Follow Us

Topics

News

More

In-depth The Challenge of Restoring Japan's Fiscal Integrity
Why Is Japan’s Consumption Tax So Low?

Kidera Hajime [Profile]

[2018.05.21]

At 8%, Japan’s current consumption tax rate is quite low compared to other advanced economies. This situation is explained by the Ministry of Finance’s postwar preference for tax policies centered on income tax and by the electoral losses of political administrations that sought either to introduce a general consumption tax or to increase the tax rate.

In April 2018, Angel Gurría, Secretary-General of the Organization for Economic Cooperation and Development, told Minister of Finance Aso Tarō, “Japan needs to raise its consumption tax rate in stages to around 19%, the average for OECD member nations.” Given the problems with public finances in Japan, why is Japan’s consumption tax rate less than the OECD average? In this report, I describe how the decision-making structure of Japanese politics has changed over time and unravel its process.

Income-Tax-Centered Policies

Before leaving a nation still exhibiting the scars of World War II, economist Carl Shoup(*1) described Japan’s tax system—long centered on indirect taxes—as “immature.”

Prior to World War II, tax policy in Japan centered on indirect revenue such as via the liquor tax. During the war years, the income tax was increased to raise war funds, becoming a central plank of the tax system. Since this made nominal income the unit of taxation, inflation bore down heavily on Japanese citizens after the war. Meanwhile, to curb inflation, the Allied occupation would not allow taxes to be lowered. This led the Ministry of Finance to introduce a turnover tax. This indirect levy on transactions at the stages of manufacture, wholesaling, and retailing invited fierce opposition from small and medium-sized enterprises, and it was withdrawn after a mere 18 months.

It was in this context that a mission led by Carl Shoup arrived in Japan to offer advice on taxation. The Shoup Mission recommended a fundamental overhaul that would place the income tax, a more modern form of taxation, at the center. The mission’s proposals were adopted nearly in full in the tax reforms of 1950. Shiozaki Jun,(*2) who was responsible for the turnover tax at the time and who later became director-general of the Tax Bureau, gradually came to recognize the superiority of an income tax that would contribute to the elimination of income differences. He has remarked that he learned the logic of democracy through the Shoup recommendations. They enabled income-tax-centered policies to take root at the Tax Bureau of the Ministry of Finance and established the direction for Japan’s postwar tax system.

Once the Allied occupation withdrew from Japan, the bureaucrats of the Tax Bureau gained authority over tax policy. The Tax Commission effectively controlled by the bureau became the highest decision-making body regarding the government’s reforms. While a value-added tax introduced by France in 1954 spread around the world, the Tax Bureau maintained its focus on income tax, and it adhered to an institutional philosophy of eliminating income differences through the adjustment of the progressive tax rate and of reducing the burden on citizens by lowering taxes. Even in the reforms of 1966, when a recession led to the issue of government bonds for the first time since World War II, the Ministry of Finance still chose to reduce income tax.

Adoption of Consumption Tax and the Age of Party-Led Tax Reform

A political realignment in 1955 gave rise to the dominance of a single party, and politicians representing special interests materialized in the Liberal Democratic Party. When the period of high economic growth ended, a politics of allocating benefits based on the natural increase of tax revenues became untenable, and such policies as tax exceptions, exemptions, and reductions gained importance. Around 1970, the LDP’s Research Commission on the Tax System began to mediate conflicts of interests between government ministries and industries and to influence the details of the tax system including exceptions and exemptions. A few members of the LDP leadership strengthened their political power to the point where the Prime Minister’s Office was simply sidestepped. In this manner, the LDP took leadership over tax policies from the Ministry of Finance. This change is epitomized by Yamanaka Sadanori,(*3) the reputed kingpin of the LDP’s tax commission, who is reported to have said that people like the prime minister who know nothing about taxes should just shut up.

