Policy Update 013 Pre-event Report No.1

Underlying the RIETI Fiscal Reform Project: A Unique and Coherent Viewpoint

TSURU Kotaro
Senior Fellow, RIETI

With tax revenue dwindling amid ongoing deflation and snowballing debts left over from massive past fiscal expenditures, Japan is now facing the potential risk of fiscal bankruptcy. Against such a backdrop, the Research Institute of Economy, Trade and Industry launched a "fiscal reform project" in December 2002. Project members have since discussed and analyzed an ideal form of fiscal system and created specific policy proposals for achieving it. In the upcoming RIETI Policy Symposium "Fiscal Reform of Japan: Redesigning the Frame of the State" to be held on March 11 and 12 at the United Nations University in Tokyo, they will present the hitherto-obtained findings of these studies while inviting commentaries from various experts in lively debate. As they prepare for the event, we asked our fellows about the focus of the symposium and the uniqueness of this project. For this the first in a series of reports in the run-up to the event, we asked RIETI Senior Fellow Kotaro Tsuru, who has been involved in the operation of it together with Project Leader Masahiko Aoki, about the background to and proceedings of the project to date, as well as about the principles underlying the symposium.

RIETI Editorial Team: Could you tell us why and how the fiscal reform project was launched?

Tsuru: This project was launched toward the end of 2002. That was the year in which fiscal problems continued to be a major issue in macroeconomic policy, and tax system reform was subjected to intensive debates at, among other places, the government's Council on Economic and Fiscal Policy. Fiscal problems are an all-Japan issue that encompasses every government agency. Therefore, we thought that this was a theme that RIETI - a research institute that advocates cross-disciplinary policy studies - was cut out for. Early in January 2003, President Aoki wrote an article entitled "Quicken Shift to a New Fiscal Framework: Flexible Implementation of Simplified Taxation System" that was published in the "Keizai Kyoshitsu" column of the Nihon Keizai Shimbun, wherein he proposed the idea that a fiscal system forms the "frame of a country (state)." With this idea as a starting point for discussion, we have studied a broad range of themes relating to the fiscal system and structures. In the one year or so since the launch of the project, we have held 14 editorial meetings in which all the project members participated. Also, in September last year, we organized a two-day workshop to present interim reports of our studies that served as the foundations for reports that will be presented at the forthcoming symposium. I firmly believe that all these activities have enabled us to substantially deepen our discussions.

RIETI Editorial Team: What are the problems plaguing Japan's fiscal system today?

Tsuru: In terms of fiscal deficits and government debts, Japan, which used to be a model student among the countries belonging to the Organisation for Economic Cooperation and Development, fell in status to become an underachiever in the 1990s. The current fiscal state of Japan is not sustainable. Although fiscal situations have been deteriorating lately both in the United States and Europe, their conditions are not comparable to the situation we have in Japan. Discussions on fiscal reconstruction tend to concentrate on where to cut fiscal expenditures or under what title taxes should be levied or increased. However, we believe that focus should be placed more on institutions, or the question of framework, to find the answers as to why we have ended up with the current conditions. To focus on institutions and frameworks is to focus on the behaviors and incentives of respective players, namely politicians, bureaucrats and members of the private sector. For instance, fiscal expenses that benefit the constituencies of influence-peddling politicians and the compartmentalized system of budget formation and expenditures under so-called "bureau-pluralism" can be cited as institutional factors behind the bloating of the government's fiscal expenditures.

RIETI Editorial Team: What is unique about the RIETI fiscal reform project?

Tsuru: The diversity of the backgrounds of project members. One characteristic of RIETI is that it embraces researchers of different types and from a variety of fields. Of the 17 researchers who are to make presentations at the upcoming conference, seven are full-time fellows at RIETI, six are full-time bureaucrats at government agencies - such as the Ministry of Economy, Trade and Industry, and the Ministry of Finance - who are engaged in research activities at RIETI as consulting fellows, and four are faculty fellows who hold positions at universities; all told, a well-balanced lineup of speakers.

