Reevaluation of “Special Taxation Measures”

Specific steps being considered to expand the tax base include a reexamination of write-offs for depreciation and a reevaluation of various “special taxation measures” introduced to address specific policy needs. Many have pointed to the need to reform these measures, which are being targeted for a zero-based review by the government Tax Commission. Specifically, the commission calls for the (1) abolition, in principle, of limited-time policy measures when their term expires; (2) establishment of expiration dates for measures whose terms are not specified, and a reprioritization of their policy focus; and (3) sweeping reevaluation, including abolition, of measures that apply to or are implemented for only a narrow range of businesses.

Many of these incentive measures were introduced on a limited-time basis to pull Japan out of deflation. Now that deflation has largely been overcome, they should quite naturally be eradicated. In the past, though, such measures often persisted even after their policy objectives had been met. The Tax Commission’s statement thus seeks to end this bad habit and restore the public’s confidence in the nation’s tax policy.

A law to enhance transparency, enacted while the Democratic Party of Japan was in power, is already leading to the abolition, under certain conditions, of measures that no longer widely apply. This is a step in the right direction, and active use should be made of this law.

In many ways, these measures are a carryover of the postwar “iron triangle”: the collusion among bureaucrats, politicians, and big business. And this is exactly the place where Abe should turn his “drill bit” to punch through the vested interests impeding structural reforms.

The Need for Structural Reform

Finally, I would add that it is not enough to simply lower the corporate tax rate. What the Japanese economy needs are structural reforms to the system of corporate taxation to win back public confidence in the government’s tax policy as a whole.

This will mean curtailing some of the tax breaks now available to various public interest corporations, including social welfare organizations, which were largely untouched in the reforms undertaken between 2000 and 2008. Given the changes in the environment surrounding public interest corporations, there should be a review of the preferential tax treatment accorded to these organizations—even when they are not-for-profit—with a view to placing them on an equal footing with private groups offering competing services.

Promoting Growth and Fiscal Consolidation

Many economists are likely to recommend that revenue shortfalls resulting from a cut in the corporate tax rate be offset with the additional revenues generated through the Abenomics policy of economic growth. Would this be feasible?

As I noted above, many former Soviet-bloc countries lowered their corporate tax rates following the Cold War to promote investments by West European companies. Germany, France, and other industrial countries responded by slashing their rates, triggering a rate-cutting war.

Corporate tax revenues as a share of gross domestic product in many member states of the European Union rose despite the lower rates—a phenomenon referred to as the corporate tax paradox. This has led some to argue that even if Japan’s rates are lowered, revenues may not drop at all.

Official EU statements ascribe this paradox to the fact that (1) the lowering of the (statutory) rate was accompanied by an expansion of the tax base and (2) the lower rates and growth strategies of member states encouraged corporate entrepreneurship, thereby boosting economic activity. An additional factor may have been the decision by many self-employed workers to incorporate their businesses in the wake of lower corporate taxes.

This experience offers a valuable lesson that if a cut in the corporate tax rate is accompanied by an expansion of the tax base and implementation of a growth strategy, policies to boost economic growth can go hand-in-hand with fiscal consolidation efforts. In other words, inducing a corporate tax paradox requires a bold growth strategy of deregulation and other measures that can boost business performance, leading to higher household incomes, dividends, and capital gains and resulting in gains in fiscal revenue and national income.

Higher revenues are a result of appropriate economic policy, not a precondition. And as long as the goal of a lower corporate tax rate is to both generate economic growth and restore fiscal health, any windfall resulting from the corporate tax paradox should rightly be utilized to achieve fiscal consolidation.

(Title photo: Corporate employees in Ōtemachi, Tokyo, where the head offices of many of Japan’s biggest companies are located. © Jiji Press.)