplemental budgets were not financed mainly by borrowing. Having to find money for the extra budgets by cutting spending in other areas or raising taxes counteracted their stimulative strength. The first and second supplemental budgets for FY 1999 illustrate this argument. The ¥519.8 billion ($4.7 billion) July 1999 spending addendum was paid for by drawing ¥150 billion ($1.4 billion) from reserves and using ¥373.7 billion ($3.4 billion) left over from FY 1998 (see Table 3). The lack of new borrowing meant no net increase in the public sector from a macro viewpoint.

Table 3: First FY 1999 Supplemental Budget, July 8, 1999

(in billions of yen)



Emergency Employment Measures


--- Job Creation by Venture Business


--- Reemployment of Middle-Aged,
--- Downsized Workers


--- Temporary Government Jobs


--- Countermeasures for Aging Society
--- and Declining Birth Rate


--- Promoting Employment of Senior
--- Citizens


--- Social Infrastructure Investment







Net Change in Expenditures



Nontax Revenues


Carryover Surplus from FY 1998


Net Change in Revenues


Source: Ministry of Finance

    The December 1999 package did count on nearly ¥1.4 trillion ($12.7 billion) in spending cuts to help balance the books but also included borrowing borrowing almost ¥7.6 trillion ($69.1 billion) in new authority and ¥1.5 trillion ($13.6 billion) in reduced revenue estimates (see Table 4). Only ¥727 billion ($6.6 billion) of the total expected increase in revenues of ¥8.3 trillion ($75.5 billion) came from nonbond sources. True believers in fiscal stimulus lauded the second FY 1999 supplementary budget as an example of what Tokyo should have been doing all along.

Table 4: Second FY 1999 Supplemental Budget, November 25, 1999

(in billions of yen)



Social Infrastructure Investment


--- Telecommunications, Science and
--- Technology


--- Social Welfare, Medical Care,
--- Education and Environment


--- Distribution System and Industrial
--- Competitiveness


--- Promotion of Private Investment
--- through Urban Redevelopment


--- Disaster Prevention


--- Disaster Reconstruction


Credit and Loan Programs


Housing Loan Aid


Employment Assistance


Financial System Stabilization


Public Nursing Care Implementation


Additional Mandatory Outlays


Housing and Urban Development Corp.


Transfer to Welfare Insurance Account









Reduction in Outlays


Transfers to Local Governments




Net Change in Expenditures




Tax Revenues


Other Revenues


Bond Issues


--- Construction


--- General Revenue


Carryover Surplus from FY 1998





Tax and Stamp Revenues


Other Revenues




Net Change in Revenues


Source: Ministry of Finance

  • The principal conduit for economic stimulus in Japan has been public works spending, a fact that was welcomed in the decades during which the war-torn country was rebuilding and catching up with the West. As Japan's economy has matured, however, economists have raised doubts about the efficacy of this type of government expenditure and public interest groups have demonized its pork-barrel aspects. Critics charge that such traditional construction projects as bridges, roads, harbors and airports no longer generate as much of an increase in private-sector activity for as long as government planners hope. In addition to this reduction of the multiplier effect, economists argue that traditional public works do not help prepare the economy for contemporary competition.

    While citizens sympathize with construction workers who depend on government contracts during hard times, they do not hesitate to complain when projects are impractical, wasteful or redundant. In addition, taxpayers are becoming more concerned about the environmental aspects of major construction projects and increasingly are willing to question bureaucrats' wisdom and corporate interests on such issues.

  • Tokyo resorted to economic stimulus plans so frequently that they lost potency. As package followed package, even as the economy continued to stagnate, their novelty and psychological impact waned. Tokyo's constant trumpeting of stimulus initiatives was compared to the boy who cried "Wolf!" Another analogy likened the constant infusions of extra spending to a drug habit: the addicted economy had become tolerant of the steady stimulus, required greater doses of spending to elicit a response and feared a sudden withdrawal of the infusions.

In sum, after 10 years of almost constant invocation with few lasting results, fiscal stimulus has lost its appeal. Yet advocates of government spending, including Clinton administration officials, argue that Tokyo has not executed the policy correctly or with enough magnitude.

