Japan's Rating Downgrade Could Help Fiscal Reforms

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

01 February 2011

After the credit rating agency, Standard and Poor’s (S&P), cut Japan’s long-term rating by one notch, citing fiscal concerns, Prime Minister Naoto Kan has promised to maintain the government’s push for tax reforms.

For the first time since 2002, S&P has reduced Japan’s long-term rating, from AA to AA-. This brings its rating to the same level as China, which had its rating improved last month.

S&P cited the expected continual rise in Japan’s already-high level of public debt, at around double the size of its gross domestic product, and a forecasted fiscal deficit that will show, at best only a marginal fall, from just over 9% last year to some 8% in 2013. It also feared the future burden on the country’s finances posed by its ageing population.

It was concerned that the Japanese government did not have a “coherent strategy” to resolve the country’s fiscal and debt problems, and doubted that the problem would be resolved by the current internal debate on reform. Given, however, that Kan has put tax and social security reforms at the top of his government’s priorities, it has subsequently been said that, perversely, the S&P downgrade may have now provided him with an opportunity to unite the country’s political parties.

The government’s reform programme is expected to include, particularly, an increase to Japan’s 5% consumption tax, whose passage will need the support of opposition parties after the government lost its majority in the parliamentary upper house last year. The government is still nervous of proposing its increase following its shelving after a proposal to double it to 10% became a major cause of the government’s unpopularity and electoral defeat in July.

Kan has accepted that he had, last year, been unable to explain a rise in consumption tax sufficiently to get the public’s approval, but that it was now imperative to discuss such an increase, and further reforms to the tax system, linked directly to providing the financial resources necessary to fund the rapidly-increasing costs of pensions and health care.

While members of the government have previously been stressing at every opportunity that present taxes will be unable to provide the necessary revenue to cope with increased social security costs, it had been said that he was unlikely to receive the necessary support even within his own Democratic Party, which has also remained divided on the policy.

With repeated calls for Kan’s resignation and for early elections to be held, it has been doubtful whether the government could even survive in the short term. However, immediately after the announcement of the S&P downgrade, he was able to reiterate his determination to formulate tax policies that he has said should be produced by the middle of this year.

Despite a political slip-up when he, at first, appeared to be unaware of the significance of the ratings cut, he has also repeated his call for fiscal restraint to be discussed across parliamentary party lines to obtain as wide-ranging an approval for tax reform as possible.

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