Japan wants it both ways on tax

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Japan, it is often said, has low, US-style taxes with high, Swedish-style levels of provision. This is meant to be a bad thing, although I have always found it an admirable proposition.

Unfortunately, it is not true. Japan does have low taxes. According to the Organisation for Economic Co-operation and Development, its tax revenue as a share of output is just below 30 per cent, among the lowest of all advanced economies. That is roughly the same proportion as the US, with only Mexican and South Korean taxpayers less burdened.

Japan’s service provision, however, is far from that of the Swedish, whose tax take is about half of output. The Japanese state, contrary to common perception, is not bloated, with relatively modest numbers of public servants spreading relatively modest amounts of largesse. It has fewer than 40 public sector employees per 1,000 people, against 80 in the US and nearly 100 in the UK. Chronic budget deficits since the 1990s notwithstanding, it spends a lower proportion of gross domestic product on its citizens than most of its peers.

Until recently, nobody noticed. With a 1 per cent jobless rate prevailing for most of the postwar period, few cared that unemployment benefit was stingy and shortlived. Treatment of Japan’s elderly has been more generous. That was easy when everyone was young. In 1970, just 7 per cent of Japanese were over 65, a proportion that had leapt to 20 per cent by 2006. By 2050, four in 10 Japanese will have reached that milestone.

That sounds like an accident waiting to happen. If the tax system is left untouched, revenue will fall as the workforce shrinks. If benefits are maintained, spending will escalate.

The government has been quietly addressing the problem. It has, for example, been raising pension premiums and capping benefits. It has also been bearing down on medical costs, but asking people to contribute more from their own pocket.

Those stealth measures, together with six years of growth and a consequent recovery in the tax take, have shrunk the budget deficit. After interest payments, this has fallen from 8 per cent of GDP in 2002 to 3.4 per cent last year.

But asking people to pay more for less is rarely popular. Japan’s 12m people aged over 75 have rebelled against changes to medical provision. Dubbed the “hurry up and die” system by furious opponents, the new set-up obliges some of the poorest Japanese to pay more for healthcare. The elderly, among the staunchest supporters of the ruling Liberal Democratic party, have struck back in several by-elections. That backlash could yet foreshadow the end of the party’s virtually unbroken half-century in power.

Faced with this dilemma, Yasuo Fukuda, the prime minister, has done what any sensible politician would do. He has run a mile. This week he said the question of raising sales tax should be considered “over the next two to three years”. Given his lack of popularity and the average lifespan of Japanese prime ministers, that should comfortably see him into retirement.

Procrastination has been a repeated pattern, loathed by Japan’s mandarins. They regard an increase in sales tax – at just 5 per cent, well below the OECD average – as indispensable. They point out that, at 180 per cent of GDP, gross debt is the highest among advanced nations, although they rarely mention that, at about 90 per cent, the net debt position is far less alarming.

The mandarins are right that the tax system needs fixing. Compliance is worse than in many developing countries. After years of growth, two-thirds of companies pay no tax at all. The current system also penalises working women, not a good idea in a country that needs to raise labour participation, and is hard on the lower middle class to the benefit of the rich.

But raising consumption tax might not be the answer on two counts. First, it is a flat tax in a relatively regressive system. The push for fiscal rectitude has already widened Japan’s income gap. A consumption tax increase would make that worse. Second, it penalises households in a country that has been trying to figure out for decades how to raise consumer demand. Taking money out of people’s pockets is surely not the answer.

There are two groups of iconoclasts who say Japan can have it both ways. One is a minority of economists who argue that, because Japan is awash with savings, it is perfectly capable of running deficits indefinitely. That would allow it to square the circle of low taxes with adequate services.

Peter Tasker of Arcus Research says the government is obliged to run deficits to offset the combined savings in the household and, increasingly, the corporate sector. Surplus savings beyond that are sent abroad, showing up in a current account surplus of about 4 per cent of GDP. The Japanese, he argues, are living below their means, exporting wealth so that the British and Americans can live beyond theirs. To grind out more tax strikes him as both unfair and unnecessary.

That could go down as wishful thinking. Endless dithering will merely bequeath the problem to future generations.

Except that the other set of iconoclasts is bond traders. Collectively, they have decided to fund Japanese 10-year debt at a rate of 1.6 per cent, what Mr Tasker calls “about the cheapest funding in history”. The bond markets, evidently, are much more comfortable with Japan’s chronic deficits than its mandarins.

david.pilling@ft.com

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