Just as insistent are those on the other side of the debate who are concerned about the long-term impact of a decade's worth of pump-priming on the government's outstanding debts and fiscal balance. With the proportion of citizens over 65 growing quickly — implying rising social welfare needs — and the country's birthrate well below the replacement rate — meaning fewer active workers in the tax base — the government could face a fiscal Armageddon in a few decades.


The FY 2000 Budget

The compilation of the general account budget for FY 2000 may have marked a turning point in the fiscal policy debate. Determined to give the economy one last push, Tokyo devised a fiscal blueprint for the fiscal year that began April 1 that is the largest initial general account spending plan in postwar history. With a total of just under ¥85 trillion ($772.7 billion), it is 3.8 percent larger than the initial budget for the previous fiscal year. Government forecasters believe that the current plan will ensure that the economy attains the government's target of 1 percent real growth in FY 2000.

The FY 2000 initial spending and tax plans generally resemble their many predecessors but do contain novel elements. Some observers praise the Obuchi cabinet's so-called Millennium Projects initiative as a new paradigm of public works. The government has earmarked ¥11.9 billion ($108.2 million) to bring high technology into Japan's classrooms, ¥15.2 billion ($138.2 million) to promote information technologies and ¥64 billion ($581.8 million) to decode the human genome and that of the rice plant. Critics say, however, that these exemplary projects represent only a tiny slice of the public works pie. They point to the 11 percent increase to ¥35.2 billion ($320 million) that Tokyo wants to put into building new Shinkansen (bullet train) lines as evidence that wasteful pork-barrel spending continues.


General Account Expenditures

Although not as large as the 5.8 percent increase recorded in the initial general account budget for FY 1996 or FY 1999's 5.4 percent mark, the proposed 3.8 percent hike for FY 2000 still is considered a strong statement of government support for a stimulative fiscal policy. However, when nondiscretionary items — national debt-service costs and revenue transfers to local governments — are subtracted, the stimulative strength of the initial FY 2000 budget is diminished significantly. At 2.6 percent, the gain in discretionary spending is just half that of the previous fiscal year (see Table 5). FY 2000's smaller rise in the total budget combined with its faster growth of nondiscretionary spending creates the divergence between discretionary outlays in the two fiscal years.

Table 5: General Account Spending (Initial), FY 1996-FY 2000

(in billions of yen and percent change)

FY 1996

FY 1997

FY 1998

FY 1999

FY 2000

Total Expenditures












Debt Service and Transfers to Local Governments












Discretionary Spending











*Includes funds to cover carryover deficit from FY 1997. Exclusive of these funds, the total for nondiscretionary items would be ¥33,354.9 billion and the change 0.7 percent.

Source: Ministry of Finance

A review of spending initiatives by purpose highlights the stimulative cast of the FY 2000 budget (see Table 6):

Table 6: Summary of Initial General Account Outlays,
FY 1999-FY 2000

(in billions of yen)

