There probably isn't anyone still arguing that Japan's finances are sound. Even so, many have voiced their opposition to the Noda administration's move to raise the consumption tax rate to 10 percent. Other than emotional reactions or Finance Ministry conspiracy theories, what is the "core of the opposition"?
The Asahi Shimbun interviewed Keio University Professor Heizo Takenaka, perhaps the most reasoned controversialist opposing to a tax hike. He supervised fiscal and economic policies in the Koizumi administration, which opted to keep the consumption tax intact. He took four ministerial posts--minister in charge of economic and fiscal policy, financial services, postal privatization, and internal affairs and communications.
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Question: Why are you opposed to raising the consumption tax?
Heizo Takenaka: If the government increases taxes before exhausting all policy efforts, such a stance of starting with a tax hike will not help the government restore its fiscal health or stabilize the social security system. The Noda administration forecasts economic growth at an extremely low 1 percent. At that growth rate, tax revenues will not increase and no matter what the government does, fiscal reconstruction is impossible. The United States and leading European nations expect economic growth of 3 to 5 percent in their efforts to rebuild their finances. Japan must achieve the same level of economic growth if it is going to commit itself to restoring its fiscal health.
Q: The nominal growth rate in Japan during the "two lost decades" has been around zero. The Western nations are also mired in low growth. Considering the reality, it could be risky to hope for excessively high growth.
A: The economic situation in Japan is abnormal. Would it then be excessively hopeful for us to return to the normal situation? Even with a declining population, I think it possible to achieve per-capita GDP growth of 2 percent. The impact of the shrinking population is estimated at most around 0.5 percent. If you subtract that, then real growth of 1.5 percent is very feasible.
Q: How can we encourage growth? That's been the chief concern up to now.
A: If the government and the Bank of Japan correct their policies and overcome deflation, they can easily achieve nominal growth of 3 percent. The BOJ has increased fund supplies to support the economy since the 1990s, but it is worried that it now holds too many assets. The central bank doesn't want to be forced to purchase any more government bonds. BOJ officials also think they can't trust the government. That's why the BOJ governor is profusely demanding that the government put its fiscal house in order first. He's right to do that, but I'd like the BOJ to think about the economy as a whole rather than just the health of its own finances.
Q: Monetary easing has its limits. Done to excess, it creates side effects. Isn't the government's growth strategy actually more important?
A: The government should terminate its bizarre policies before thinking about growth strategy. Prime examples are employment adjustment subsidies that make companies hold on to redundant personnel and the law on measures to facilitate financing that can hinder banks from collecting loans from small and midsize enterprises (because the law allows borrowers to defer repayment). Labor isn't going where it is needed and the banks can't extend new loans. To encourage economic growth, we need to provide greater freedom to the private sector by lowering the tax burden and easing regulations. That is the right path.
Q: Even if we want growth, shouldn we make prudent economic forecasts?
A: If the government can't do things it is supposed to do, then it should step aside. If we assume nominal growth of 1 percent as we have until now, then we would have to raise the consumption tax rate to 17 percent, almost as high as Germany's (19 percent), in order to achieve the government's goal of eliminating the primary balance deficit.
Q: Consumption tax rates of 15 to 20 percent are standard in major developed countries. I think Japan, with its quickly graying society, cannot help but raise the tax rate to the same level as Germany.
A: It would be a problem if our tax rate become as high as in Germany while our defective social security system is left unattended. In addition, the rate will continue to be hiked. In other words, if we raise the tax without fixing our social security system or creating decent economic growth, then Japan will head down the road to a low-welfare, high-tax state. Plus, if the government disappoints the people by failing to benefit them in exchange for adding tax burdens on them, it could invite a situation in which the government cannot raise taxes when it really needs to do so.
Q: Is it too early to raise the tax?
A: There is a rule derived by Alberto Alesina, a professor of political economy at Harvard University. When he examined hundreds of cases of fiscal reform by industrialized countries, he found that they succeeded when they raised taxes only after thoroughly cutting expenditures, and they failed when they raised taxes first. The Noda administration's approach is a classic example of a failure.
Q: Japan's government spending, excluding social security expenditures, is the smallest among the developed nations in terms of ratio of the spending to GDP. You could say it's "the world's smallest government." Can the government really cut expenditures any further?
A: You're turning reality on its head. The government's expenditures total 96 trillion yen ($1.2 trillion) in real terms this fiscal year. The figure rose by 14 trillion yen from five years earlier, but only around 4 trillion yen of that is a natural increase in social security expenses caused by the aging population. The remaining increase of 10 trillion yen is attributed partly to the child allowance and other policies under the Democratic Party of Japan's manifest. The increase is also derived from the expanded spending for the economic stimulus measures taken when the U.S. investment bank Lehman Brothers collapsed in 2008. The allocation has not been reduced since then.
