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.