FY 1999


FY 2000


Discretionary Items

Human Services





Education and Science















Economic Cooperation





Public Works





Special Targeted Spending Brackets





Small Business Measures





Food Control Programs





Energy Measures





Administration and Operations





Transfer to Industrial Investment Special Account










aaa Subtotal





Nondiscretionary Items

Tax Transfers to Local Governments





Other Transfers to Local Governments





Debt Service





aaa Subtotal





Funds to Settle FY 1997 Deficit










Source: Ministry of Finance

  • Total public works outlays are unchanged from FY 1999's record level of just more than ¥9.9 trillion ($90 billion), a figure that includes a ¥500 billion ($4.5 billion) fund for Millennium Projects. This special kitty is former Prime Minister Keizo Obuchi's answer to criticism that traditional public works endeavors do not help move Japan forward. Millennium Project funds will be awarded to ministries and agencies on an open, competitive basis in three areas: improving the country's distribution system, building advanced communications systems, and developing and implementing cutting-edge technologies. Although the special fund represents only 5 percent of total public works outlays, the idea is sound and is a start at changing the hidebound system.
  • Social welfare programs will benefit from a 4.1 percent hike to ¥16.8 trillion ($152.7 billion), with the rise covering the inauguration of Tokyo's home nursing-care plan and assistance for families with young children. The ruling Liberal Democratic Party and its legislative allies, the New Komeito and the New Conservative Party (see JEI Report No. 15B, April 14, 2000) have been arguing over how to distribute the burden of paying for the new nursing-care program. One faction says that the government should bear most of the cost; others insist that users pay for the benefit.
  • Education and science outlays will increase 0.9 percent to just over ¥6.5 trillion ($59.1 billion). The Ministry of Education plans to put at least one personal computer in every classroom and to wire every school for Internet access over the next few fiscal years. Also on MOE's agenda is an upcoming reform of the higher education system,1 which likely will require money for new facilities and training.
  • Programs to help small companies cope with the changing economy will see their funding grow by 1 percent to ¥194.3 billion ($1.8 billion). Small businesses also will get targeted tax breaks for investing in high technology equipment and training.
  • Almost ¥6 trillion ($54.5 billion) is allocated for administrative costs, an extraordinary jump of 11.3 percent. The money will pay for the scheduled January 1, 2001 reorganization of the central government bureaucracy (see JEI Report No. 27B, July 16, 1999) as well as a modest salary increase for civil servants.
  • Local governments will see their ordinary revenue-sharing transfers rise 8.8 percent to ¥14 trillion ($127.3 billion), and will receive a special transfer worth ¥914 billion ($8.3 billion). Many subnational units are teetering on the edge of insolvency, according to the Ministry of Home Affairs. In FY 1998, for example, the ministry reported that all 47 prefectural governments had ended the year in the red, including such major metropolitan areas as Tokyo and Osaka.2 The number of municipalities operating at a loss more than doubled from the year before, according to MHA, and other indicators of local fiscal health sank to new lows. Since local governments actually accept bids and sign contracts for public works projects, their financial well-being is critical to Tokyo.
  • The government's already huge debt-service costs are projected to climb another 10.8 percent to nearly ¥22 trillion ($200 billion) in FY 2000. Part of this boost is attributable to Tokyo's plans to increase its reserve for failed banks by ¥4.5 trillion ($40.9 billion). As the government's outstanding debt reaches Herculean proportions, interest payments are expected to hit ¥10.7 trillion ($97.3 billion).
  • Funding for official development assistance, which is broader than the economic cooperation category shown in Appendix Table 3, will ease by 0.2 percent to ¥984.2 billion ($8.9 billion). While money for foreign aid will be tighter overall, certain high-priority initiatives have been given the thumbs up, including extra funding for environmental protection projects and social development (¥12 billion or $109.1 million), clean-energy projects (¥1.8 billion or $16.4 million), child-welfare programs (¥800 million or $7.3 million), nongovernmental organizations in war-torn countries (¥500 million or $4.5 million), land-mine clearing (¥2.7 billion or $24.5 million), and afforestation (¥400 million or $3.3 million). Ministry of Foreign Affairs officials are betting that the slight drop in total ODA money will be more than offset by the yen's 14 percent appreciation against the dollar since the initial budget for FY 2000 was compiled. MOFA spokespersons add that in the coming fiscal year. the ministry will focus on boosting the efficiency of Japan's foreign aid program and on funneling more money into humanitarian aid.3
  • Defense spending will edge up 0.1 percent to just over ¥4.9 trillion ($44.5 billion), after taking cuts in both FY 1998 and FY 1999. Personnel-related costs are projected to rise by ¥36 billion ($327.3 million) to more than ¥2.2 trillion ($20 billion), due mainly to an expected surge in retirements. Outlays to implement the decisions of the U.S.-Japan Special Action Committee on Okinawa will surpass ¥14 billion ($127.3 million), a gain of 15.6 percent. One controversial move is a 2.8 percent slash in host-nation support to ¥260.3 billion ($2.4 billion) as a result of Tokyo's cancellation of several base-improvement projects. Washington has resisted the reduction in Japan's financing for U.S. forces based on Japanese soil (see JEI Report No. 12B, March 24, 2000). On the plus side, the Obuchi cabinet added ¥2 billion ($18.2 million) to the FY 2000 budget as Japan's share of the cost of developing a theater missile defense system with the United States.

