Fiscal 2018 Tax Reforms Aim at Overcoming Deflation

Morinobu Shigeki [Profile]

[2018.01.16] Read in: 日本語 | 简体字 | العربية | Русский |

The ruling coalition’s a tax reform package for fiscal 2018 responds to new work style reforms, bolsters income redistribution, and adds a new tax for travelers.

The Liberal Democratic Party and Kōmeitō announced a tax reform package for fiscal 2018 that will affect the income tax, the corporate tax, and the tax on business succession (inheritance tax) as well as establish such new taxes as a departure tax for travelers leaving Japan.

Strengthening Income Redistribution

Changes to the income tax include a reduction in the upper limit in earned income deductions for salaried employees and an expansion of the basic deduction for all taxpayers. These changes seek to respond to the government’s new work style reforms and to strengthen income redistribution.

The basic earned income deduction has long been standard for salaried employees. However, repeated measures to reduce taxes have increased it to an excessive level compared to other leading nations. In the last few years the government has placed an upper limit on the income deduction of high earners and reduced the amount of the deduction. The current tax reforms also curb the deduction, while including a measure to prevent the tax burden from increasing for households with children or family members needing nursing care. Under the new plan the tax burden will rise for salaried employees with an annual income exceeding ¥8.5 million, a change that will affect 2 million people, or about 4% of taxpayers. Meanwhile, with the increase of the basic deduction, the tax burden will decline for freelancers and the self-employed, whose numbers are expected to grow through work style reforms.

The taxation of pensions has also been strengthened. A higher tax burden will be placed on pension beneficiaries with pension income exceeding ¥10 million and on pension beneficiaries with earned income exceeding ¥10 million. This change will affect about 200,000 people, or about 0.5% of pension beneficiaries.

The administration of Prime Minister Abe Shinzō has not brought up the topic of taxpayer burden for some time. However, the current tax reforms have at long last examined the issue and have strengthened income redistribution. As such, the reforms represent a major turn toward preventing a widening of the income divide. Several factors explain this change. On the political front, the huge coalition victory in the most recent general election has stabilized political foundations. Another factor is the government’s desire to address the regressive impact on the relative tax burden of people with low incomes from the pending increase of the consumption tax in October 2019. The hope is that a higher consumption tax will be accepted if high earners are made to bear a larger income tax burden.

Encouraging Wage Increases and Capital Investment

The tax plan also made changes to the corporate tax as advanced economies are competing to reduce their corporate rates. US President Donald Trump pushed to cut the US corporate taxes to around 20% based on the view that the current average of 29.7% needed to be reduced to maintain competitiveness.

Japanese companies’ retained earnings marked a record high of more than ¥400 trillion at fiscal 2016 year-end. A major issue for Japan has been changing corporate behavior to direct such earnings toward boosting stagnant wages and increasing capital expenditures.

To encourage companies to allocate their retained earnings toward raising wages and increasing capital expenditures, the current tax reforms enable large firms to apply a tax credit of up to 20% and take advantage of a special provision lowering the effective tax rate to around 25% when they increase employee wages by 3% or more and make capital expenditures of 90% or more of current-year depreciation. The effective tax rate will be reduced by a similar amount when small and medium-sized companies increase wages by 1.5% or more against the previous fiscal year.

Such changes would run counter to the usual approach to reforming the corporate tax by expanding the tax base and reducing the tax rate. However, in view of Japan’s current economic situation, the government adopted the special tax measure for a limited period of three years out of a sense of urgency in getting firms to direct retained earnings toward higher wages and capital expenditures.

Promoting Succession of Small and Medium-Sized Companies

Another noteworthy change is the significant easing of the tax on business succession in light of the aging of the owners of small and medium-size businesses and the difficulty of finding successors. Over the next 10 years small and medium-sized businesses that meet certain conditions will have the tax on the total amount of succeeded shares waived when succeeded by the children or other relatives of the owner. Formerly, the number of jobs retained needed to average 80% of the level before succession for a period of five years after succession, but this condition was relaxed to make the tax measure easier to use.

New Measures for Travelers

Another development was the establishment of a departure tax in response to the need to develop tourism infrastructure to support the surging number of visitors to Japan. Starting on January 7, 2019, travelers will be assessed a tax of ¥1,000 when they leave Japan. However, the specific areas in which this tax revenue will be utilized will need careful monitoring going forward.

Currently, foreign travelers to Japan are exempt from paying consumption tax when buying either general goods or consumables costing ¥5,000 or more. The reforms change this to a combined total of ¥5,000 or more for both to make the duty-free measure easier to use.

In the area of international taxation, when a foreign company engages in business in Japan, it is not taxed if it does not have branch or fixed place of business. Because of the growing number of companies taking advantage of this loophole through transborder online services, though, the government has more carefully defined what constitutes a permanent establishment, bringing Japan in line with the international standards discussed as part of the OECD’s base erosion and profit shifting project. In the case of countries with tax treaties with Japan, such treaties will need to be revised.

Looking back on the five years of the Abe administration, Abenomics initially had an enormous effect on the growth of Japan’s economy through the depreciation of the yen and the growth of exports. More recently, however, Japan’s middle class has seen widening income disparity. The current tax reforms also aim to support the economy through the final stages of overcoming deflation.

(Originally published in Japanese on December 19, 2017. Banner photo: Chinese tourists departing from Kansai International Airport in February 2016 after spending the lunar new year in Japan. © Jiji.)

  • [2018.01.16]

Professor of Law, Chūō University. Senior Fellow, Tokyo Foundation. Born in Hiroshima in 1950. After earning a law degree from Kyoto University in 1973, joined the Ministry of Finance. Served as head of the Co-ordination Division, Tax Bureau; director-general of Tokyo Customs; and president of MOF’s Policy Research Institute. Holds an LLD in tax law. Is the author of many books, including Nihon no zeisei: Nani ga mondai ka (Flaws in Japan’s Tax System) and Shōhizei: Jōshiki no uso (Common Misconceptions about the Consumption Tax).

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