Raise consumption tax? Lower corporate tax? Or both?
At last politicians here seem to be taking the problem of Japan’s shocking finances seriously. During the upper house election campaign both ruling and opposition parties talked about raising the consumption tax from its current level of 5%.
Greece’s debt crisis has opened people’s eyes to the fact that debt problems cannot be ignored forever. At about 200% of GDP, Japan’s public debt is the biggest in the industrialised world and it’s getting bigger all the time. For this year’s budget of ¥92.3 trillion, the government is actually borrowing more money than its combined tax revenues.
Breaking the political taboo of a sales tax hike has triggered countless headlines, but what at first glance seems contradictory is that those same politicians have also been calling for a reduction in the corporate tax. Surely, it can’t make sense to raise one tax and lower the other?
Most observers would agree that to tackle Japan’s debts, the government must cut spending, increase revenue and boost economic growth. Raising the sales tax would fill the coffers while many argue that cutting corporate taxes would stimulate the economy.
“The problem with Japan’s finances is that we have a huge shortfall in revenue,” says Yasuhisa Abe, director of Nippon Keidanren’s Business Infrastructure Bureau. “Putting the DPJ’s manifesto to one side, if we just look at the nation’s social security costs, they’re rising each year by almost ¥2 trillion. How can we cover these costs in a nation that’s shrinking and greying? Raising the sales tax is the only way.”
Abe dismisses the argument that Japan is safe from a financial crisis like Greece’s because its bonds are 95% domestically owned. Japan will soon reach the limit of domestic demand for bonds, he argues, and it’s not a question of 10 years or even five.
Takero Doi, an economics professor at Keio University, is also calling for a hike in the consumption tax rate as part of comprehensive tax reforms that would see the income tax base widened, deductions replaced with tax credits and corporate tax rates lowered.
“We can no longer put off dealing with our debts. So, while trying to minimise the tax increase and potential harm to economic growth, the question is which tax to raise,” Doi says. “That tax is the sales tax.
“Research shows that countries with higher rates of income and corporate tax have lower growth, while countries with higher rates of consumption tax have relatively higher rates of growth,” Doi says, referring to a long-term study of Organisation for Economic Co-operation and Development (OECD) data.
While a higher consumption tax rate might have a less detrimental effect on growth than higher income or corporate tax, when it comes to actually boosting growth, cutting tax on profits is the strategy recommended by many, including Doi.
The argument goes that reducing corporate taxes frees up more cash for companies to reinvest in future products and expansion, while it also helps attract foreign direct investment and keeps domestic firms investing at home.
“At the moment companies are investing based on their own cash flow, so unless that cash flow is somehow increased, investment can’t rise beyond current levels,” says Naoyasu Yoshimura, deputy director of the corporate tax division at the Ministry of Economy, Trade and Industry (METI).
But perhaps the most striking point is that while Japan’s corporate tax rates are at a similar level to those of the United States, they are much higher than those in Europe and many parts of Asia.
“Combining the national and local rates, corporate tax [in Japan] is 40.69% ,” Yoshimura says. Most European countries, on the other hand, now tax company profits at rates well below 30%. Differences in tax rates, Yoshimura says, are prompting firms in Japan to move their production and financial operations to countries with lower taxes.
“This means lost employment and opportunities for future growth in Japan. It’s probably not a good thing for the world to engage in a race to lower corporate taxes, but since most major nations have corporate tax rates between 25% and 30%, this is the level we have to show a clear sign of working towards.”
This June, METI called on the government to cut the tax by five percentage points in fiscal 2011. Yoshimura acknowledges this would only be a “first step”. But for foreign companies, he says, it would reduce the time needed to recoup investment in Japan, even if it might not be enough to convince them to establish their Asian headquarters in Japan.
Keidanren’s Abe says there’s no correct figure for corporate tax in absolute terms. It can only be high relative to rates in other countries. But if Japan’s rate stays where it is, Abe too is concerned about domestic firms moving their operations abroad.
“The corporate tax comes down to a question of employment,” he says. “Panasonic, Sony, Toshiba, Hitachi, they are Japanese brands, but look at the back of their products and you’ll see made in Taiwan, Malaysia, China. That’s the current state of electrical goods.
“We’ve been saying the same thing will happen with cars, and it’s already happening with Nissan’s March. If the auto industry moves out of Japan, we won’t be able to maintain existing employment levels in this country.”