Citizens probably think that the DPJ has eliminated waste as they have seen its administration's budget screening process. But that cut only around 1.7 trillion yen. The amount of new wasteful spending in the budget is by far greater. The tax rate hike of 5 percentage points will add 13 trillion yen to tax revenues. But the revenue increase will be offset largely by the 10-trillion increase in spending to finance the pork-barrel policies implemented after the change of government. That's why the planned tax hike will not contribute much to the efforts to restore fiscal health and improve the social security system.
Q: In the past you've said "a consumption tax rate hike of up to 10 percent is inevitable." Would you accept a tax increase of that degree depending on conditions?
A: Taking into consideration Japan's tax-bearing capacity (the ability to pay taxes) and using common sense, I believe that the consumption tax burden can be increased to the same level as in New York where the sales tax rate is 9 percent. We must find an answer to the question: Why are we going to raise the tax?
Q: What purposes would be acceptable?
A: First is to improve the social security for young generations. For example, allowances for child-rearing or maternity leave, and training for women to return to the workplace. Japan is way behind Europe in this area. We should set aside money for the young rather than using any more for the elderly. We should also cut pension benefits for old people earning high incomes and redistribute them to poor seniors.
Second is decentralization of power. I think Osaka Mayor Toru Hashimoto makes a logical argument. The point of social security is to redistribute income, so normally we should cover the cost by raising income taxes. We need to hold off on consumption taxes as much as possible for the sake of decentralizing power.
Third is lowering the corporate tax. Japan's tax rate is incredibly high compared with the rest of the world. We absolutely have to lower it. Consumption tax hikes in the future would be acceptable for those purposes.
Q: But if a tax increase is delayed, then that will also make government finances worse in the meantime.
A: The government could meet its target of putting the primary balance in the black by 2020 without a consumption tax hike. They could do so by setting a ceiling on the budget and not raising expenditures, and by stimulating the economy to increase tax revenues. This is how the Koizumi administration reduced the primary balance deficit from 28 trillion yen in fiscal 2003 to 6 trillion yen four years later. If we had continued with those policies, then we would have put the balance in the black one or two years ago.
Q: I admit that the measures you and Koizumi took to reform government spending were effective. But at the same time, I think the Koizumi administration should have also committed itself to raising the consumption tax.
A: The typical criticism from politicians who opposed our structural reform policies is, "Why didn't you raise the tax when the economy was good?" But we had a clear plan. Without a tax hike we would put the primary balance in the black by around 2011, and then move on to the second phase: rebuilding public finance and reforming the social security system. Implementing policies in the right order is key.
Q: After enacting the postal service privatization law in 2005, was a tax increase not on the agenda for the remaining year of the administration?
A: It takes at least two years to implement major policies. So it was enough for the Koizumi administration to achieve two or three issues during the five years and five months in office. The issues we tackled were disposing of bad loans at banks, privatizing Japan Highway Public Corp. and privatizing the postal service. During the last year, we focused on concrete measures to curb growth in budget spending. If you criticize us because you still think our reforms were not enough, I have to just accept the criticism.
Q: Do you agree with raising income taxes to enhance redistribution of wealth?
A: The biggest problem with Japan's income tax system is that it does not collect taxes from the middle class properly. Eighty percent of taxpayers in Japan are subject to an income tax rate of 10 percent or less. Such low tax rates apply to around 15 percent of taxpayers in Britain, and 30 to 40 percent in the United States and Germany. The large ratio in Japan is abnormal. This of course leads to insufficient tax collection and a weakened effect from redistributing income. The government should deal with this problem.
Right now it looks like the top rate of 50 percent (including individual resident taxes) will go up a bit, but this will not solve the root problem we have with redistribution.
Q: It seems that the choice of many citizens is a "medium welfare standards, medium burden" state. What's your idea of that?
A: If you rank countries by how small their governments are in terms of the ratio of their budget spending to the GDP, then the smallest group used to include the United States and Japan. In the second group you have Germany and Britain. France and northern European countries are in the third group. But Japan has expanded its expenditures over the past few years and moved over completely into the second group. Japan can't create a low welfare, low burden country anymore. If we keep this up, it will become difficult to stop the government from growing beyond a midsize scale.
Q: Is your argument for pursuing growth persuasive enough for the young generation that grew up in the slow-growth society after Japan's economic bubble burst?
A: Is zero-percent growth really all right? If it continues for several years, South Korea will probably surpass Japan in terms of per capita income. What I want to say to the anti-growth camp is: "You have the freedom to become poor. But don't hold back the people who want to become wealthy."
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