On the downside, food control programs will suffer a 16.7 percent cut to ¥223.9 billion ($2 billion) under the initial FY 2000 spending plan, while energy projects face a 2.8 percent drop to ¥635.1 billion ($5.8 billion). Because the number of World War II veterans and their dependents continues to decline, pension costs are expected to fall 3.6 percent to just over ¥1.4 trillion (12.3 billion).


General Account Revenues

Analysts at MOF's Budget Bureau expect tax and stamp revenues to rise 3.3 percent in FY 2000 as the economic recovery takes hold (see Table 7). However, they also project that government borrowing will grow another 5 percent despite the economic rebound. New issues of construction bonds are supposed to drop a slight 2 percent to ¥9.2 trillion ($83.6 billion), but general borrowing will jump by 8.1 percent to nearly ¥23.5 trillion ($213.6 billion), a new high for an initial budget. The overall increase in the sale of new bonds will bring the FY 2000 initial spending plan's dependence on borrowing to a record 38.4 percent (see Appendix Table 1 and 2).

Table 7: Summary of Initial General Account Revenue Estimates,
FY 1999-FY 2000

(in billions of yen)

FY 1999


FY 2000


Tax and Stamp Receipts





Nontax Receipts










aaa Construction





aaa General Revenue










Source: Ministry of Finance

A closer look at revenues (see Appendix Table 4) reveals some interesting assumptions by budget planners. The expected 25.7 percent gain in personal income taxes withheld from workers' paychecks raises questions, especially since it appears that this year's shunto (spring wage negotiations) will yield a record-low average hike of less than 2 percent (see JEI Report No. 15B, April 14, 2000) and since corporations plan to continue downsizing. The 4.6 percent drop in receipts from corporate income taxes also is something of a puzzle. Many companies are expecting to return to profitability in FY 2000 and tougher accounting rules will make it more difficult to avoid taxes. However, the decline is not beyond reason, given the Japanese tax codes that allow companies operating in the red to avoid most taxes. Finally, the 5 percent reduction in consumption tax revenues is in line with the recent weakness of consumer spending but does not jibe with the government's rosy expectations of renewed economic growth in FY 2000.

As for tax reforms, the FY 2000 blueprint contains no earthshaking items. The implementation of revised rules that are less favorable for new home buyers has been moved from January 1, 2000 to July 30, 2001. The more restrictive provisions will allow purchasers to claim tax credits for mortgages for six years, rather than the current 15, and will offer smaller credits.

Small and midsize enterprises are granted special depreciation credits for new machinery and investment in research and development. Entrepreneurial or venture SMEs that meet the requirements of the so-called Angel Tax Plan also can extend special tax treatment to investors if the company conducts an initial public offering within a specified period. Capital gains taxes may be cut as much as 50 percent if all conditions are met.

The scheduled introduction of defined-contribution pension plans modeled after U.S.-style 401(k) plans (see JEI Report No. 4B, January 28, 2000) demanded some clarification of the tax code. In most cases, contributions to the new retirement vehicle will be fully tax deductible, as long as the premiums do not exceed ceilings based on employment status. Although the reforms state that the premiums are subject to the Special Corporate Tax on Pension Funds, this 1 percent levy has been suspended indefinitely.

Responding to constituent complaints, the FY 2000 tax bill contains relief for surviving relatives faced with stiff inheritance taxes. These changes underlie the projected 14.2 percent decline in inheritance tax revenues and the 66.7 percent plunge in receipts from real estate-related levies.

Overall, the FY 2000 tax reforms will reduce the government's expected revenues by ¥147 billion ($1.3 billion) the first year they are in effect (see Table 8). The net change hides higher taxes for families with children as well as the scale of corporate investment incentives.

