Japanese Sales Tax Hike Critical, Says IMF

by Mary Swire, Tax-News.com, Hong Kong

21 May 2010

The International Monetary Fund (IMF) has urged the government to perform a u-turn on its short-term moratorium on consumption tax hikes. Underscoring the need to capitalize on improved conditions in the economy, the Fund on May 19 advocated that the government hike the sales tax to reduce the country’s deficit and public debt - the highest among industrialized nations.

While the IMF has admitted that Japan’s debt levels pose less risk to global markets compared to other highly indebted nations, it highlighted that, with global scrutiny of public finances increasing, "the need for early and credible fiscal adjustment has become critical.”

“The fiscal response to last year’s recession was necessary and effective, but has pushed public debt to unprecedented levels,” the Fund observed, adding that: “In our view, fiscal adjustment should start in FY2011, beginning with a gradual increase in the consumption tax, to take advantage of the cyclical recovery.”

Were the government to introduce the Fund’s recommendation, it would signify a major u-turn on Prime Minister, Yukio Hatoyama’s election pledge to defer increasing the country’s sales tax until the next lower house election, which could be held as late as 2013.

Japan levies a 5% consumption tax - 4% federally and 1% at municipal level - on the majority of goods. Export-related transactions and certain types of services provided to non-residents are zero-rated.

However, while the IMF is calling for fiscal consolidation, the Ministry of Economy, Trade and Industry has recommended a dramatic cut to the corporate income tax rate, which currently totals 40.7%, by as much as 15%, to bring it in line with international norms. At the very least, the Ministry said the corporate tax rate should be cut by 5%, although this would reduce already lacklustre tax receipts by a third, it was disclosed.

The IMF welcomed Japan’s “ambitious pro-growth agenda," stating that “raising competition would enhance Japan’s long-term growth prospects,” particularly in light of faster growth in the region. Nevertheless, with instability surrounding debt globally, the Fund argued that any cut to the corporate tax rate be coupled with a sales tax hike to check rising deficit and debt levels. Japan's public debt currently stands at more than double the country's gross domestic product.

The Japanese government is expected to publish its new fiscal strategy in June.

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