21st Century Shape of Japan Series, No. 10

TO BE EFFECTIVE, GOVERNMENT REFORMS MUST BE ACCOMPANIED BY TAX REFORM

Revise the Income Tax Law so that expenses incurred in cultivating creativity and providing child care are viewed as necessary expenses

The first pronouncement made by the Koizumi Cabinet was "Economic recovery is contingent upon structural reforms." That pronouncement engendered the Reform Schedule issued by the Council on Economic and Fiscal Policy. Structural reforms, to be effectuated primarily by the government, include the following.

1. Reform of the administrative structure (mainly fiscal reform), i.e., the privatization or elimination of special and authorized public corporations
   
   
2. Rationalization of the recently reorganized central bureaucracy
   
   
3. Consolidation of local government entities; transfer of more authority to local government
   
   
4. The abolition or easing of regulations, a process strongly advocated by the Council for Regulatory Reform

These reforms will be reflected in the FY2002 budget. The problem is that any effects they have on economic recovery will be indirect, since the relevant economic indicator is the GDP growth rate. Final government consumption expenditures, public fixed capital formation, and increases in public inventories account for 24% of GDP, while the private sector accounts for 74%. Thus, it is obvious that economic recovery hinges on the vitality of the private sector. Increases in final private consumption expenditures, private residential investment, and private plant and equipment investment will lead directly to economic recovery.

What can the government do to encourage consumption and investment in the private sector? Normally, it would not be involved, since the private sector accomplishes these things on its own. However, the government can stimulate economic activity indirectly by the way in which it levies taxes. Therefore, structural reforms must be accompanied by reform of the tax system. Structural reforms can only provide an infrastructure for activity in the private sector. The most effective way to encourage private corporations to make effective use of that infrastructure is to reform tax law.

Economic recovery is contingent upon tax reforms

Why should tax laws be amended? There are several reasons, as follows.

1. In terms of the industrial structure, there is an urgent need for tax reforms that will nurture new growth industries. The government has issued a reform schedule, but has not specified any revisions of the tax system that will propel its reforms. Historically, Japan's cabinets have failed to bolster economic stimulus packages with tax law reform.
   
   
2. To develop innovative, intellectual products and to transform Japan into a repository of intellectual assets, tax reforms that support new products and skill development (of employees, researchers, and managers) are essential.
   
   
3. If we are to convince more corporations to restructure and to adopt the performance-based wage system, we will need programs that help reduce the strain on household budgets. Currently, there are more than 20,000 children on child-care facility waiting lists; this problem demands urgent resolution. If we expand the number of privately run child-care facilities, and establish a support system for women in the labor force, the birth rate, which is abysmally low, should rise. To that end, amendment of the Income Tax Law will be required.

Three tax law revisions that will bring about private sector-led economic recovery

First of all, we need to make it easier for new growth industries to raise funds by establishing a special stock exchange. The need to convert from indirect to direct financing has already been indicated, but the enactment and amendment of the requisite laws are lagging behind. The proposals issued recently by the Tax Commission are not forceful enough. Tax-free status should be afforded to profits realized on the transfer of property and dividends from investments in securities. A loss-offset program, which allows people to carry losses over from one tax year to the next, and then combine them with other income, should be instituted. Secondary industries, once the backbone of Japanese industry, have been taken over by China, which threatens to become the world's manufacturing center. Accordingly, Japan must make a structural transition, focusing on high-level, intellectual products created by the collective intelligence of the Japanese. The \1,400 trillion in financial funds held by individuals must be shifted en masse to this new growth area. Securities market-related tax reforms are also required to achieve this goal.

Second, the transition from a manufacturing nation to one that develops intellectual products can be accomplished only by respecting and encouraging innovation, and research and development. Intellectual industries are only as good as the intellectual developments of people who work in them. The traditional corporate employee is, in Marxist terms, a mere laborer. But today's employees are the generators of the nation's wealth (intellectual assets). We must change our value system so that we view expenses incurred in developing employees' skills as investments in the development of intellectual products.

Third, once the seniority-based wage system and lifetime employment have been superseded by wage systems based on performance and ability, it will no longer be possible to support a family on one income. More women will be entering the labor market. However, due to the shortage of day-care facilities, there is no incentive for them to bear children. That is why the birth rate is so low in Japan. We must eliminate the long waiting lists at existing day-care centers by establishing more facilities, and permit parents to deduct child-care-related expenses (approximately \120,000 per month) from their income tax payments. The desire to nurture future generations of creative people is one harbored not only by parents and grandparents, but also by every citizen of this nation. These are not future liabilities, but investments in the future.

According to Article 57.2 of the Income Tax Law, and Article 167.3 of the Income Tax Law Enforcement Ordinance, the scope of special expenditures of wage-earners is limited to five items. This list should be expanded to include expenses incurred in the pursuit of individual self-development, research and development, the purchase and maintenance of machinery, electronic equipment, devices and laboratories necessary for these, and child care. The Income Tax Law must be amended so that these expenses can be deducted from income.

These same allowances should be extended to sole proprietors. Namely, most of the household and household-related expenditures of sole proprietors should be recognized as necessary expenses (investments in intellectual product development). Consequently, Article 45 of the Income Tax Law and Article 96 of the Income Tax Law Enforcement Ordinance, which state that household-related expenses cannot be deducted as necessary expenses, should be amended so that the exception becomes the rule.