Taxation In Japan Essay, Research Paper
The role of taxation in the transformation of the Japanese
Economy Introduction Before the Meiji restoration under the
feudal Tokugawa Shogunate, taxation was mainly a tool for
warfare and military power. The system was highly
regressive and pressed lightly on the rich and profit-earners.
It was calculated to preserve a very unequal distribution on
incomes and to stimulate the accumulation of private capital.
This tendency somehow continued and was magnified before
W.W.II when direct taxation was introduced for a more
equal and balanced system. However, the Meiji restoration
did bring with it tremendous changes to the tax system and
the use of the revenues. The Japanese government has since
had an active participation in the economy, yet not
controlling it directly but rather through market mechanisms.
It took responsibility for promoting economic growth by
using incentives and taxes collected in an effective way. The
often cited goal of taxation in western countries that was
equality was often sacrificed for the goal of economic growth
in order to prevent being colonized, then to pursuit the desire
to become an imperialist nation and then for pride and
export. The role of government and its fiscal policies played
an important role in the transformation of the Japanese
economy through the periods of Meiji restoration, before
W.W.II and post W.W.II period where taxes respectively
shifted from land taxes to internal indirect taxes to income /
direct taxes. (Fig 1) Period of Meiji Restoration During the
first years of the Meiji reforms, the government had serious
financial difficulties with tax revenues inadequate for its
massive commitments. In 1873, land reforms gave tittles to
landowners and customary tenants, freed the transfer and
sale of land from feudal restrictions and imposed tax
obligations equal to 3 per cent (which was lowered to 2.5%
in 1878) of the value of land. In addition a 30% local surtax
was imposed on the land taxes. These heavy land taxes were
used to provide monetary compensations to the old ruling
class for the termination of their feudal incomes in kind and
to finance the new administration which introduced new
education and to support its military. The agricultural sector,
and in fact the peasants, therefore bore the great bulk of the
cost to Japan’s modernization. The land taxes contributed to
over 70% of the central government’s revenue during the first
decade of the Restoration. Since the capital needs of
agriculture were small even after the landlords devotion to
the improvement of agricultural techniques and introduction
of winter drainage, the increasing savings and surplus of
landlords were transferred out of the primary sector into
other sectors. The fiscal system as a whole was heavy in
absolute terms yet highly regressive. The burden was
constantly on the agriculture sector, even when
non-agricultural sectors were growing at a phenomenal rate.
As seen in Figure 1, under indirect taxes, before the turn of
the century, the excise taxes played a prominent yet second
to land taxes at about 20% of the government’s total
revenue. These included taxes on soya, sugar, textiles and
government monopoly profits in tobacco, camphor and salt.
The combined effect of the land taxes and consumption
taxes was heavy taxes on both peasant and consumer and a
lighter burden for the landlord and industrial-merchant
classes. The income tax did not appear until 1887 and the
business tax which was the corporate tax did not come into
effect until 1896 and at a low flat rate of 3%. The result was
the subsidizing of the manufacturing and service sector at the
expense of the primary sector. To strengthen the incentives
for reinvestment and accumulation of productive wealth was
strengthened by the absence of inheritance and real estate
taxes before 1905 and a relatively low rate thereafter. The
role of the family and the firm that existed also as a closely
bound unit also made the saving, transferring form generation
to generation and development favorable. Therefore, the
Zaibatsus, the conglomerate oligopolies could charge
monopoly prices and concentrate on exports. At this time,
between the 1870-1900, there was the traditional export
expansion of silk and other produces, coupled with mild
primary import substitution. Tariffs and revenue on foreign
trade were also low at the time due to the fact that the
Japanese government was under the influence of foreign
countries and autonomy of tariffs was not until 1899.
