There are many concerns about Abenomics losing its power to reform the economy, but major developments in tax reform prove that Abenomics is alive and well, says Naoki Kamiyama, Chief Strategist, Nikko Asset Management.
The Liberal Democratic Party (LDP) and Komeito unveiled the ruling coalition's framework for tax system reform in December 2015. From an investment perspective, the important elements of the reform are the cut to the effective corporate tax rate and the introduction of tax relief to accompany the upcoming consumption tax rate hike.
The timing of the effective corporate tax rate cut has been brought forward from FY2017 to FY2016 following dialogue between the Abe administration and the business community. This is a positive change. To begin with, cutting the rate will enhance Japan's competitiveness as a location. By firstly lowering the rate to a level close to that of Germany, the government has signalled that it will keep a close watch on the competitiveness of Japan. While the competitiveness of a location is not determined by tax rates alone, it is important that the government has shown how it intends to invigorate Japan's economy.
The government will also work to maintain overall corporate tax revenue by reinforcing pro forma standard taxation, which will be a positive for fiscal reconstruction. Far from being a "pork-barrel" policy, the entire tax system reform will help to reduce excessive competition and strengthen Japan's industrial structure. This will be achieved by lightening the tax burden on companies with high earning power, while increasing the burden on those with lower earning power (those with paid-in capital of more than JPY1 billion), making taxation a factor in widening the earning capacity gap. By keeping corporate tax revenue unchanged, the reform also demonstrates Japan's strong fiscal discipline to investors.
In this sense, the effective corporate tax rate cut shows that the administration is still capable of exerting the leadership to put Abenomics into practice. Investors should be informed that assistance to enhance earning power of companies, as included in the new growth strategy of 2014, has sped up the pace of tax system reform; that they can expect enhanced competitiveness for Japan and speedier industrial metabolism; and that the government is also mindful of fiscal restructuring.
The fact that the introduction of relief from the consumption tax rate was a political solution created during 2015 demonstrates the leadership ability of the current administration. Consumption tax will be raised to 10 per cent (from the current rate of 8 per cent) effective April 2017. The maintenance of a lower rate for items such as food (the current rate of 8 per cent) at the time of the tax hike was advocated by Komeito. Part of the LDP and the Ministry of Finance opposed applying any reduced rate for specific items on the grounds of possible burdens on companies' IT systems and other complications.
Prioritising smooth political management, the Abe administration took heed of Komeito's preferences and decided to maintain the tax rate for food and beverages at 8 per cent (with some exceptions such as alcoholic beverages and eating out). As a way of easing the regressive nature of consumption tax, providing subsidies to those with low incomes is thought to be more reasonable than lowering the rate for specific products in theory (as buying intentions differ between individuals). In this case, however, it seems the government was concerned that the sense of an increased tax burden from the hike could cause consumption to weaken, as Komento thought.
On a technical level, as products go through various stages of transactions involving manufacturers, wholesalers, retail outlets, and others, it is necessary to manage the taxation amounts paid at each of these stages using invoices. Invoices play important roles in many European countries, where lower tax rates for specific product categories have been introduced. In Japan, however, companies will begin issuing invoices in April 2021, giving them leeway to respond to their introduction.
The other side of the coin is that implementing a reduced taxation rate makes it difficult to maintain planned social security expenditure. While the reduced rate is not a "pork-barrel" measure, consumption tax revenue is in principle used for social security expenditure, meaning that fiscal discipline will slacken if social security costs are not reduced. Some believe that this can be alleviated by increased tax revenue resulting from economic expansion, but as neither consumption tax revenue nor social security expenditure fluctuates over time, it is inadvisable to associate them with temporary increases or decreases in tax revenue. Looking ahead, we expect that the Abe administration will show leadership on this issue.
The coalition's FY2016 framework for tax system reform has generally been a demonstration of the Abe administration's leadership. Although the corporate tax rate reduction is not such a large one from a macroeconomic perspective, bringing it forward by a year has sent out a strong message. In addition, the tax relief accompanying the consumption tax hike seems an appropriate compromise in political terms. The lightened tax burden and the introduction of invoices can also be said to have further eased the passage for the consumption tax hike, which will bolster the social insurance needed for Japan's ageing society.
Although the consumption tax hike in April 2017 is legally set and the most likely scenario, it is not unchangeable. If Japan were to face a sizeable recession in 1st half of 2016, a snap election of the lower house in July with upper house election is possible to change laws to avoid a tax hike in a slow economy.