Table 8: Estimated Value of 2000 Tax Reforms

(in billions of yen)

Private Investment Incentives




aaa End Extra Child Allowance


aaa Special Corporate Taxes


aaa Other




Source: Ministry of Finance

Fiscal Investment and Loan Program

One traditional budget system scheduled for major changes is the Fiscal Investment and Loan Program, the government's second capital budget. In preparation for a complete overhaul of the FILP in FY 2001,4 the Finance Ministry had sought an 18.7 percent reduction in spending to just under ¥43 trillion ($390.9 billion). The FILP approved by the Diet was only slightly more generous than the MOF proposal (see Table 9 and Appendix Table 5), adding up to a 17.4 percent cut to ¥43.7 trillion ($397.3 billion). With increases over the initial FY 1999 budget of 5.1 percent each, welfare and land conservation/disaster programs were the biggest winners. The only other categories to be blessed with additional money were agriculture (3.6 percent), roads (2.4 percent) and education (1 percent). Funding for the remaining eight categories, including regional development, communications and economic cooperation, will be pared by as little as 0.8 percent (small business) to as much as 51.2 percent (industry and technology).

The 54.2 percent plunge from FY 1999's mark in portfolio investment funds presages the fundamental FILP reform. This drop shows that the FILP's role as an investor of trust and pension funds controlled by the government already has begun to shrink rapidly. By January 1, 2001, this role will disappear entirely. Control of the trust and pension funds will be returned to the Ministry of Health and Welfare and the Ministry of Posts and Telecommunications. With the population graying rapidly, MHW and MPT have argued for the freedom to invest these funds where they can earn sufficiently high returns, an argument that must mean that money lent to the FILP was not working hard enough.

The postal savings system, which is run by MPT, contributed ¥11.5 trillion ($10.5 billion) to the initial FY 1999 FILP, an amount buried within the Trust Fund Bureau's overall figure. While the bureau's employee and national pension funds will continue to lend money to the FILP in FY 2000, it will be smaller than the year before. Government-administered or controlled pension plans are scheduled to provide only ¥2.7 trillion ($24.5 billion) in FY 2000, compared with the ¥4.3 trillion ($39.1 billion) in FY 1999. Other Trust Fund Bureau programs will divert more money to the FILP in FY 2000 compared with the year before — a projected ¥30.6 trillion ($278.2 billion) versus an initial ¥27.9 trillion ($253.6 billion) — but the gain will not offset the other two reductions. Overall, the Trust Fund Bureau is expected to allocate ¥10.4 trillion ($94.5 billion) less to the FILP in FY 2000.

As wrenching as these changes may appear, they are merely the beginning of the process. The Diet is considering legislation that would establish the final details of the FILP's reform. If adopted, the FILP and the many quasi-governmental agencies it funds would be forced to undergo a rapid transition to a market-based fund-raising system.


The Focus Edges Toward Taxes

The deficit spending that has characterized Tokyo's budgets for the last decade has concerned Japanese and foreign observers alike. The Finance Ministry calculates that by the end of FY 2000, the central government's outstanding debt will top ¥364 trillion ($3.3 trillion), while local government debt will total ¥283 trillion ($2.6 trillion). Together, central and local authorities will owe ¥647 trillion ($5.9 trillion), or more than 130 percent of Japan's GDP5 — the highest such level among Group of Seven industrial nations. Economists are engaged in a heated debate over the impact of this mountain of debt at the same time they are weighing Tokyo's options for ensuring stable growth in the near term. Although politicians and bureaucrats are loath to utter the T-word publicly during an election year, taxes are edging toward center stage in the evolving discussions of Japan's fiscal policy.

In one sense, the Japanese public is ready for this debate since it is suffering from "fiscal stimulus overload." The idea that the government can spend its way out of a recession has been discredited — or at least shown to be an incomplete answer. As a nation of savers, the Japanese easily can understand the dangers of getting deeply into debt. Although the options for dealing with creditors that are available to individuals are significantly different from those available to sovereign nations, taxpayers understand that if the government spends freely now, they eventually will get handed the bill, either in the form of higher taxes or as inflation that erodes the value of their savings.


Income Taxes

Highly progressive personal income tax rates have been considered an important part of social as well as economic development in postwar Japan.6 High marginal income taxes narrowed the income distribution gap between rich and poor, allowing most Japanese to believe, with some justification, that they were solidly in the middle class. A decade of stagnation in the 1990s is changing this. Just as winners and losers are emerging among companies, income variation among households is widening.7

Tokyo has tried cutting income taxes to help boost the economy several times over the last decade. The issue became a major political theme in 1994, eventually leading to a two-year, ¥5.5 trillion ($50 billion) reduction. The cut consisted of permanent rate changes worth ¥3.5 trillion ($31.8 billion) and rebates valued at ¥1 trillion ($9.1 billion) in each of the two years. The rebate was extended for a third year, finally expiring in 1997. Because the economy was performing very poorly and the banking industry's nonperforming-loan crisis was building, households cautiously saved their tax windfall instead of spending it.

