Institutional transformation: 1993 as a turning point
Future historians would recall 1993 as a turning point at which Japan entered the era of institutional transformation. It is about that time when the burst of economic bubble was widely recognized and the single-party rule by the Liberal Democratic Party came to an end. Ever since, various social rules, which people had long taken for granted, have begun to falter. Nevertheless, people generally remain numb to the changes that are now occurring in the institutional systems. Why is it so? I believe this numbness is attributable to the fact that the "frame of the country (state)" - which is formed by relationships between politicians and businesses, between politicians and voters, between bureaucrats and bureaucrats, and between bureaucrats and politicians - remains unchanged. To foster various innovative efforts in the private-sector domain and promote the evolution of a vigorous Japan model, it is necessary to carry out drastic reform on the political and administrative systems and enhance their complementary functions.
A fiscal system forms the foundation of the state as an institution. A government, in exchange for its duty to provide public goods and services in a broad sense, is given power to levy taxes as a means to finance its activities. Giving such authority to a government, however, also means giving the government the potential ability to unilaterally infringe on (part of) people's personal property rights.
From this fundamental structure evolves the "frame of a state," or various institutional frameworks that control or allow for the discretionary exercise of power by a government. In today's Japan, I am afraid that the very "frame" of the state is being questioned.
Many people say that Japanese households have financial assets worth \1.4 quadrillion even though Japan's economy remains stagnant. In reality, however, half that value has been virtually eroded for the future repayment of government debts. Worse still, because most of the debt repayment burdens extend over future generations, we embrace this serious problem in terms of intergenerational distribution.
It is egoistic for older generations to blindly rush for economic pump-priming measures through expansionary fiscal expenditure with no regard for the future. On the other hand, however, no fundamental solution comes out by simply calling for streamlining administration and restricting the issuance of government bonds. The question is how we create a mechanism that enables citizens (taxpayers) to monitor the efficiency and fairness of government activities.
Transforming into a country with discipline
First, let's take a look at the decision-making mechanism for fiscal expenditures. Currently, intensive prior screening of budgetary requests by the Ministry of Finance's Budget Bureau and the single-year budget system, under which budget needs to be implemented strictly within a single fiscal year, form the backbone of the mechanism. However, as the world is becoming increasingly complicated and going through drastic changes, various problems that cannot be properly coped with under the existing mechanism are emerging.
I do not mean to question the quality or moral of individual budget examiners at the Ministry of Finance. Even an examiner who is subjectively austere, neutral and capable, would find it difficult to assess and judge, beforehand and in line with the principle of zero-based budgeting, the relevance of meticulous budgetary requests filed by each government ministry. Thus, every year, budget negotiations between the Ministry of Finance and each requesting ministry center on ups and downs in allocations for routine budgetary items.
As a result, budget officials at requesting ministries would get credit for their career by winning additional budget allocations, not by saving on budget. Meanwhile, new budget items must be "prudently" negotiated for several years and then go through a stage at which they receive funds from a discretionary reserve before becoming a full-fledged budgetary item entitled to budget allocation under its own name. The existing decision-making mechanism for budget expenditures, thus, has a built-in inertia that leads to expansive and rigid expenditures.
A paradigm shift from the ex ante screening system to an ex post assessment system must take place. For instance, we can envision a mechanism in which the Council on Economic and Fiscal Policy would set basic guidelines for the functional distributions of fiscal expenditures in line with the Cabinet's policy priorities. Based on these guidelines, the Ministry of Finance would draft a plan on budget allocations for respective ministries, which would be deliberated and approved by the Diet. Based on the Diet decision, government ministries would formulate more concrete budget plans respectively. In doing so, however, they would be allowed to fine-tune their actual expenditures flexibly by spreading expenditures beyond a single fiscal year. The Ministry of Finance, while seeking advice from external experts, is to conduct strict ex post assessment on the effect of fiscal expenditures by each ministry and report its assessment results to the Diet.
Such a mechanism that facilitates the feedback of ex post assessment results would help curb each government ministry's wasteful expenditures. Politicians, for their part, would be able to wipe out their conventional image as a mediator of individual interest groups by participating in a budget formulation process through more fundamental policy dialogue.