However, this tradition had little change even after the
gradual regaining of autonomy. This was a very different
from the path followed by other developing countries which
usually place heavy taxes on trade because they are the
simplest and easiest form of taxation. Japan, by not following
the easy path and concentrating on export substitution and
land taxes for internal revenue creating a thriving export of
primary goods before the 1920s. Period before W.W.II The
era of the land taxes ended in 1908 and was followed by
indirect taxes, mainly on alcoholic beverages and tobacco. It
was not until 1935 that income taxes on individuals and
corporations became the most important source of total
revenues. The modern tax form only took form in the 1940
to prepare for the wartime economy, the whole tax system
was thoroughly overhauled to base on direct taxes. The
individual tax was a scheduler tax, under which different
sources of income were levied by different tax rates. It was
supplemented by a progressive comprehensive tax which
applied to an individual’s aggregated income above a specific
amount. On the other hand, the corporate income tax was
imposed on corporate income at a flat rate of 18%. The
commodity tax was introduced in 1937 mainly to collect
revenue for wartime expenses, and the tax on alcoholic
beverage was also simplified in 1940. The relative share of
indirect taxes fell as a result of the tax reforms. The 1940
reform also separated the personal income tax from
corporate income tax. This period saw the rise of the power
of the military in the government and influence after the
winning wars of the Sino-Japaneses and Russia-Japanese
earlier in the century and the ailing and corruption of the
civilian government. The government was engaged in
continuous military activities and was penalized with
increased tariffs. However, due to expansion of its own
empire and influence which included Taiwan and Korea,
export suffered little and actually had a 70% increase in
volume between 1929 and 1937. This period also saw
heavy taxes and direct investment of government in industries
resulting in rapid growth of war related industries. This
period ended with the GNP declining from 1939 and 1944.
The tax system became the tool for direct financing in this
period. The military drove the economy and accounted for
27.98% of GNP by the second world war which could be
said as the grand continuation of the feudal Tokugawa
Shogunate military expansion policies. Post W.W.II With the
occupation forces lead by the United States taking over the
government, reforms were held on all aspects of the
government. Immediately after the war, the scheduler tax on
individual income was replaced by a unified tax on an
aggregate basis with graduated tax rates. In order to collect
necessary revenues, a 1% turnover tax was levied on the
basis of the sales amount at every stage of transaction. As
for the long term tax system design, it was also based on the
US system but was also an experimental ground for the
Shoup Mission which was a pioneer in many aspects of the
direct tax. The Shoup reform in 1949 was not the first
reform after the war to the chaotic after-war tax system, but
it has had the most lasting effect on the development of the
Japanese economy. The Shops Report tried to build a
progressive direct tax based tax system with local autonomy
and simplicity that would be permanent and stable. Indirect
taxes were not recommended due to the inequality among
the tax payers, dull the sense of civic responsibility and make
local governments uneasy. However, the Japanese
government regained autonomy during the Korean war and
made modifications such as the resuming taxation at the
national level and sacrificing equity which Shops put at the
utmost priority for convenience of efficiency and
administration. The burden on firms, especially big business
was lowered. This was to give priority to the restoration of
the postwar economy and the promotion of capital
accumulation. Capital gains tax was abolished, under the
missions guidelines and this had a effect of the promotion of
capital accumulation as a national goal. Although partially
successful, the Shoup plan broke away from the military
roots of the Japanese tax system and engaged in a
responsive tax system which was in touch with the economy.
The four major taxes, income, corporate, accession and
consumption taxes all varied to different degrees from the
Shops Mission. However, the four taxes have been
remarkably stable in structure since 1950. The global income
tax system proposed by Shops was modified to a
combination of a comprehensive tax and a scheduler tax.
Instead of aggregating most incomes with progressive tax
rates, some incomes such as capital gains or interest income
were now subject to income taxation or were taxed at
reduced flat rates, separate from other incomes. These tax
concessions were intended to stimulate savings and income
and to improve the welfare level among specific taxpayers.
