Fiscal Policy

Miscellaneous Notes

Fall 2000

Economics 285

Main Tax Issues

• Japan is not a “republic” so the national budget is key.– In contrast, any analysis of the US must focus on state

and local government

• You need to examine:– The main budget– Supplemental budgets– FILP (Fiscal Investment & Loan Program)

Why does it matter?

• Taxes distort decisions– Inefficient taxes can be costly!

• Ex: a 100% tax generates no revenue but stifles activity!

– Taxes can change income distribution• Shouldn’t the rich pay proportionately more?

– Taxes can be unfair if random in impact• Shouldn’t people with identical incomes pay

identical taxes?

Why does it matter (II)• Aggregate levels are part of fiscal policy

• Taxes have “feedback” (multiplier) aspects

• Deficits (surpluses) affect interest rates

• Are current policies sustainable?

• Used well?• What are they spent on?

• Have they “worked” as fiscal policy?

• Is more decentralization desirable?• Local government ability to set priorities

Expenditures

• How does the Japanese government view its role in society?

• The structure of expenditures is one measure of how the government views its role

• Need to disentangle “rational” policy from the purely political

• Examples• National health care

• Construction

Are Japanese Taxes High?

Comparative Structure

CompositionComposition

of

Taxes in

Japan

Overview of Public Finances

Entitlements in JapanEntitlements in Japan

Japan’s Old Age Boom:

Ratio of Elderly to PopulationRatio of Elderly to Population

Trend of the Number of Births and the Total Fertility RateTrend of the Number of Births and the Total Fertility Rate

Toward the Future

• Japan will have a high “dependency ratio”• Dfn: ratio of working to population

• Will approach 1:2

• To maintain current consumption levels for the elderly will entail huge transfers

• Will the tax rates needed to do that be politically feasible?

• Some projections call for a 25% consumption tax!

FILP

Fiscal Investment and Loan Program

Local Government Income & Expenditures

F

I

L

P

Some FILP Details

Example of FILP in Action: Road Construction

Issues

• Is fiscal policy effective?

• Is public investment useful?

• Are taxes equitable?• Do taxes impose small distortions or large

one? (“excess burden” is the jargon)

Crayon• Small business & farm taxation

• Claim: tax evasion is widespread

– Wage earners pay 90% (ku)• Payroll deductions make it hard to evade taxes

– Farmers pay no taxes (rei)• Allowed to operate on a cash basis

• Never audited

– Small business pays 40% (yon)• No requirement to keep books for very small firms

• Very, very low audit rates

• Published handbooks to audit triggers

• Early retirment by tax auditors, to set up tax offices

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Real Estate Taxes

• Huge increase in postwar land prices– But only modest capital gains exemption

– No deduction if use proceeds to buy new home

• Impact– Represses transactions - compared to the US, few sales

– Makes it hard to move with job rotations• Many Japanese live apart from their families

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• But education, other factors add to reluctance to move

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Effectiveness

• On-again, off-again policies• Expectations matter!

• Examples• Consumption vouchers

• Temporary tax cuts: April 1997– Date of future tax increase well publicized!

– Coincided with a scheduled increase in the consumption tax (national sales tax)

– Deep recession followed

Multiplier AnalysisGrowth Rate Private Fixed Residential

Real GDP Real GDP Consumption Investment Construction Exports Imports Nominal GDP1st year 1.21 1.21 0.26 0.39 1.30 -0.02 1.66 1.292nd year 1.31 0.10 0.47 0.97 0.62 -0.20 2.42 1.673rd year 1.24 -0.08 0.66 0.81 0.45 -0.63 3.04 2.04

Private GDP Capacity Fiscal Deficit Long-term Current Account Yen - DollarDeflator Hourly Wages Unemployment Utilization (% of GDP) Interest rates (% of GDP) Rate

1st year 0.04 0.22 -0.07 2.59 -0.60 0.08 -0.16 -0.062nd year 0.19 0.70 -0.13 2.81 -0.33 0.24 -0.25 -0.553rd year 0.52 1.07 -0.12 2.70 -0.31 0.35 -0.41 -0.65

Response to a Permanent Increase of Government Investment by 1% of GDP (real variables)

Growth Rate Private Fixed ResidentialReal GDP Real GDP Consumption Investment Construction Exports Imports Nominal GDP

