IMF Urges Japanese Consumption Tax Hike

by Mike Godfrey, Tax-News.com, Washington

20 July 2010

In an Article IV consultation with Japan, the International Monetary Fund concluded that adjustments towards fiscal consolidation needed to focus on a gradual increase in the consumption tax, supported by comprehensive tax reform, limits on non-social security spending growth, and reforms to entitlement programs.

The IMF stated that consolidation adjustments could be achieved in a number of ways centered around an increase in the consumption tax rate. Given the limited scope for cutting expenditures, the IMF thought fiscal adjustment would need to rely mainly on new revenue sources and limits on spending growth. In addition to letting fiscal stimulus expire (savings of 1–2% of GDP), the main elements of a credible package could include:

• A gradual increase of the consumption tax to 15% beginning in FY2011 and distributed over several years, which could generate 4–5% of GDP of revenue;
• A reduction of personal income tax allowances;
• Corporate tax reform to stimulate domestic investment;
• A single number system for taxpayers and social security to help in strengthening collections;
• Limiting expenditure growth; and
• Reforming pension entitlements in line with rising life expectancy.

The IMF and Japanese government together observed that a higher consumption tax would have the additional advantage of reducing the cyclical volatility of the tax base. The government also indicated that discussions were ongoing about a possible reduction in the corporate income tax rate.

As part of a possible fiscal rule, the IMF noted that the government was considering a “pay-as you-go” requirement (where new expenditures would be funded by offsetting spending cuts or additional revenue) and introducing a multi-year expenditure framework to strengthen budget discipline and planning.

The IMF said the government had stressed that any medium-term adjustment plans would need to be based on prudent macroeconomic assumptions and include sufficient flexibility to avoid the fiscal strategy being derailed by unexpected swings in growth.

Because of synergies between fiscal and structural reforms, the IMF noted the possibility of comprehensive reform legislation linking fiscal consolidation to growth enhancing measures and social security reforms.

With the large domestic investor base, the near-term financing risk was thought to be minimal and demand for long-term debt was robust, particularly among life insurance companies. The government would continue lengthening maturities of JGBs to reduce roll-over risks, according to the IMF.

The government told the IMF that in assessing fiscal risks, short-term financing bills should be treated separately from JGBs since the former were primarily used for cash management and were backed by the government’s foreign exchange reserve holdings.

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