For Abe and Yoshimura the issues surrounding the two taxes are clearly separate. For his part, Doi stresses that, while a 10% cut in the corporate tax could be compensated for with a 4% rise in the consumption tax, it’s not a question of using a tax hike to finance a tax cut or a case of consumers versus corporations, since everyone benefits from economic growth.
Abe says there is also a difference in relative importance. Perhaps surprisingly for a business lobby representative, he says the need to raise the sales tax is more pressing than cutting the corporate tax.
But Tommy Kullberg, EBC chairman, says there should be no more waiting for a reduction in corporate tax rates.
“What we need is stimulus on the growth side,” Kullberg says. “Look at all the stimulus we’ve already had. The government has even been handing out cash to people, but how much growth has it created in the Japanese economy? People are just saving it.”
Kullberg adheres to the view that the corporate tax rate is an advert for a country and stresses that a lower rate can encourage companies to invest. He cites the example of his home country of Sweden which, despite its reputation for high taxes, has a rate of 26%.
“There’s no doubt it’s triggering foreign direct investment, and that’s what we need in Japan to increase competition and get protected Japanese companies back in business,” he says.
Kullberg talks about FDI as if it were a jump lead for sparking Japan’s stalled economic engine back into activity after two lost decades of stagnation. He refers to the impact on Japanese competitors of two companies he has been involved with, IKEA and H&M, in “stimulating business, not killing it”. Exposure to the toughest competition in the world is what drives development, he argues, not clinging to established practices of the past.
An anecdote about a recent shopping trip for a TV back in Stockholm well illustrates his argument.
“We could hardly find a Sony. When we did, it was in a corner. It looked thick and the technology old. Samsung and LG TVs from South Korea were top-of-the-line in terms of price and quality, and standing out en masse everywhere. This is a dramatic change compared to when we last bought a TV 10 years ago. Japan has not kept up with the competition.”
Boost growth
But if the need to lower the corporate tax and boost growth is such a no-brainer, why hasn’t the Japanese government already done it?
“Let’s sit in the chair of the Japanese minister of finance,” says Hans-Peter Musahl, a partner with Ernst & Young Shinnihon Tax in Tokyo who handles international and transaction tax services. “First of all, he has far less tax revenue than if he were in a country in Europe.”
While Japan generated tax revenue equivalent to 27.9% of its GDP in 2007, most countries in Europe had tax revenues between 30% and 48% of GDP. In the case of France, the figure was as high as 43% of GDP, he says.
“The result is that Japan needs to finance its spending by taking on debt, the limits of which have been made clear by the financial crisis,” explains Musahl, who is also head of the EBC Tax Committee. “Japan is paying interest on 200% of its GDP.”
“If I were sitting in the Ministry of Finance and somebody requested a significant corporate tax reduction, I would simply say, ‘How can I finance it?’ This is where the dilemma starts,” Musahl says.
According to Musahl, the corporate tax rate in Japan, which is at a world high of 42.1% in major cities such as Tokyo, also provides a relatively high proportion of tax revenue at about 20%, compared with less than 10% in Germany, for instance.
Raising the consumption tax seems like a more practical proposition, considering the much higher rates in Europe of 15% to 25%, he points out.
But Japan has been wary of doing this, he says, partly for fear of sparking a recession, as happened when then-prime minister Ryutaro Hashimoto raised the tax from 3% to 5% in 1997, a move Musahl describes as “the right thing to do at the wrong time.”
Nevertheless, Musahl believes a compromise can be reached. The corporate tax rate could be lowered, with countermeasures – such as restricting the change to companies of a certain size, or by discontinuing certain tax benefits – introduced to help compensate for the loss in revenue.
In the case of the consumption tax, maintaining or reducing the rate on essentials such as food might make it easier to raise the tax on other items. Increments of two percentage points in alternate years could limit the shock to the economy.
Regarding the effect on European firms, Musahl says a consumption tax increase would have a similar effect on everyone, although the double burden of consumption tax and acquisition taxes in the case of vehicles is a cause for concern.
On the other hand, a reduction in the corporate tax rate would be very positive for successful European firms already based in Japan. That being said, companies looking to enter, or in the process of entering, the Japanese market – a process Musahl describes as a five to ten year undertaking – might prefer to see the period for carrying over losses extended from the existing limit of seven years.
For Kullberg, lower corporate tax rates would encourage existing European firms to “take a fresh look at their operations” and move away from a low market share/high margin model, and to operate more like they do in the rest of the world.
Following his line of argument, that would not only be good for them, but also be good for the Japanese economy – and, by extension, those empty government coffers.