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Japan's New PM Faces Taxing Questions

by Mary Swire,, Hong Kong

01 October 2007

Facing a mountain of government debt and a future shortfall in social security funding, Japan's new Prime Minister Yasuo Fukuda will be called upon to make some tough decisions on tax policy, especially with regard to the politically-sensitive issue of the consumption tax.

Before a succession of political scandals, an electoral reverse and a foreign policy deadlock overtook former Prime Minister Shinzo Abe, Fukuda said during a debate in Tokyo that a rise in the 5% consumption tax was "inevitable". But, since Fukuda was sworn in as Japan's new Prime Minister earlier this week, the leadership of the ruling LDP party has softened its tone, with party Secretary General, Bunmei Ibuki ruling out any decision on the matter in the immediate future during an interview on Thursday.

However, the LDP's new policy chief, former Finance Minister Sadakazu Tanigaki, is in no doubt that Japan will have to face up to the fact that consumption tax will have to rise if the government is to meet its future social security obligations.

"We are not going to resort to the sales tax from the beginning, but in the end I think we will conclude that it's best to finance the pension scheme with the sales tax," he told Reuters.

With a debt equal to 150% of its gross domestic product - the highest in the industrialized world - and a demographic timebomb ticking as Japan's working population diminishes in comparison to the retired, tax and fiscal reform has been a major priority for successive governments in recent years. However, agreement on the measures needed has been hard to come by, and a decision on the consumption tax, which is perhaps the tax with most scope to raise revenues, has been repeatedly put off.

It is thought by economists that a government plan to boost its contributions to the state pension fund by 2.5 trillion yen (US$21.6 billion) in 2009/10 could be easily offset by a 1% rise in consumption tax. But even a relatively small rise in the levy could prove very unpopular, and similar moves in the past have contributed to the downfall of at least two Prime Ministers. Moreover, a devastating defeat in elections to the upper house of parliament earlier in the year, when the opposition Democratic Party, which opposes a hike in consumption tax, won a substantial majority, has further hamstrung the government on the issue of tax reform.

According to the IMF, increasing the rate of Japan's consumption tax would be less detrimental to growth and more equitable across generations than other forms of tax-raising measures. The IMF has also urged Japan to widen its tax base "given the size of the task at hand". Some IMF Directors have, however, viewed the authorities' focus on expenditure adjustments as "broadly appropriate at this juncture". But with the government intending to balance the budget by 2011/12, some tough decisions on taxation will have to be made in the months and years ahead, whatever the political leanings of the party in power.

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