As for corporate income taxes, a split-rate system rather
than a uniform one in which a single rate is imposed on a
whole corporate income. This was similar to the one used in
West Germany in which retained profits and dividends were
taxed at different rates. Numerous tax measures have made
the corporate income tax extraordinarily complicated. As for
the accession tax on transfer of wealth proposed by Shops
Mission was replaced by a combination of inheritance and
gift taxes. Consumption taxes, in contrast to the general
modification of direct taxes remained unchanged since the
Shops Mission and there has been no general consumption
tax in Japan until April 1989. Therefore, Japan depends its
revenue from taxes on income and corporate income taxes,
which is the highest among OECD countries. Social security
contributions which are equivalent to payroll taxes also play
an equally important role in the raising of taxes. Japan is also
the only advanced country that does not impose a general
consumption tax. In 1985, of the total tax revenues collected
in Japan, 45.8% came from individuals and corporate
income taxes, 30.2% from social security contributions, 14%
from taxes on goods and services, 8.6% from property tax
and 1.1% from inheritance and gift taxes. Before the 1973
oil shock, the government engaged in a tax system with
incentives to promote exports, private savings and
investment, housing and technological development to
promote economic growth. These measures were included in
the Special Tax Measures Law and was formulated to
prepare a list of most of the incentive provisions applying
mainly to individual and corporate income taxes. As seen in
Figure 2 and Table 1, the corporate revenue lost to these
special tax measures but declined in importance after the mid
-1970s. The special tax measures was around 12.6 and
13.2% of total income tax revenues in the late 1950s fell to
8-9% in 1961-1962 then rose to 12% in 1965 and then
gradually declined to 5.0% in the early 1980s. The special
measures could be classified into tax exemptions and credits
and tax deferrals like accelerated depreciation and tax-free
reserves. These exemptions targeted specific industries such
as steel and machinery and also developing technological
innovation. The six main objectives of the tax incentives are
outlined the Ministry of Finance (MOF) as promotion of
saving; promotion of environmental quality and regional
development, promotion of natural resources, promotion of
technological development and modernization of industrial
equipment, strengthening of the financial position of firms and
other incentives. As seen in Table 2, the greatest decline in
importance is promotion of export and foreign investment
which included special deductions of export income from
taxation and accelerated depreciation for export orientated
firms. However, this is still an understatement of the
magnitude of tax incentives due to hidden incentives that are
not included by the MOF in special tax incentives. Firstly,
there is the provision for capital gains, interest and dividends
as part of the basic income tax law. Second, the
fractionation of individual income tax into separate classified
taxes loses a great deal of revenue and greatly reduces the
progressivity of the nominal rate structure, particularly at the
top brackets. Third, business expenses as special
depreciation accounting and deduction for part of social and
entertainment expenses are also not included. Fourth,
housing subsidy and low interest loans to executives are not
regarded as special tax measure. Fifth, the official estimate of
revenue is constantly low, so therefore, the special tax
measures are estimated low. Another feature of the Japanese
growth economy was the annual tax-cutting policy due to the
fact that GNP rose by an average of 15% a year between
1950 and 1960. The reason for the annual cuts were due to
the fact that Japan had a highly elastic income tax reaching
2.0 in the 1960s meaning that for every 10% growth in GDP
that would be a 20% growth in revenue. The Japanese
government did not use the money in the expansion of
<
Social welfare was also limited for the insistence on
investment into growth and export. The tax cutting policy is
to keep the revenues to national income constant at around
20%. This was maintained between 1955 to 1965. This was
targeted at the individual income tax while both corporate
income tax and indirect taxes showed varying changes over
time. Corporate taxes increased much more frequently while
indirect taxes were raised to adjusted for the rise in
commodity prices. The result of the tax cutting and keeping a
lid on the growth of the public sector coupled by the lowest
expense on defense in the developed country was the lowest
tax rates in the developed country. Therefore, this permitted
the rapid increase in private demand. As mentioned above,
the tax system stresses simplicity instead of equity with the
result of benefiting business and professionals rather than the
employee. First, the Shops Mission suggested the "blue
return" system which is a self-assessment income tax for
small to medium size businesses. The benefits of the blue
return include basic deduction for blue return, special
deductions for wages of family members working in the
same company, and special tax-tree reserves for employees’
retirements, allowance for bad debt etc. These special
treatments reduce the tax burden of the family small business
firms. Secondly, there is the issue of withholding tax system
for wage and salary incomes. More than 80% of individual
income tax is withheld at the source. Although withholding is
applied to interest, dividend, and other income, the largest
portion of withheld taxes relate to employment income. As
seen in Figure 3, the income of salary earners is almost fully
identified by tax authorities while self-employed and farmers
have much an advantage in taxable income. This is often
referred as the "ku-ro-yon", 9-6-4 ratio of salaried workers,
self-employed and farmers. The third issue is the anonymous
and fictitious accounts. Banks accounts could be opened
with seals rather than signatures and banks make no attempt
to identify the seals. By creating a number of these tax-free
treatments, the wealthy was able to abuse the system.
