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IMF Calls Second Japanese Sales Tax Hike 'Critical'

by Mary Swire,, Hong Kong

05 August 2014

At the conclusion of its Article IV consultation with Japan, the International Monetary Fund (IMF) stated that, within the country's need to pursue a medium-term fiscal consolidation plan, the second stage increase in the consumption tax to ten percent should go ahead as planned in October 2015.

The IMF welcomed the fact that "the underlying momentum in Japan's economy remains solid, with growth expected above potential. … [However, it also] emphasized that a concrete medium-term fiscal plan beyond 2015 is needed to build confidence in the path of public finances and limit fiscal risks." It encouraged the authorities to strike the right balance between fostering fiscal adjustment and supporting growth, with the scope for additional fiscal stimulus now being limited.

"With regard to fiscal policy, the rise in the consumption tax rate from five to eight percent [in April this year] was a major accomplishment, and the implementation next year of the planned hike to ten percent with uniform rates would represent further important progress," said Jerry Schiff, the IMF's Deputy Director for Asia and Pacific Department and Mission Chief for Japan. "But significantly more adjustment will also be needed to bring debt down as a share of gross domestic product (GDP)."

Despite consecutive consumption tax increases, it has previously been forecast that the gross debt-to-GDP ratio would still remain above 240 percent. It has been estimated that fiscal consolidation of at least ten percent of GDP will be needed over the next decade to put that ratio on a downward path.

There was therefore seen to be a need to lay out a concrete medium-term plan to reduce debt, and, in this regard, while the IMF concurred that the planned cut in the high corporate tax rate from over 35 percent to 30 percent or less could lift investment, it should proceed only in combination with measures to offset the consequent revenue losses.

The IMF noted that there is some scope for corporate tax base broadening, but that "an elimination of the most distortionary allowances or incentives, such as those for small and medium-sized enterprises [that currently pay tax at reduced rates or are tax-exempt], would provide only limited revenue gains. In addition, removal of some key allowances, for instance for research and development expenses, could weaken the positive investment effects of a rate cut and should be avoided."

It suggested that, "to limit fiscal risks while maximizing the economic impact, a new corporate tax schedule should be announced upfront, but phased in over time. This would help reduce the revenue costs and allow offsetting measures to be introduced over time to limit their growth impact."

It also considered that, as an alternative to a corporate tax rate cut, "consideration could be given to opt for an allowance for corporate equity (ACE), which would be a more cost effective way of encouraging investment." An ACE treats debt and equity financing in the same manner and has recently been adopted in some advanced and emerging economies.

Overall, the IMF agreed, Schiff concluded, that the medium-term fiscal adjustment "should be done in as pro-growth a manner as possible. There are a number of measures, including steps to broaden the personal income tax base, that can help reduce the deficit while also providing better incentives to work and invest."

TAGS: tax | economics | business | value added tax (VAT) | sales tax | fiscal policy | corporation tax | small and medium-sized enterprises (SME) | tax rates | tax breaks | individual income tax | Japan | research and development

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