Tax Analysts Blog

Japan Cuts Its Corporate Tax Leaving US with the World’s Top Rate

Posted on Dec 27, 2010
On December 24 the Japanese cabinet headed by Prime Minister Naoto Kan agreed to a budget including a cut in the corporate tax rate, effective April 1, 2011, from 39.5 percent to 35 percent. Barring unforeseen circumstances the Japanese parliament will approve this plan early in 2011. After this change the United States--with a combined federal-state rate of 39.2 percent—will have the highest corporate tax rate in the world.

The long-awaited rate cut was welcome by the business community, but it falls far short of a rate in the mid-twenties that is widely regarded as necessary to make Japan competitive. Without a consumption tax hike, however, the prospects of further corporate rate cuts are nil. And without a consumption tax hike, significant deficit reduction is impossible.

For these reasons all experts and major political parties agree the consumption tax rate—currently 5 percent—must rise to at least 10 percent. There is only one problem: Japan’s electorate. Japanese voters have continued their long tradition of punishing Prime Ministers who support higher consumption taxes. On July 12 voters handed Prime Minister Kan a major defeat as his coalition lost control of the upper house of the Japanese parliament. (The upper house cannot block passage of the budget.) After that setback, Kan, the fiscally conservative former Finance Minister, an outspoken defender of consumption tax hikes, kept his comments about the consumption tax to a minimum.

Rocked by a recession after two decades of economic stagnation, the Japanese political scene is anything but stable. In September 2009 after 50 years of nearly continuous power the Liberal Democratic Party was ousted by the Democratic Party of Japan. Kan is the fifth prime minister to hold office since September 2006. And after the July election setback he has barely been able to hold his coalition together. His party has been rocked by scandal with the indictment of party boss Ichiro Ozawa for illegal campaign financing. In addition, his weak handling of disputes with China and Russia have been unpopular. His approval rating now stands at about 20 percent.

Political instability is not conducive to long-term deficit reduction. Japan’s opposition parties smell blood and, at least for now, are reluctant to work toward a non-partisan solution. As a result, the proposed budget for fiscal year 2011 (beginning in April) has a deficit equal to approximately 10 percent of gross domestic product. The amount of new borrowing is actually larger than the amount of tax collected.

As in the United States the press in Japan gives inordinate attention to the drama of political infighting rather than the dreary business of managing the economy. When policy does take precedence over politics, the focus is on reducing unemployment. This comes naturally to politicians because job creation most typically translates into cutting taxes and increasing spending. That’s the easy part of fiscal policy. With the latest budget deals in both Japan and the United States, the hard part—deficit reduction—has yet again been postponed. Promises of fiscal rectitude fill the airways, but no concrete steps have been taken in either country. Both countries are on unsustainable fiscal paths. In both countries the political machinery seems incapable of addressing the issue. But if the logjams are not broken, both countries face fiscal collapse.

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