Therefore, although the tax system structure was not
prominently regressive, the legislative side make the
wage-earners pay a higher price of taxation for the reason of
simplicity to businesses as proposed by the government. Tax
Structure and Economic Development In the period since
the Meiji Restoration, there has been government transfer
and tax incentive from the peasant and wage earners to
business to stimulate growth. Japan has had phenomenal
growth in the past hundred years, however, the question is
that if there is a direct relationship between tax structure and
economic development. In Table 3, y/N stands for per
capita real GNP with N as the total population, Ag/Y is the
agricultural products’ share in GNP with Ag as the output of
the primary sector, M/Y or (M+X)/Y as the openness of the
economy where M and X stand for import and export
respectively. As seen in Table 3, there is a significant
correlation between y/N, Ag/Y and T/Y between
1885-1944. Before the war, the agriculture sector still
played an important role in taxation structure. This is often
referred to as the dual sector and where the taxes in the form
of land taxes were charged heavily in taxation. There is also
no correlation between the postwar period of 1951-86 but
y/N and T/Y are still significantly related. As from
1951-1986, openness provides a better index than the other
two variables mentioned 25 years before the prewar period,
and it becomes even more significant in explaining T/Y for
the postwar period. Therefore, there is a correlation
between the openness of the economy, which is imports and
exports and the taxation structure. However, one could
emphasize the passive nature of the evolving tax system , in
which one could even say that the major determinant of tax
structure change is the structural change in the economy itself
during the process of economic development. When we
consider Table 4, where Tl is land taxes, Ti is indirect taxes,
and Ty income taxes on individual and corporate income. It
shows the relationship (R2)that land taxes made up the
principal shares revenue in 1885-1898 while indirect taxes
made up 1899-1935 and incomes taxes from 1936-86. This
proves the time division as mentioned above. However,
more importantly, as y/N increases, Tl/Tn and Ti/Tn
decreases. The relative importance of land and indirect taxes
faded when growth increased. As for the openness (M/Y or
(M+X)/Y) can be explained from the opposite signs in Ti/Tn
before and after the war (3.101 to -1.808). The negative
correlation after the war showed that openness was no
longer effective in increasing the indirect tax base at this level
of economic development and that the declining importance
of indirect taxes happen to have a close bearing with the
openness in a growing economy. That leaves us with Ty/Tn
dominantly affected by y/N, with the relative share of income
taxes rising in the course of development. The supply-side
point of view emphasizes the link between savings and
investment with I=S+(T-G) with net export as zero. As taxes
revenue were greater than government expenditures before
1975, investment from saving could be maximized. With net
exports as positive, it would also help on investment in the
country. As seen in Table 5, there was constant government
surplus before 1975. Therefore, it was only 1975, that the
government could continue the role using taxes to promote
investment and growth. As deficit grew, it would eat into the
savings and therefore investment. This was also the
tax-cutting policy which was before 1975 to prevent the
overburden of the tax payer with their high elasticity of
personal tax revenue. The growth can be shown using the
formula k=sx-(n+d)k which means for an increase in capital
stock savings has to be larger than depreciation. The
Japanese government promoted savings through tax cuts and
tax incentives and also allowed increased depreciation under
tax laws more rapid growth. Studies of the impact of the
special tax measures on Japanese economic growth are, for
the most part, inconclusive. There is virtually no relation
between the special tax measure to promote household
savings and the rate of private savings. Many of the special
tax measure were used in industries that were not regarded
as strategic from the standpoint of growth, such as the textile
industry which received favorable treatment but grew
relatively slowly. As mentioned above, though, the initial
depreciation allowances were used widely for expansion and
modernization in such strategic industries as steel and
machinery. Therefore, except for the stimulus in these
industries, the special tax measure did not have a substantial
effect on investment and growth. Although the tax system
and its effect on the economy is inconclusive, tax system may
affect economic activity in several ways. First, fro business
and managerial incentives, the regular salary earners with tax
withholding has a fully taxable income. As for the business
innovator and risk taker, the rewards are scarcely taxed by
the tax system which permits the tax-free accumulation of
capital gains and requires only modest tax payments on other
property incomes. As for management incentive, the typical
manager obtains his satisfaction through prestige of job,
expense of account which is often easily deductible under tax
laws. Implicit tax exemption fro unrealized capital gains
derived from undistributed corporate earnings permit the
manager to accumulate large amount of corporate wealth.
