RIETI Report December 2003

Initiatives for Fiscal Reconstruction <RIETI Featured Fellow> DOI Takero

Greetings from RIETI

The most difficult thing about Christmas is shopping. Not just fighting the crowds as one does it all at the last minute on Christmas Eve, but finding a meaningful present that will hopefully not be in the bin the day after Christmas. This is all the more exacerbated by the fear of the gift one gives being outdone by the gift one receives. There has been a trend in the U.S. to take the stress and materialistic guilt out of buying a present by donating the equivalent to a charity on the would-be receiver's behalf. Although this is undoubtedly a worthy use of money, Japan adopts the simplest and most embarrassment-free method of dealing with the exchange of presents at New Year in the form of the "otoshidama" - a strictly monetary gift.

This month RIETI Report had the pleasure of speaking with RIETI Consulting Fellow Professor Doi and hearing what sort of changes in the tax burden could be around the corner next year. (DC)


DOI Takero
After graduating from the Faculty of Economics at Osaka University, Prof. Doi went on to earn a master's degree and a Ph.D. in economics from the University of Tokyo. From 2001 to 2002, he was also a visiting scholar at the Graduate School of International Relations and Pacific Studies in the University of California, San Diego. In addition to having joined RIETI as a Consulting Fellow in January 2003, Prof. Doi presently serves in a number of roles in the economics arena, including: Visiting Economist, Economic and Social Research Institute, Cabinet Office, Government of Japan (since 1998); Associate Professor, Faculty of Economics, Keio University (since 2002); and Senior Economist, Policy Research Institute, Ministry of Finance, Government of Japan (since 2002). Recent publications include Public Finance and Japanese Economy, Kobun-sha (2002), and Introduction to Public Economics, Nippon Hyoron-sha (2002), both in Japanese.

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Initiatives for Fiscal Reconstruction

RIETI Report: The government is now finalizing tax reform plans and a budget draft for the next fiscal year. As a basis for assessing the ongoing debates on tax and fiscal measures, what is your observation of the current state of Japan's fiscal condition? And in which direction should we go from there?

Doi: Given the scale of outstanding government bonds, we cannot afford to keep on doing what we have been doing up until now and we must restore fiscal discipline. We must keep this in mind when designing fiscal management and a new tax structure. My understanding is that it is inevitable to increase taxes. There have been calls for fiscal reconstruction without tax increases; and based on such an idea, the government has been trying to cut expenditures. By now, however, it has become obvious that simply cutting expenditures is not enough to curb new issues of government bonds which amount to the tune of a little less than ¥40 trillion every year.

Ideally, we should be able to reduce the amount of outstanding government bonds, rather than simply cutting back on new issues, though the current economic condition is not yet ready for that. Regardless of the economic conditions, however, we need to start reducing new issues of government bonds. In this regard, I would like to welcome the fact that government officials began to vocally address the need to keep the percentage of total revenue supplied by bonds to no more than 50%.

It is indeed deplorable that we need to discuss the numerical target on such a base level. But still, I felt relieved to see that Japan has retained at least some sense of fiscal discipline after having gone through the history of breaking a series of fiscal bulwarks. The first bulwark, no-debt policy, was broken in 1965 with the introduction of "construction bonds," exclusively for the purpose of financing construction projects. Then, in 1975, the government began to issue deficit-covering bonds to help finance general expenditures, breaking the second bulwark of limiting government debts only to those for construction projects. The construction-bond-only policy was briefly revived during the bubble era, but was abandoned again following the burst of the bubble as the government embarked on sprees of expenditures to pump-prime the economy. Today, roughly two thirds of newly issued government bonds are deficit-covering bonds.

In answering the crucial question as to what we should do about the fast eroding of fiscal discipline, we have no other choice but to increase taxes. It is against such a background that the 50% figure came out.

RIETI Report: What is the driving force behind it? Is it because the sense of crisis is being shared more widely or because the government believes the economic condition has become stable enough to address the fiscal problem?

Doi: I believe that the sense of crisis, or the perception that the current situation is extremely abnormal, is basically the reason behind it, although it remains questionable as to what extent such a sense of crisis is being shared within the government.

At the same time, however, it is necessary to make people understand the degree of fiscal constraints. When the government has ample expendable financial resources, people can ask for what they want. But they cannot go scrounging when the government has fiscal difficulties. They need to understand that they would have to give up some of the benefits they are entitled to.

RIETI Report: That would bring up the question as to whether the government has been making sufficient information disclosure. What is your observation with regard to this?

Doi: Yes, disclosure is quite important. By now, it has become quite obvious that the government itself is saddled with an enormous amount of debts. In addition, we are beginning to see the problem of pension liability. So far we know that the public pension program is substantially underfunded. But the exact amount by which the program is underfunded would differ, depending on what promises are made regarding future payments. This would be clarified in the ongoing process of pension reform.

