A
working paper (WP) released by International Monetary Fund (IMF) has
mooted wider tax reforms in Japan as the long-term impact of proposed
reduction in corporate income tax (CIT) on economic growth is likely to
be modest.
The Paper captioned 'Japan's Corporate Income Tax: Facts, Issues and Reform Options' says: "Japan's
current CIT creates large distortions on investment, debt structures,
and income shifting. A lower CIT rate, as envisaged by the current
administration is expected to mitigate these distortions. In the
short-run, moreover, it can help unlock the large cash reserves held by
corporations, also if the rate cut is implemented gradually over
several years. The long-run growth impact of a CIT rate cut is expected
to be positive but modest."
Statutory CIT rate is among the highest in the OECD and Asia. Several
structural weaknesses still characterize today's CIT system in Japan.
To stimulate the economy and attract more investment to the country,
the Japanese government announced its intention to reduce the statutory
CIT rate to below 30 percent in its revised growth strategy in June
2014.
Pitching for wider tax reforms taking into account the country's
fiscal constraints, WP has discussed three options. The first option is
a CIT rate cut financed by other fiscal measures outside the CIT.
Second, the government could seek base-broadening measures within the
CIT. Third, a more cost-effective CIT reform to eliminate the main
distortions is by introducing an allowance-for-corporate-equity (ACE),
which has recently gained traction in several countries and which has
particular merit for Japan.
According to WP, compensating fiscal measures are needed to finance a
cut in the CIT rate as it is unlikely to be self-financing against the
backdrop of tight fiscal situation. This raises several issues.
It says: "A
reform package that includes a further increase in the consumption tax
is beneficial on efficiency grounds but could raise distributional
concerns which may need to be addressed. The scope for base broadening
within the CIT is limited, and such reforms run the risk of undoing the
positive investment effects of a rate cut. Still, the elimination of
some tax incentives and the special treatment of SMEs could yield
efficiency gains and help simplify the CIT. Also higher dividend taxes
and a lower wage deduction can compensate for incurred revenue losses
from a lower CIT rate and restore neutrality in the taxation of SMEs.
Various local CITs could be replaced by more efficient recurrent
immovable property taxes to provide local communities with a more
stable revenue source. Given these considerations, a comprehensive
reform would be the preferred strategy to address several of the
weaknesses of the current CIT in Japan."
Several circumstances make CIT reform in Japan different from that in
other countries. First, deflation has induced Japanese corporations to
repay their debt and build up significant cash reserves through
retained earnings. CIT reform could help unlock this cash in the short
run by encouraging investment, raising wages, and breaking the spiral
that leads to deflation.
The Japanese CIT rate varies by firm size, income level and region
(due to various local taxes), leading to a complex system of differing
rates (Table 1). The overall CIT burden-adjusted for the deductibility
of the local enterprise taxes and after the repeal of the special
reconstruction tax in April 2014-ranges from 21 percent (for income of
up to ¥4 million earned by small corporations located in an area
applying the standard local tax rate) to almost 36.3 percent (for small
corporations with income over ¥25 million in the Tokyo area). Large
corporations with capital over ¥100 million-approximately 1 percent of
all corporations in Japan-face an overall CIT rate of around 35.6
percent in the Tokyo area and 34.5 in areas applying the standard local
rate. In addition, they face a local tax of 0.48 percent of annual
value added (including profits, wages, and interest) and 0.2 percent of
capital, even when they record losses.
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