Some of the criticisms that came to be heard were the unfairness of the income tax and the need for stable tax revenues in view of the regular issue of government bonds. In response, the Tax Bureau began to consider the use of indirect taxes. At that time these were a specific consumption tax assessed individually on such items as automobiles or liquor. The work of reforming the tax system ran into difficulties, however, when related business interests banded together and when politicians became involved, even when concerning a few items or a modest tax rate. As the bureaucrats of the Tax Bureau became tied up in responding to individual industries, they became more receptive to the idea of a general consumption tax that would assess a fixed rate on all products and services.

The Tax Bureau initially turned to the prime minister, who it sought to win over as opportunities arose. In this it succeeded, and the cabinet of Prime Minister Ōhira Masayoshi decided in January 1979 to aim for the introduction of a consumption tax in fiscal 1980. Prime Minister Nakasone Yasuhiro, strongly influenced by President Reagan’s tax reforms of 1985, developed an interest in fundamental tax reform, including the introduction of a general consumption tax. Both prime ministers, however, encountered strong opposition from voters, and both lost badly in elections: Prime Minister Ōhira in a House of Representatives election in 1979 and Prime Minister Nakasone in a House of Councillors by-election and in nationwide local elections in 1987. Consequently, the introduction of the consumption tax was abandoned.

Takeshita Noboru, who followed Nakasone as prime minister, viewed the introduction of a general consumption tax favorably. Yamanaka, who led the LDP’s tax commission and criticized Nakasone as ignorant about taxes, was open to such a tax. Yamanaka believed that Nakasone’s failure resulted from the opposition of small and medium-sized enterprises and the distribution industry. He held many hearings at the party tax commission attended by industry organizations, and he developed many tax exceptions for small and medium-sized enterprises, such as the temporary allowance of price cartels prohibited by the Antimonopoly Act. Gradually, business interests were pacified, and opposition weakened. On Christmas Eve of 1988, the Consumption Tax Act was finally passed. Even so, the LDP suffered a major loss in the House of Councillors election of the following year.

Prime Minister Takeshita Noboru in conversation with Yamanaka Sadanori (left), chair of the LDP’s Research Commission on the Tax System, on May 18, 1988, at the Prime Minister’s Office in Tokyo. The party tax commission adopted a tax reform plan that included the introduction of a 3% consumption tax in June. A related bill was passed in December and became law. (© Jiji)

The LDP’s tax commission remained powerful in subsequent years. In the first half of the 2000s, when Prime Minister Koizumi Jun’ichirō pushed for structural reforms, he left the discussion to the party tax commission and did not seek to assert leadership.

The Political History of the Consumption Tax

(*1) ^ US economist and professor of Columbia University (1902–2000).

(*2) ^ After working for the Ministry of Finance, became an LDP member of the House of Representatives, and later served as director-general of the Economic Planning Agency and director-general of the Management and Coordination Agency (1917–2011).

(*3) ^ An LDP politician (1921-2004). Served in such positions as director-general of the Defense Agency and the minister of economy, trade, and industry.

  • [2018.05.21]

Associate Professor of the School of Political Science and Economics of Meiji University. Born in Tokyo in 1978. Completed part of a doctorate program of the Graduate School of Arts and Sciences of the University of Tokyo. Doctor of Philosophy. Served as an associate professor of the Faculty of Law of Hokkai-Gakuen University before assuming his current position in 2014. Publications include Futatsu no seiken kōtai seisaku wa kawattanoka (Two Changes in Administration: Did Government Policies Change?).

Related articles
Other articles in this report
  • The Convenient Assumptions Behind Japan’s New Fiscal StrategyAbe Shinzō’s new plan to restore sound public finances postpones for five years the achievement of a primary balance surplus. This does little to quell uncertainties about the management of economic and fiscal risks, since it assumes the economy will grow rapidly through the maintenance of loose monetary policies.
  • Toward More Sustainable Social Security for JapanJapan’s public finances are burdened with massive deficits. The author explains the structural problems of public finances and their medium- to long-term risks.

Related articles

Video highlights

バナーエリア2
  • From our columnists
  • In the news