The larger problem is with the implicit debts that exist outside the government, most conspicuously those held by special public corporations (SPCs). The ongoing controversy over the four highway-related SPCs, which are suspected to be in a state of insolvency, is a symbolical case showing the nature of the whole problem surrounding various SPCs. That is to say, we have been unable to tell whether or not a certain SPC is insolvent, let alone the exact amount by which its liability exceeds assets, up until the moment the government finally decides to dissolve the SPC at the taxpayer's cost.

If people were to see a series of SPCs go under, pessimistic sentiment would spread. Still, the government had better disclose, rather than hide, all the existing problems, and do so as quickly as possible. People would probably ask who are responsible for the problems and this question, of course, must be answered. But once we are through with such a process, we should stop counting the amount of money that was lost and start thinking how we can best deal with the situation. This would inevitably necessitate the injection of a substantial amount of taxpayers' money and the government should waste no time in taking appropriate fiscal steps.

We must not repeat the mistake we made with the debts left by the former Japanese National Railways (JNR). At the time of its privatization in 1987, it was expected that some ¥14 trillion (out of a total ¥25.5 trillion in long-term debts taken over by the Japanese National Railway Settlement Corp.) would become irrecoverable and have to be covered by taxpayers' money eventually. The JNRSC, however, was unable to sell its assets immediately as the government feared that such a move would add more fuel to the then-ongoing asset inflation. Consequently, the amount of debts ballooned to ¥28 trillion in 1998 when the JNRSC was dissolved with the government taking over the liability that was left behind. We must not let the same thing happen again.

In solving the hitherto unaddressed implicit debt problems, the government would have to secure more tax revenue from those who can afford it no matter how difficult that may be. Before asking them to accept a greater burden, however, the government needs to show that it has done all it can do to cut expenditures.

RIETI Report: In achieving that end, what specific measures should the government take in the short term? Among those being proposed for the next fiscal year, what specific measures are you focusing on?

Doi: A proposal to increase the taxation of pension benefits, which has been put forward by the government's Tax Commission, is very much to the point. The idea is to ask rich elderly people to pay more taxes. Although the overall tax rates need to be raised, we cannot keep passing on the whole burden to the younger generation while letting most elderly people get away without paying any income tax. So, I do welcome the proposed increase of pension benefit taxation by means of lowering the maximum deductible amount.

Meanwhile, although some people are calling for the extension of the soon-to-expire special tax breaks for housing loans, I am opposed to the idea. Basically, I believe it is undesirable to use tax incentives to make people buy a specific item or property. Particularly with regard to the housing loan tax break, the impact is limited to bringing forward the timing at which people buy a house. Even if the government let the special scheme expire as planned, it is unlikely to bring any serious dampening effect on housing investments or the overall economy. People wishing to buy a house would do so sooner or later with or without the special scheme.

Deflation is the prime reason behind the stagnant housing investments. People wait to buy a house because they expect that prices will be lower next year. So, with or without tax breaks, once they begin to see signs of the ongoing deflation coming to an end, it will give a real push for housing investments.

Apropos of the fiscal predicaments of certain local governments, another focal point, which is subject to further discussion at the Tax Commission, is the "trinity" reform on taxation mechanisms of the local and national governments. This reform should be carried out in a way as to transfer taxation authority from the central government to local governments. I have great reservations about the idea of transferring tax revenues, which is tantamount to making the central and local governments vie for a bigger slice of the pie already out there when none of them can afford to give up any.

However, some positive moves are emerging. The Ministry of Public Management, Home Affairs, Posts and Telecommunications has recently proposed a plan to increase the amount of fixed per capita levy, or the non-income-linked portion of residential tax. The ministry also said it will revise the Local Tax Law to eliminate the ceilings on local tax rates. These steps are important for creating an environment where each local government borrows and repays debts under its own responsibility.

In addition to these measures, I have been calling for a shift from the current positive list system, under which the law stipulates what taxes a local government is allowed to impose, to the negative list system where a local government would be free to impose any new taxes other than those prohibited by law.

RIETI Report: So, all in all, we must be prepared for increasing tax burdens.

Doi: Yes. Actually, for the next 15 to 20 years, we had better not expect any net decrease in tax burdens. Moreover, I believe that the government should refrain from implementing discretionary tax incentives, even after the economy has recovered substantially.

The core problem with the Japanese economy is deflation and we cannot lift the economy by turning to tax breaks as an alternative to counter-deflation measures. However, we need to be careful about the timing of increasing taxes so as not to hamper economic recovery. This is why I believe the government should be focusing on the taxation of the elderly population, whose consumption behaviors are least affected by ups and downs in tax burdens. Those who are concerned about their health keep a firm hand on their purse strings regardless of the economic conditions, while those determined to enjoy their remaining life would not stop spending simply because they have to pay some additional taxes.

In the mid- to long term, the government would have to raise the consumption tax rate to a two-digit figure, while increasing the overall income taxes by lowering the minimum taxable amount to collect more taxes from low income earners and increasing the maximum tax rate applicable to high income earners. But the current economic condition is not yet ready for that.


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Initiatives for Fiscal Reconstruction <RIETI Featured Fellow> DOI Takero

DOI TakeroFaculty Fellow, RIETI

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