With the economy still shaky, policymakers are eyeing plans to lower income taxes again to help spur consumption. Although the banking industry has put most of its bad-loan problems behind it, corporate Japan is engaged in a major downsizing campaign.8 Given such restructuring coupled with several years of minimal wage hikes, it would not be surprising if Japanese households again chose to save any tax windfall instead of going on a shopping spree.

Corporate income taxes also are on the table. While Japanese executives long have complained that the tax code puts them at a disadvantage with some of their foreign rivals, overseas firms have expressed the opposite view. As Tokyo groped for revenue in the mid-1990s, Japanese corporations had to bear a special levy, something executives do not want to repeat.

Tokyo metropolitan Gov. Shintaro Ishihara, however, has other ideas. Faced with plummeting revenues, Mr. Ishihara boldly suggested a special levy aimed at the country's largest banks that would replace the local corporate income tax for five years. Moreover, the 3-percent levy would not be based on net profits but on gross profits, meaning that even firms that suffered net losses would have to pony up (see JEI Report No. 7B, February 18, 2000).

Central government authorities were at least as furious with Mr. Ishihara's proposal as were the executives of targeted banks. After digging through the law books, the cabinet and the Finance Ministry had to admit that they could not prevent the Tokyo city government from levying the tax. The Tokyo metropolitan assembly approved the plan, which became effective April 1. Banks moved immediately to stop the tax in court, but the legal prospects of the case are unclear. In any event, because of the way local corporate income taxes are calculated and collected, banks will not have to pay the new tax until June 2001.

Central authorities were angry with Mr. Ishihara — in part because he beat them to the policy. In response to another major criticism of the current corporate tax system — that companies reporting net losses essentially are exempt from paying taxes — the government had been examining the idea of basing corporate taxes on some other measure of business activity that included gross sales and profits. With such a tax now in operation, central authorities have a test case to evaluate the pros and cons of this approach.


Consumption Tax

Controversial from the moment it was first imposed in FY 1989, the national and local consumption levy continues to be a flash point in the reform debate. Many tax experts long have warned that the government's reliance on direct taxes would become untenable as the country's demographics changed to a population heavily weighted with senior citizens. Thus, the original rationale for the consumption tax was to reduce dependence on personal income taxes in a very gradual fashion.

After some initial grumbling and effort to work through compliance issues, the nation's businesses and consumers grudgingly, but not quietly, accepted the levy. Observers say that the new tax's unpopularity helped evict the Liberal Democratic Party from control of the government in 1993. The tax played a similar role in 1998 and was a factor in the resignation of Prime Minister Ryutaro Hashimoto (see JEI Report No. 27B, July 17, 1998). Voters were unhappy when the tax was boosted by 2 percentage points in 1997, snuffing out a nascent economic recovery.

Fiscal experts say that despite this checkered past, further increases in the consumption tax are inevitable, given Japan's changing demographic and economic situation. One analyst has estimated that the tax would have to be pushed as high as 12 percent for the next 25 years in order to balance the budget and begin to pay down the outstanding national debt.9 Such numbers naturally give pause to politicians, even those who agree that higher consumption taxes are vital.

To get over any "sticker shock," some politicians and bureaucrats have suggested gradually boosting the levy over a period of decades. In addition, they would build flexibility into the schedule to give policymakers room to respond to an economic downturn. Another idea is to earmark consumption tax revenues for social welfare programs, reasoning that voters would find such a tax more palatable if they directly benefited from it.

Still another variant that has been proposed is a value-added tax. One of the attributes of a broad VAT is that its amount usually is hidden in the price of a product or a service rather than explicitly added to the final bill. Politicians might see the disguise as a distinct advantage since consumers would not be reminded of the tax amount everytime they made a purchase.