Second, there is the question of taxation reform. Under the name of neutrality and technicality, Japan has developed a complex web of tax laws. Criticism is growing over the exclusive and arbitrary role of the LDP's Research Commission on the Tax System in changing the nation's taxation system. Due to the rigidity of the taxation system, the government has been almost entirely counting on fiscal measures to stimulate the economy. But it has now become clear that public expenditures have little multiplier effect as a means to create jobs.
Rather, it is hoped that the taxation scheme will be transformed into one that would motivate companies to make capital investment, for instance, through neutral reduction of corporate tax burdens. Such a paradigm shift will also call for the leadership of the Cabinet. Party politicians' knowledge on taxation systems should be demonstrated in the course of transparent processes such as the Cabinet and open debates at the Diet or elsewhere.
Furthermore, the taxation base needs to be expanded based on a universal rule. This is necessary not only as a means to fulfill a technical need to increase fiscal revenues.
From the standpoint of those who are exempted from taxes, a state (politicians) is (are) nothing but an indulgent guardian from whom they one-sidedly seek economic benefits (rents). A moral hazard, in which operators of small and midsize enterprises intentionally generate losses by lavishing on themselves so that they can evade tax payments, has been rampant.
In order to create the form of a country with discipline, the minimum taxable income needs to be lowered, thereby obliging more low-income earners to pay income tax, while pro-forma standard taxes should be imposed, as a general rule, on all companies which receive the benefits of public services in various forms, such as the protection of contracts and the provision of public infrastructure. The measure would increase taxpayers' incentive to monitor the government's wasteful expenditures.
Third, the decentralization of fiscal authorities needs to be promoted. In distributing public infrastructure such as roads, education and nursing services for the elderly and infants, the conventional uniform management by the central government cannot fulfill people's increasingly diversifying needs. The time when providing uniform standard services through the intensive central management was a top policy agenda has come to an end.
For instance, if privatized companies owned roads, it would limit their fresh investment within the scope of their respective toll revenues. This should not be the only institutional device for preventing wasteful expenditures on road constructions. The measure may end up keeping toll rates at high levels, which may undermine the Japanese industry's competitiveness in the global market.
Roads, as a public asset, have a public goods aspect that calls for financing by taxes. Still, it is necessary to create a mechanism that facilitates investment in accordance with economic needs by preventing a budget-grabbing game among local governments and wasteful investment, for instance, on the construction of two stretches of roads - a farm road and a general-purpose road - in parallel. To achieve this end, it is necessary to transfer decision-making authority and relevant taxation authority from the central to each local government that is held directly accountable to beneficiaries. The Ministry of Public Management, Home Affairs, Posts and Telecommunications' guarantee attached to bonds issued by local governments and the existing subsidy system for public investments drive local governments to lax fiscal expenditures, fostering a moral hazard among them. In this regard, the concept of fiscal federalism, which has been attracting attention lately in the fields of political economics and public finance, is quite suggestive.
According to this concept, the central government needs to make an institutional commitment (promise) that it will not bail out a local government in fiscal crisis as an incentive to enhance efficiency and fiscal discipline in the provision of public assets. The integration of the European Union (EU), in this point of view, is meaningful. As a result of giving the European Central Bank the exclusive right to issue currency, the member states of the EU have been effectively forced to be subjected to harmful budgetary constraint as they are no longer able to finance fiscal deficits by printing bank notes.
Taxpayers' judgment to become driving forces for reform
In order to realize the aforementioned reform in Japan, allocation of roles and responsibilities among the Cabinet, central administrative ministries and agencies, and local governments needs to be changed drastically. The relationships between politicians and administrators as well as the mindsets of citizens, taxpayers and voters must be changed, too. But this is no easy road and neither politicians in Nagatacho nor bureaucrats in Kasumigaseki will likely initiate such changes.
Ultimately, taxpayers (or voters) hold the key to selecting a model such as the one described here. Sooner or later, people may become more conscious about making choices. The tendency observed in a series of recent local elections points to such a potential possibility. And it implies why the year of 1993 was the milestone mentioned at the beginning of this article.
* This is the translation of the Japanese article in the "Keizai Kyoshitsu" column of Nikkei Shimbun on Jan. 7, 2003.
January 7, 2003 Nikkei Shimbun