Second, the effect on economic stability, Japan with its high
elasticity on income taxation could be used for the stabilizing
effect of the economy to cushion the economic bumps.
However, the Japanese government has reduced the tax rate
and used monetary policy for short-run stabilization. As for
the effects on saving and investment, gross savings increased
from about 25% of GNP in the mid-1950s to about 40% in
the 1970s. Increase of the stock of capital is important for
growth because it raises productivity directly and permits the
adoption of newer and more efficient technologies. The
national budget with its surpluses added to the national
saving and helped to provide the margin of resources needed
for the production of large and growing volume of investment
good. Government savings also averaged above 40% of
private savings even with the annual tax reductions. This was
due to the systematic underestimation of tax revenues. The
policies to promote private investment such as accelerated
depreciation makes bankers more willing to make loans.
Therefore, the tax incentives made have had an indirect
effect on investment and growth. Finally, the simple fact that
the low tax rate in Japan may be the prevailing explanation
for the high rate of private saving and investment in Japan.
Other Determinants of Tax Structure Development and
Growth The military factor before W.W.II and after was
reduced drastically to less than 1 % of GNP. Before the
W.W.II the figure was around 28% of GNP. This is low in
international comparisons of military expenses-GNP ratio
where it is 6.3% in the USA. Japan has a low level of
welfare commitments. The average transfer payments to
national income in 1961-1970 in various countries was
20.8% in France, 7% in USA with 5% in Japan. By 1984,
the US ratio grew to 15.1% while France went up to
35.2%, in comparison with Japan’s 14%. Another factor is
the savings in Japanese thriftiness. Even at high direct
taxation on the wage earner, the average saving rate was still
between 25% and 40% GNP. This started since the Meiji
Restoration with moral suasion from the government with
slogans like "Let us avoid all luxuries so that we keep up
with the world; truly the development of our national
productive strength has its roots in reverent obedience." This
was coupled with the favorable inheritance tax laws and
capital gains law that made accumulation of wealth feasible
and worthwhile to the family centered Japanese worker.
Future of Tax System in Japan As seen in Table 5, huge
deficits arose since 1975 from the first oil shock and
accelerated due to the second one and amounted to 4.4 %
of the GNP in 1979. This has caused more alarm compared
with other countries with similar levels of debt. The
government was no longer able to cut taxes on personal
taxes and government incentive programs because of their
large losses in tax revenue were cut (Table 1). On top of the
economic repercussions, the original tax system was
repressive and unjust for the stress on simplicity. In 1989,
the Value Added Tax (VAT) was added as the consumption
indirect tax after almost ten years of debate at 3%. Reform
was necessary for between 1975 and 1984, the tax burden
rose sharply in Japan with central government taxes up by
4.1% and local taxes by 2.7% taxes. The dissatisfactions
could be categorized in the difference in tax burden among
taxpayers in which the tax ratio was "ku-ro-yon", 9-6-4 ratio
among workers, self-employed and farmers. Mismatch
between the wage system and income tax structure in which
the wages rose with seniority and taxes also increased
steeply where the middle class need it the most with the
children’s education or for a residence. Therefore the
progressiveness of the income tax for middle-class salaried
workers is too high. The unfairness in taxation on capital
income, as mentioned above is major source of savings and
investment but also is a source of inequitable tax system and
behind the massive account surpluses. The heavy corporate
tax burden which has risked dramatically since the 1970s
have caused much complaint. The outdated indirect taxes
which pose no tax on service is a failure to reflect the
changing consumption patterns. The standard procedure for
the tax reform is to reduce marginal tax rates by broadening
the tax base with the introduction of indirect consumption
taxes. It is also a cheaper and more effective way to
stimulate savings for consumption tax does not tax savings
instead of using special tax incentives. The reform is also
necessary in view of the aging population and its need for
larger social security . Tax preferences for expenses and
depreciation allowance should be reduced to reduce the loss
in tax revenue. A comprehensive tax system will not only will
achieve what Shops Mission’s real goal of tax equity but also
ensure the future mature growth of Japan for with a large
deficit, the previous tax provisions and incentives can no
longer be continued. Japan’s tax system is still midway
between a comprehensive income tax and an expenditure
tax. Change is necessary, but the role of government and
taxation still pose many hard decisions to politicians.
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