President Trump’s ‘Big Beautiful’ budget bill will add US$3 trillion to the United States’ US$35 trillion in public debt over the next few years, further increasing the country’s 125 per cent debt-to-GDP ratio. Japan’s government debt is double that as a proportion of GDP, at over 250 per cent.
Debt of any kind needs to be repaid — in this case by future taxpayers — but is not inherently bad. Borrowing to spend on education, health, infrastructure and the provision of other public goods can boost productivity, growth and future tax receipts. The United States and Japan, unlike Argentina or Greece, have debt denominated in their own currencies and will likely avoid defaulting on their debt or experiencing a financial crisis. But the repayment burden could be very high, especially when interest rates rise.
No wonder the fantasy of Modern Monetary Theory was so appealing to many in Japan: why not just keep printing money? The proponents of that form of pseudo-economics have been quiet since the return of inflation after the COVID-19 pandemic.
The Bank of Japan fought the spike in inflation with one hand tied behind its back, hoping that price rises were transitory. Simply put, raising interest rates to fight inflation would increase the repayment burden on government debt. The inflation rate did moderate last year, down close to the central bank’s 2 per cent target after spiking to over 4 per cent after COVID-19. But it is back up to over 3.5 per cent as voters head to the polls for Japan’s upper house elections on 20 July.
Cost of living pressures dominate the public policy debate in Japan, just as they have elsewhere, but that debate takes on a particular meaning in a country that had no inflation for decades until very recently, and where real wages are falling.
The Liberal Democratic Party (LDP) is in minority government in the lower house of parliament and could lose its majority in the upper house, which would put in doubt its ability to form government. Prime Minister Shigeru Ishiba has been under pressure from opposition parties, his own party and public opinion polls to cut the consumption tax in half to 5 per cent until real wages rise. Instead, he has promised a different populist measure of cash handouts of 20,000 yen (US$140) to every citizen and double that for children and low-income earners to compensate for price pressures on Japanese households. That will likely add to the inflationary pressure and public debt, although not by as much as a consumption tax cut.
Ishiba has refused to cut the consumption tax, citing the public debt emergency. He could also have argued that it is the tax that is favoured by economists because it is broad-based and more efficient than other tax regimes. Unlike other taxes, if consumption taxes are implemented without exceptions, they are difficult to avoid and hit big spenders. Consumption taxes have become a central part of a well-functioning tax system internationally.
In this week’s lead article, Richard Katz reminds us that ‘this is hardly the first time the LDP and Ministry of Finance have “cried wolf” over Japan’s fiscal situation’. Since 1975, when Japan ran a budget deficit, successive Finance Ministers and Prime Ministers have been ringing the alarm bells on imminent fiscal crises. When Japan’s public debt was at today’s US levels in 2001, then Finance Minister Kiichi Miyazawa argued that Japanese government finances ‘were very close to collapsing’.
Many investors lost fortunes short-selling Japanese government bonds that fund the government’s deficits — in what became known as the ‘widow-maker’ trade — believing that the unprecedented debt was unsustainable.
Yet the fiscal crisis hasn’t materialised and all that crying wolf has now led to debt apathy among the Japanese public. Some reassure themselves that government debt net of assets is smaller, but the largest government asset is the pension fund that cannot be liquidated without creating a different kind of crisis.
With no credible plan to resolve the cost of living crisis in Japan, populist calls for consumption tax cuts and cash handouts are likely to become louder. Katz notes the appeal of raising the corporate tax rate — corporate taxes have fallen and company profits and cash holdings have risen — to fund a permanent consumption tax cut but the effects of that are unclear, in theory and on the evidence.
What Japan needs is a mature and sensible approach to fiscal policy, to build a tax and transfer system that is sustainable even as the ageing population makes larger claims on the health and pension system.
A first step might be for Japan to create an independent fiscal institution, like the Congressional Budget Office in the United States or Parliamentary Budget Office in Australia, and their equivalents found in most OECD economies. An independent fiscal institution would bring more transparency and accountability to tax policy. That would be the start of a mature approach to tax reform in Japan that goes beyond ad hoc tinkering at the edges in response to immediate political pressures.
The EAF Editorial Board is located in the Crawford School of Public Policy, College of Law, Policy and Governance, The Australian National University.
Source: East Asia Forum
