The IMF issued a report on Japan’s economic position on 31 July 2017 following the conclusion of discussions under Article IV of the IMF’s articles of association.
The report notes that Japan’s economy is growing above potential with positive private consumption growth and stronger private investment. There are however labor shortages, weak wage growth and persistently low inflation. The IMF expects the growth to continue through 2017 but to fall back in 2018 if the fiscal stimulus support decreases as currently planned.
The IMF directors consider that the current favorable environment provides an opportunity to go ahead with a comprehensive reform package to sustain growth, raise inflation and deal with the medium term challenges including fiscal consolidation and increasing potential growth.
A selected issues paper published at the same time as the report looks at tax policy challenges of an aging and declining population. This notes that the consumption tax should remain the main part of revenue reform but that the timing of rate increases is important. Other potential tax measures should also be examined.
The consumption tax is an important policy owing to the size of the public debt and the need for more health and social security spending for the ageing population. Although expenditure reform is also required Japan will need additional revenue. The consumption tax rate is currently low relative to other industrialized countries and there is therefore room for raising the tax rate. Also the efficiency of collection of the consumption tax is high so more revenue can be raised with low collection costs. Raising the consumption tax rate is likely to be less detrimental to economic growth than other tax options. A gradual increase each year would reduce any volatility of the impact on growth. The IMF is therefore proposing gradual increases to the consumption tax as part of a broader fiscal adjustment package.
Other potential tax measures
Other taxes such as a tighter personal income tax, property tax, inheritance tax or asset and wealth tax could also be examined to supplement the revenue gains that can be earned from the consumption tax increase.
Personal income tax
Tightening the personal income tax would contribute to revenue growth. The top rate of personal income tax is currently one of the highest in the OECD but reforms could focus on addressing inequality and eliminating disincentives to work. The low collection level of the tax indicates that there are a large number of deductions and these enable the higher earners to obtain benefits. The deductions could be replaced with more progressive measures such as targeted tax credits.
This could be linked to other reforms such as eliminating disincentives to full-time or regular work resulting from the operation of the spousal tax deduction. Exemptions for pension income could be reduced and targeted tax credits for elderly workers could increase incentives for them to remain in the labor market.
In Japan only 30% of local tax revenue is raised from recurrent property tax, compared with 100% in the UK and Australia, 90% in Canada and 75% in the US. Raising property taxes would provide a more stable revenue base for local governments and reduce the level of transfers from the center. This could encourage growth and raise revenue as property tax is the most efficient tax.
Asset or wealth tax
Only a few countries currently use wealth taxes and one important motivation for them has been as a temporary measure in a broader fiscal consolidation. Countries that scrapped their wealth taxes cited high administrative costs compared to revenue collected and problems of capital flight as reasons for its discontinuance. Generally a wealth tax is best structured with very few exemptions, a high threshold of liability and a flat marginal rate set at a low level.