The government and ruling parties have decided to revise the “1.03-million-yen wall,” which represents the annual income limit below which taxation is avoided and consists of the basic income deduction of 480,000 yen and the minimum employment income deduction of 550,000 yen. The government is revising the limit after accepting the request of the Democratic Party for the People, which pledged to increase the disposable income of the people.
On the other hand, the government has set a goal of achieving a primary balance surplus for the central and local governments in fiscal 2025. If the tax exemption threshold is raised to 1.78 million yen from 1.03 million yen at present as requested by the Democratic Party for the People, income and resident tax are expected to fall by 7 to 8 trillion yen. If the tax cut is permanent, it will be difficult to achieve a primary balance surplus.
Certainly, there is the argument that if households’ disposable income increases thanks to the raised tax exemption threshold, consumption will be stimulated, boosting tax revenues. However, this claim may be too optimistic. If public finances deteriorate, social security and other benefits for citizens will be impaired.
Expanding Income Deductions and Challenges
An important consideration is whose disposable income will be raised. The expansion of income deductions does not benefit all taxpayers equally: it works in favor of high-income earners. For example, let’s check a case in which the basic income deduction is increased by 200,000 yen. As the top income tax rate is 45%, the tax reduction for taxpayers subject to the 45% income tax rate would be 90,000 yen (200,000 yen × 45%). Taxpayers who are subject to the minimum income tax rate of 5% would only benefit from a 10,000-yen reduction (200,000 yen ×5%).
The annual income level of 1.03 million yen is considered a barrier to employment. If a university student’s annual income exceeds 1.03 million yen, the student will be disqualified for the income tax deduction for specified dependent exemption for income tax purposes, burdening the student’s parents with a sudden increase in income tax. Working students thus often adjust their work schedules to prevent annual income from exceeding 1.03 million yen. Under the working student deduction system, however, students themselves do not have to pay income tax unless annual income surpasses 1.3 million yen.
If a measure is taken to raise the annual income threshold for the deduction for specified dependents in addition to the conventional and special spousal deductions to 1.5 million yen and reduce the deduction incrementally as income rises beyond the threshold, however, the barrier to an increase in the tax burden on parents will be eliminated. If the goal is to encourage part-time students and others to work, increasing the annual income threshold for the specified dependent deduction would suffice. The government has also decided to raise the annual income threshold under which people are eligible for the deduction. However, no tax cut will affect all taxpayers.
Tax Exemption - Another wall
However, there are reasons for dissatisfaction among the public, especially low-income workers. In a new economic stimulus package, as a response to inflation, the government decided to provide a 30,000-yen cash stipend to households that are exempt from resident tax (about 14 million households). Here is another wall defined by “tax exemption.” This wall begins with the cash stipend for households whose earnings are above the tax exemption threshold (1 million yen in annual income for a single-person household).
Many of these tax-exempt households are elderly, so the cash stipend is essentially support for the elderly. In Japan, there is no system to support working low-income earners like the earned income credit (tax credit with benefits) in the United States or the Universal Credit in the United Kingdom. If the income deductions were expanded for these people, it would disproportionately benefit high-income earners, as noted above.
Politicians are incentivized to take advantage of a defective safety net for pork-barrel spending to easily shift public opinion in their favor. What is required is a system such as a tax credit with benefits that both supports low-income workers and encourages them to work (thus stimulating economic growth).
>> Original text in Japanese
* Translated by RIETI.
December 28, 2024 / January 4, 2025 Weekly Toyo Keizai