Other Taxes

The central government has been stung by critics who claim that in the 1990s, outdated rules, regulations and bureaucratic practices prevented the country from adapting more quickly to changing economic realities, prolonging the stagnation. The government is committed not only to its administrative restructuring, but also to reviewing such key laws as the Commercial Code with an eye toward updating them. Tax codes certainly are getting their share of attention in this revamp, as shown in several different areas:

Real Estate Taxes - The country's nonperforming-loan problems can be traced to the precipitous decline in property values since 1989. One method of disposing of bad loans that was used successfully in the United States involved bundling together real estate and other assets pledged as collateral and using them as a basis for issuing a security. Tokyo tried to emulate this success in late 1998 by permitting the establishment of special purpose corporations whose primary function would be to act as intermediaries in the securitization process. After a year of operation, however, government and private-sector analysts realized that taxes on land transactions and other tax issues were blocking the smooth operation of SPCs. Although in most cases, these payments are refunded eventually, sellers and buyers are forced to give the tax collector significant sums of money up front to conclude the securitization deal. The Finance Ministry has been trying to get legislation passed that would make the process more flexible. However, the Home Affairs Ministry is resisting because the proposed changes would further hurt the finances of local governments, which actually collect the money.

"Green" Taxes - Japan's growing environmental consciousness has generated a spirited debate on several taxes with a "green" tint. To promote energy conservation, for example, the Ministry of International Trade and Industry wants to fatten the tax breaks given to buyers of electric or low-emissions vehicles. The Finance Ministry, on the other hand, wants to reduce the advantage because it feels that even drivers of clean vehicles should bear a fair share of the cost of building and maintaining roads.

Imposing a tax on companies whose activities emit large amounts of carbon dioxide and other so-called greenhouse gases is another flash point. Under the 1997 Kyoto Protocol, Japan is committed to cutting its output of greenhouse gases by 6 percent at some point between 2008 and 2012.10 Environmental activists argue that taxes on polluting activities would provide a very strong incentive for offenders to reform. Many executives, however, counter that imposing a potentially heavy tax at a time when companies are struggling to stay in business is not good policy.

Tobacco Tax - While the anti-smoking forces recently have scored some successes against tobacco companies in the United States, the movement is just beginning in Japan. Since the government retains a controlling share of Japan Tobacco Inc. and JT still has a legal monopoly on producing cigarettes in Japan, official resistance to anti-smoking campaigns is understandable. Powerful advocates for change do exist, however. Shizuka Kamei, a chief LDP policymaker, proposed in January that the tax on tobacco products be increased as part of the FY 2000 tax bill. His recommendation was snuffed out quickly by his LDP colleagues and JT officials. Given the Clinton administration's success at fattening revenues and deterring smokers by jacking up the federal cigarette tax, however, Mr. Kamei's idea is likely to resurface in the future.


The Long-Term View

Japanese politicians and bureaucrats clearly have no lack of short-term fiscal issues to debate. At the same time, they generally agree that long-range issues need to be tackled.

Budget Process Reform - As Mr. Obuchi's Millennium Projects concept shows, some movement toward addressing long-standing complaints about the budget process has occurred. The Finance Ministry's iron grip on the system has distorted the thrust of fiscal policy, according to some critics, bending it from serving the nation's needs to accommodating those of the bureaucracy. Because bureaucratic politics play such a large role in the process, decisions are not always made on the basis of merit. Critics point out, for example, that public works funds are handed out to the Ministries of Construction, Transport, and Education and Welfare according to an unchanging formula because it smooths the process. Each gets its customary share, but the money may not be allocated optimally from society's standpoint.

The most recent serious attempt to revamp the budget process was the Fiscal Structural Reform Act of 1997.11 The law set out both general and specific goals, including:

  • Cutting the combined central and local government budget deficit to 3 percent or less of GDP by FY 2003.
  • Ending new issues of general revenue bonds by FY 2003.
  • Restructuring the Fiscal Investment and Loan Program.
  • Setting caps through FY 2000 for spending categories previously considered sacred, for example, defense and official development assistance.
  • Cutting FY 1998's public works budget by at least 7 percent from the FY 1997 level.

These admirable goals were torpedoed, however, by the long-running recession. The law has been in temporary suspension since FY 1998 to give the government more flexibility to get the economy moving. The law may eventually have its full intended impact, but that day is a way off.