When discussing the fiscal system, it is important to know the actualities of the decision-making processes for budget formation and taxation schemes. In this respect, we have three officials from the Ministry of Finance on our team. We also have a local government official who is well-versed in local finance, while another member of the project used to work as a public servant in the U.S. on the Senate Budget Committee. So, it is fair to say that our project members are very much tuned into what happens in the real field of operations.

Also, although the fiscal system has been chosen as our theme, only a few of our project members are from the area of public finance study. So, another unique aspect of our project is that researchers specialized in a range of fields - including political science, economics of institutions, information and incentives, economic history, and business administration - are tackling this issue with a variety of approaches that differ from conventional ones. For instance, when Senior Fellow Yoshinori Yokoyama, who has years of experience as a business consultant, was asked by the Japanese government to give advice on how to solve the nation's fiscal problems, he offered concrete policy proposals for solutions and strategies from a unique position as if he were a consultant to the Japanese government. We have had researchers from manifold and diverse backgrounds discuss freely and without reservation, notwithstanding their original affiliation or footing there. Indeed, our members are so forthcoming with their opinions that our discussions have often become a little too heated. Nonetheless, such debates have been very stimulating to our team and helped deepen discussions thereby having a positive synergistic effect.

RIETI Editorial Team: Could you give us an overview of how the symposium will run?

Tsuru: On the first day (March 11) of the two-day symposium, discussions will center on general issues. In Session 1, presentations will provide a bird's-eye view of the whole project, while Session 2 will focus on the relationships between fiscal, political and bureaucratic systems. Following that, in Session 3 we will try to put our ideas into historical context and discuss the issue of public awareness, specifically, by reflecting on Japan's pre-war fiscal system and deriving lessons from the U.S. experience with not-for-profit (NPO) activities. Session 4, the last session of the first day, and the entire second day of the symposium (March 12) will be devoted to discussions on tax, budget and local public finance systems, which are key components of the institutional design of the fiscal system. Here again, various perspectives will be offered for discussion, including quite unconventional ones. We will look at Japan's fiscal structure in various ways, for instance, defining it as a problem of long-term budgetary constraints or approaching from the viewpoints of political economic science, management and the system of governance. In the final part of the symposium, we will discuss the long-term outlook for Japan's fiscal situation based on figures, using model simulation and analysis of balance sheets.

RIETI Editorial Team: Finally, what will be the underlying principles throughout the symposium?

Tsuru: We are still discussing our cross-cutting conclusions. But we don't want to stop at just what to do with fiscal deficits and government debts. Starting with how we should reform incentives for players involved in the fiscal system and structures, we would like to lead our discussion eventually to the issue of public awareness and politics.

Firstly, with regard to the organizational structure of the government and the decision-making process, there is the argument of how to strike a balance between centralization and decentralization. The presence of influence-peddling politicians who seek to dispense favors to their respective constituency and bureaucrats who prioritize securing their own ministry's interests have been cited as reasons behind the lax fiscal management. And now, through the experiences of other countries, the necessity of having a decision-making authority centralized in the prime minister and/or finance minister has been clearly understood. On the other hand, however, it is also true that such centralization is apt to undermine transparency and flexibility in fiscal policy. The question of how to create a transparent and independent organization that can carry out cross-sectional fiscal reform - including improvement of the existing Council on Economic and Fiscal Policy - will become a key point.

In order for fiscal reform to succeed, public awareness must also be changed. Each person needs to understand the problem of "long-term budget constraints" and clearly recognize that we cannot forever keep passing burdens onto future generations. Greater taxpayer awareness might enable the government to capture a greater scope of the people's income or bring the taxpayer to recognize the need and responsibility to monitor the government so as to ensure efficient use of their money. A big question is whether or not Japanese taxpayers will come to recognize this. Such a change in the people's awareness - which would make the fiscal problem a major point of contest among parties and might enable a supra-partisan consensus of not postponing its solution - would be a major step toward the realization of fiscal reform.

>> Original text in Japanese

February 23, 2004