A New Era Carved by Fiscal Reconstruction and Tax Reform

Japan's government debt (total for national and local governments) was approximately 250 trillion yen at the end of March 1989 (the end of fiscal year 1988), but it is expected to accumulate to approximately 1,100 trillion yen by the end of fiscal year 2018, swelling approximately 4.4 times during the Heisei era. While Japan's nominal GDP (Gross Domestic Product) grew from 412 trillion yen in 1989 to 549 trillion yen in 2018 (preliminary figures), government debt grew significantly more than that.

After the collapse of the bubble economy, large-scale public works projects were carried out by issuing more government bonds under the guise of economic stimulus, but the prosperity of the Showa era could not be recovered. In the end, the economy did not improve, and only debt remained.

Public finances during the Heisei era deteriorated to the point of no return amidst repeated cycles of fiscal stimulus and fiscal reconstruction. It was as if one repeated dieting and rebounding until it became impossible to return to one's original weight. Fiscal stimulus would be implemented as an economic measure, only to be criticized as wasteful, leading to efforts in administrative and fiscal reform to cut expenditures. While the fiscal balance would improve temporarily, an economic crisis would unfortunately occur, bringing everything back to square one and leading to yet another round of fiscal stimulus for economic measures. Then came the criticism of wasteful spending. It was a cycle of repetition.

It was around this time that, faced with the economic difficulties of the bubble's collapse, economic measures were taken but proved ineffective, and the construction of hot spring resorts in rural villages was criticized.

Subsequently, the Hashimoto Cabinet embarked on administrative and fiscal reforms and planned to reduce the fiscal deficit. However, immediately afterward, a financial crisis triggered by the failure of major financial institutions occurred in Japan, and the Hashimoto Cabinet's fiscal structural reforms were forced to a halt.

In the succeeding Obuchi Cabinet, government bonds were issued in increasing numbers for public works projects as crisis measures, to the point where the Prime Minister himself joked about being the "world's biggest debtor." Even so, the disposal of bad loans did not progress, and the economy remained stagnant. Since the problem lay in the financial sector, it was something that fiscal policy could not solve.

Amidst this sense of stagnation, the Koizumi Cabinet, which took power advocating to "destroy the LDP," worked on administrative and fiscal reforms during its long tenure, leading to progress in expenditure cuts and a reduction in the fiscal deficit. At the end of the administration, a fiscal consolidation goal was set to achieve a primary balance surplus in fiscal year 2011 before handing over the reins. The primary balance is an indicator of whether this year's policy expenses can be covered by this year's tax revenue; if policy expenses cannot be covered by tax revenue alone and the government must rely on debt for funding, it results in a deficit.

However, due to the global financial crisis that intensified with the Lehman shock in 2008, Japan's economy also fell significantly, forcing the withdrawal of the fiscal consolidation goal and leading to a renewed focus on economic stimulus measures.

In the Abe Cabinet, the last cabinet of the Heisei era, while it cannot be said to be as enthusiastic about fiscal reconstruction as previous administrations, the primary balance deficit has been steadily decreasing. That said, although the target year for achieving the fiscal consolidation goal set by the second Abe Cabinet was 2020, the target year was postponed to fiscal year 2025 because it was decided to allocate the financial resources obtained from the consumption tax hike to increasing social security costs rather than improving the fiscal balance.

Turning our attention to the consumption tax, it was established in April 1989 with a tax rate of 3%. It was truly meant to be the tax that symbolized the Heisei era. At the time, the heavy burden of income tax was strongly recognized among the public, and the "review of the direct-to-indirect tax ratio"—the idea that it would be better to distribute the tax burden not only to direct taxes like income and corporate tax but also to indirect taxes paid at the consumption stage—was a strong motivation for tax reform. Major tax reforms were carried out during the transition from Showa to Heisei under the Nakasone and Takeshita Cabinets.

In fact, no large-scale tax reform surpassing this was ever carried out during the Heisei era. While there were administrations that sought tax reform, perhaps due to the trauma of being unable to implement consumption tax hikes, politicians did not actively attempt to persuade the public.

During that time, the environment surrounding the Japanese economy changed significantly. The Cold War ended, and globalization progressed. As the birthrate declined and the population aged further, and social security costs became increasingly necessary, the population of the working generation that bears those costs began to decrease. Reform of the social security system was also slow, and benefits for the elderly remained preserved.

Under such circumstances, even if one tried to cover financial resources by increasing corporate tax, it is difficult to impose heavy tax payments on Japanese companies exposed to fierce international competition. Even if one tried to increase income tax, under the current tax system, the heavy tax burden would fall only on the working generation, while the elderly would pay almost nothing. The intergenerational gap between benefits and burdens could expand further. Inheritance tax only generates a little over 2 trillion yen in current tax revenue and cannot support the entire budget.

Consequently, among the core taxes, the consumption tax is the one that can minimize the damage to the Japanese economy. Academic research suggests that to obtain the same tax revenue, the consumption tax is less likely to lower the economic growth rate than income or corporate taxes. Since consumption tax is not levied on exports, export competitiveness can be maintained even if the tax rate rises. It can demand a burden not only from the working generation but also from the elderly generation, contributing to the correction of intergenerational inequality.

Of course, since correcting income inequality through income tax is also important, a balanced application of both consumption tax and income tax is required.

In the fiscal management of the Heisei era, no politician appeared who could carry out tax reform in a timely and appropriate manner. Along with fiscal reconstruction to prevent the accumulated government debt from expanding, a major homework assignment has been left for the new era.