FILP Reform - One goal of the 1997 Structural Reform Act appears to be nearing realization: restructuring the FILP. If, as expected, the Diet approves the pending reform legislation, the process could be initiated as early as January 2001. Because the FILP funds so many quasi-governmental agencies — for example, regional development agencies, the Housing Loan Corp., the Small Business Finance Corp., the Japan Highway Public Corp. and the Pension Welfare Service Public Corp. — that play important roles in the economy, fundamental changes in the program will have wide-ranging effects. Experts agree that it could take decades to complete the transition and that the costs could be far higher than Tokyo is willing to admit. The Finance Ministry recently warned that it would take ¥5 trillion ($45.5 billion) just to pay off the current debts of the operations funded by the FILP; private-sector analysts say that the true price tag is several times this amount.12

Funding Social Welfare Programs - The Japanese have enjoyed state-funded drug prescription and other social welfare programs and now can apply for home nursing-care assistance. Policymakers are debating whether the government can afford to continue this largess. The negotiations between the LDP and its coalition allies over the ¥4.3 trillion ($39.1 billion) home-care program illustrate the point. The LDP and the New Komeito proposed collecting insurance premiums from everyone aged 40 and older. The Liberal Party — a part of which remains in the ruling coalition as the New Conservative Party — countered with the idea that consumption tax revenues be used to cover not only the new program but also the existing basic national pension system and any other medical services for the elderly as well. A wide range of social factors were brought into the debate, but the issue really boils down to who is going to pay.

Such knotty problems will keep politicians busy for years. Clearly, however, fiscal stimulus will not be employed in the immediate future as heartily as it was in the past decade. Rising concerns about the national debt leave little room for maneuver. But removing fiscal stimulus from the government's arsenal of economic tools would be unrealistic and short-sighted. The consensus, however, is that the sooner Tokyo begins to take action on the long-term problem of the mounting national debt, the easier it will be to resolve. Suddenly turning off the steady stream of fiscal stimulus that began in the early 1990s might be traumatic in the short term, but slowing it gradually will take political will, something that may be in short supply in an election year.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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1aa See Jon Choy, "Japan's Educational System Heads For Reform," JEI Report No. 46A, December 10, 1999. Return to Text

2aa See Hiroyuki Takahashi, "Fiscal Crises In Japan's Prefectures And The Debate On Corporate Tax Reform," JEI Report No. 40A, October 22, 1999. Return to Text

3aa See Marc Castellano, "Japan's Foreign Aid Program In The New Millennium: Rethinking Development," JEI Report No. 6A, February 11, 2000. Return to Text

4aa See Douglas Ostrom, "Government Deficits And Debt: Tokyo's Dilemma," JEI Report No. 2A, January 14, 2000, pp. 10-11. Return to Text

5aa Ministry of Finance, Midterm Fiscal Outlook, FY 2000 General Account Budget. Return to Text

6aa See Hiroyuki Takahashi, "Prospects For Personal Income Tax Reform In Japan," JEI Report No. 24A, June 26, 1998. Return to Text

7aa See Douglas Ostrom, "Rich And Poor In Japan: How Wide Is The Gap?" JEI Report No. 37A, October 1, 1998. Return to Text

8aa See Arthur J. Alexander, "The Japanese Economy In Transition," JEI Report No. 44A, November 19, 1999. Return to Text

9aa Hiroki Tanaka, "Japan's Balance Sheet: How Lack Of Accountability Has Led To Excessive Government Debt," ASIA 21, December 1999, p. 55. Return to Text

10aa See Jon Choy, "The Kyoto Protocol And Japan's Energy Policies," JEI Report No. 10A, March 13, 1998. Return to Text

11aa See Jon Choy, "Japanese Fiscal Policy: One Foot On The Gas, The Other Tied To The Brake," JEI Report No. 16A, April 24, 1998. Return to Text

12aa Gillian Tett, "State-funded projects in Japan 'are losing $47bn,'" Financial Times, March 29, 2000, p. 4. Return to Text

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

Top aaaa Issue Index aaaa 2000 Archive Index aaaa Subscriber Area aaaa Home