1st year 0.41 0.41 0.53 0.81 0.10 0.00 0.56 0.432nd year 0.57 0.16 0.57 1.77 0.34 -0.07 1.11 0.693rd year 0.22 -0.37 0.37 0.65 0.24 -0.23 0.96 0.49

Private GDP Capacity Fiscal Deficit Long-term Current Account Yen - DollarDeflator Hourly Wages Unemployment Utilization (% of GDP) Interest rates (% of GDP) Rate

1st year 0.01 0.05 -0.02 0.88 -0.89 0.03 -0.05 -0.022nd year 0.09 0.28 -0.06 1.15 -0.78 0.11 -0.11 -0.263rd year 0.21 0.37 -0.03 0.36 -0.88 0.14 -0.13 -0.38

Response to a Permanent Personal Income Tax Reduction of 1% of nominal GDP

More multiplier dataOctober 1998 EPA Domestic Model

Growth Rate Private Fixed ResidentialReal GDP Real GDP Consumption Investment Construction Exports Imports Nominal GDP

1st year -0.09 -0.09 -0.03 -0.28 -0.25 -0.10 -0.12 -0.102nd year -0.37 -0.28 -0.10 -1.33 -0.69 -0.50 -0.38 -0.413rd year -0.63 -0.27 -0.14 -2.28 -0.62 -0.82 -0.28 -0.77

Private GDP Capacity Fiscal Deficit Long-term Current Account Yen - DollarDeflator Hourly Wages Unemployment Utilization (% of GDP) Interest rates (% of GDP) Rate

1st year -0.02 -0.01 0.00 -0.20 -0.03 0.27 -0.01 -0.742nd year -0.09 -0.10 0.02 -0.77 -0.16 0.40 0.00 -2.193rd year -0.27 -0.27 0.05 -1.27 -0.33 0.37 0.03 -2.37

Response to an Increase in Short-term Interest Rates by 1 percentage point

Growth Rate Private Fixed ResidentialReal GDP Real GDP Consumption Investment Construction Exports Imports Nominal GDP

1st year 0.40 0.40 0.01 0.77 0.86 1.63 0.15 0.412nd year 1.06 0.67 0.10 2.56 0.18 3.19 -0.89 1.213rd year 1.88 0.84 0.37 4.48 0.35 3.87 -2.17 2.37

Private GDP Capacity Fiscal Deficit Long-term Current Account Yen - DollarDeflator Hourly Wages Unemployment Utilization (% of GDP) Interest rates (% of GDP) Rate

1st year 0.18 0.05 -0.02 0.88 0.09 0.09 -0.04 10.002nd year 0.60 0.33 -0.08 2.27 0.32 0.29 -0.01 10.003rd year 1.08 0.86 -0.15 3.96 0.67 0.44 -0.02 10.00

Response to 10% Devaluation of the Yen against the US Dollar

Usefulness of Investment

• Niigata highways• National Road 17-go parallels Kanetsu Highway

• 17-go is bumper-to-bumper traffic on 2 lanes

• Kanetsu Highway is empty

– Tolls unreasonable under FILP “self-finance” concept, rendering roads useless

• Regional airports• No useage, might never be even without steep

landing fees. Pure pork barrel / poor planning.

Not all bad

• Carl Shoup instituted tax reform under the Occupation. While partial, historically Japan had:

• No double taxation of dividends

• No capital gains taxes on securities

• Simple structure to income taxes that lessened the resources devoted to tax dodges

• Large basic exemptions that limited the regressiveness of taxes

Sustainability• Current deficit levels are not sustainable

• 140% of GDP gross government debt (central & local)

• Government is vulnerable to higher interest rates• Demographic transition implies huge future

obligations• Just-published (Oct 12?, 2000) national balance

sheet shows up to ¥700 trillion (US$7 trillion) in excess liabilities [with no correction for dubious assets]

• That’s more than 100% of GDP…not an amount that can be borrowed

The End

• Resources:– Government web sites in English provide an

overview of the budget and FILP– Hiromitsu Ishi, The Japanese Tax System. 2nd

edition, Clarendon Press (Oxford), 1993.– Various JEI reports - see their web site and

(partial) search capabilities, plus the printed indexes for older years in Leyburn.