Japan's tax plan to bet on better growth

Japan's government is leaning towards a long-term fiscal plan that relies heavily on economic growth in a high-stakes bet on the success of prime minister Shinzo Abe's stimulus.

A new medium-term fiscal plan is expected this summer, and while people involved say nothing has been decided yet, most discussions rely on an optimistic economic scenario published by the Cabinet Office in February.

If the government adopts such a plan it will mean only modest spending cuts or tax rises in the next few years. That could leave a large deficit if the forecast economic growth does not materialise and may lead to downgrades by credit rating agencies.

Strengthening the opposition to planning for tax rises or spending cuts, a number of Japanese economists and politicians think even the Cabinet Office figures are not optimistic enough, underestimating the tax revenues from higher growth.

"Without growth, there can be no fiscal reconstruction," says Yoshimi Watanabe, the former leader of Your party. "There should certainly be no rise in consumption tax until we're completely out of deflation."

Japan has the largest deficit of any advanced country, according to the International Monetary Fund, at 6.2 per cent of gross domestic product in 2015. It also has a large existing public debt of 246 per cent of GDP, on a gross basis.

Mr Abe's government is under pressure to set out a more detailed fiscal strategy after he postponed a planned rise in consumption tax from 8 per cent to 10 per cent. That tax increase is now scheduled for April 2017.

Based on the Cabinet Office forecast, Japan would only need a further fiscal adjustment of 1.6 per cent of GDP to hit its goal of a primary budget balance, which excludes interest payments, by 2020. The ruling Liberal Democratic party is debating how to achieve that - most likely by restraining growth in healthcare spending.

But such a plan depends on the controversial economic forecast, which assumes full success for Abenomics. It relies on the Bank of Japan producing steady 2 per cent inflation and higher labour force participation among almost every demographic group.

For example, it has 79 per cent of women aged 30-34 in the labour force by 2020 and 86 per cent by 2030, compared with 69 per cent in 2012. That would take Japan to Scandinavian levels of female participation.

Most importantly, the forecast assumes the structural reforms of Abenomics will generate an acceleration in productivity growth to 2.2 per cent a year by the 2020s - the level prevailing in the 1980s.

Overall, it forecasts Japan will outgrow the US in every year from 2018 to 2023, comparing with estimates from the Congressional Budget Office, despite the much faster ageing of its population.

Taro Kono, a senior figure in the ruling Liberal Democratic party, has warned against making fiscal plans based on rosy assumptions. He says it is "certainly conceivable" that high growth would not come through.

"Reaching primary balance by 2020 is an international commitment, so if we can't do it with economic growth, we will have to raise taxes or cut spending," Mr Kono says.

A number of politicians, however, think the picture is even better because the Cabinet Office figures assume tax revenue will rise more or less in line with economic growth. Keiichiro Asao, an independent member of parliament, and Mr Watanabe argue revenues could actually rise at two or three times the pace of growth.

"If we have 4 per cent nominal growth that could mean 12 per cent growth in tax revenues," Mr Watanabe says. Such figures would rapidly reduce the deficit - but relying on them would leave a big gap if the assumption turns out to be wrong.

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