On September 30, the first business day after Mr. Ishiba Shigeru was elected as the new president of the Liberal Democratic Party, Tokyo stock prices plummeted, with the drop temporarily exceeding 2,000 yen. One factor cited for the decline is said to be Mr. Ishiba’s positive stance on strengthening taxation on financial income.
However, this issue is not new. The current system under which the income tax burden rate decreases for taxpayers with annual incomes exceeding 100 million yen, or the so-called " 100-million-yen wall," has long been a topic of concern.
A sense of unfairness in tax burdens
The income tax system in Japan imposes progressive taxation (up to 45%) for salary and business income, while a tax of 15% (20% in total when adding local tax) is imposed uniformly on financial income, such as interest, dividends, and capital gains. As high-income earners tend to have a larger portion of their income from capital gains, their effective income tax burden decreases.
In order to address this source of unfairness, the FY 2023 tax reform introduced measures to ensure that taxpayers with incomes over three billion yen face a minimum tax rate of 22.5% on total income. However, the numbers of individuals affected by this measure is very limited.
The treatment of financial income is also a concern in terms of the social insurance system. Currently, social insurance premiums are calculated based on earned income. For financial income, if taxpayers file a tax return, their income is reflected in the calculation of social insurance premiums. However, when financial income is taxed at source in specified accounts for transactions of stocks or investment trusts, filing of an income-tax return is not required and financial income is not reflected in the calculation of social insurance premiums.
This imbalance in treatment based on income type and whether or not a tax return has been filed is unfair. In the United States, in consideration of the fact that the maximum rate of Medicare tax on earned income is 3.8%, a new system was introduced to additionally impose a tax of 3.8% on net investment income from interest and dividends, etc. for taxpayers whose total income is above a certain level. In France, where social insurance premiums are converted to taxes, the general social contribution is imposed not only on salaries and pensions, but also on financial income.
Concerns over the strengthening of taxation
On the other hand, there are significant concerns over the strengthening of taxation. For example, the strengthening of taxation could hinder working generations' asset formation in preparation for their retirement. In order to prevent this, tax-free saving systems which exempt investment profits from taxation are effective. In practice, the government has made the NISA program permanent and significantly raised the annual investment limit. The government may also expand the individual-type defined contribution pension plan (iDeCo).
However, as the objective of these measures is to secure funds for retirement rather than creating inheritances, it would be preferable to limit the period during which people can hold assets tax-free. The NISA program sets no upper age limit. In contrast, the Individual Retirement Account (IRA) plan, a tax-free savings system in the United States, sets the upper age limit for withdrawal at 70.5 years, and the Registered Pension Plan (RPP) in Canada is set at 72 years old.
Efforts should also be made to direct the assets of wealthy individuals toward investment in startups and similar ventures. The FY2023 tax reform adopted a measure to exempt tax on amounts up to 2 billion yen for individual investors who reinvest capital gains from stock sales in startup companies.
An expenditure tax is essentially the generalization of this concept. Expenditure tax bases taxation on the amount of income that remains after deducting the amount of investment. Even if a taxpayer earns a high income, taxation on their income is deferred as long as they recycle their funds from their income into the economy in the form of re-investment.
On the contrary, when funds are withdrawn from investments for consumption (negative investment), the tax burden increases. The NISA program and iDeCo, mentioned above, are types of expenditure tax. If the government intends to strengthen taxation on financial income, approaches like the expenditure tax should be adopt to avoid hindering economic activity.
>> Original text in Japanese
* Translated by RIETI.
October 26, 2024 Weekly Toyo Keizai