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Monday, Dec. 24, 2007

JAPANESE PERSPECTIVES

Tax transfers from rich areas to rural poses problems


On the surface, the ruling coalition's tax reform package for fiscal 2008 contains a number of promising proposals, including the transfer of local corporate tax revenue from better-off prefectures to fiscally distressed rural areas, a new system to let people combine stock investment returns with dividends when declaring taxable income, preferential treatment for small and medium-size firms, and tax deductions to promote the use of ethanol in fuel.

On the closely watched consumption tax issue, however, the ruling parties failed to make any detailed or specific proposals for hiking the levy. They only hinted at the likelihood of a future hike being the primary source of revenue for financing the rise in social security spending, including the scheduled increase in the government's contribution to the basic pension scheme.

Behind the ruling alliance's reluctance to debate a consumption tax hike is the divided Diet, where the Upper House is being controlled by the opposition camp for the first time in decades.

Yuji Tsushima, head of the Liberal Democratic Party's tax panel, repeatedly called for public discussion on choosing between reducing welfare spending or increasing the tax burden.

But given the possibility that the Lower House might be dissolved for a snap election in the course of deliberating new antiterrorism legislation, many LDP lawmakers feared the loss of voter support if words spread of an upcoming tax hike.

In any case, the next step is for the government to put the coalition's proposals into legal steps. But it is doubtful that one of the measures — the transfer of local corporate tax revenue between regions — will produce the desired effects, mainly for the following three reasons.

One is that revenue from the local tax — imposed on businesses situated in certain areas — is to be transferred to other areas in which taxpayers have nothing to do. Even as a temporary measure, this runs counter to the principles of local taxation and ultimately may be considered unconstitutional.

The 5 percent consumption tax is in fact a combination of the 4 percent national tax and a 1 percent local tax. An LDP panel discussing steps to address the urban-rural gap also called for expanding the local share of the consumption tax to 2 percent. But the Finance Ministry rejected the proposal and instead argued that parts of local tax revenue should be redistributed among various regions.

But a move like that could destroy the decision-making hierarchy of the tax system, making it unclear who makes the decisions on what portions of the tax. Although the step is being proposed as a temporary measure, it might become permanent if it entails legislation to change the portion of local taxes up for redistribution into national tax.

Would it be possible in the United States to move part of the tax revenue in a certain state to another state? This is a sign that the principle of local autonomy has not taken root firmly enough in Japan.

The coalition's tax package also called for implementing the so-called hometown tax payment, which allows an urban resident from a rural area to claim local tax deductions after agreeing to make donations to his or her hometown to support its depleted finances. This scheme depends on the voluntary goodwill of individual taxpayers and it will be difficult to make any estimate of its financial impact.

The second problem is that tax grants and subsidies from the central government to municipalities have traditionally been ineffective at revitalizing rural economies. In fact, it is exactly this kind of support that has sustained many inefficient businesses and organizations that would otherwise have been weeded out long ago. Transferring tax revenues to rural areas could simply be repeating the same mistake.

Under the principle of local autonomy, prefectures and municipalities are responsible for raising the money needed to cover their own expenses. Local governments must make self-help efforts to streamline the public sector and raise local tax rates to make ends meet.

What is needed is a way to efficiently distribute national tax revenue so that Japan can truly revitalize its local economies. Skimming revenues from urban areas might provide temporary relief to rural municipalities, but it will also allow them to delay the efforts needed to put their house in order.

The third problem is that the decline in urban productivity that might result from diverting tax money to rural areas will bring down overall productivity as well. The reality is that, in an international comparison, Japanese cities lag behind many of their rivals not just in the west, but elsewhere in Asia, in terms of such basic infrastructure as roads and airports. Shifting a portion of urban tax revenue to rural areas could exacerbate this problem.

Revitalizing the Japanese economy as a whole — and finding a way to solve its debt-ridden public finances — will be impossible unless the international competitiveness of its major cities improves.

Teruhiko Mano is a professor at Seigakuin University Graduate School.


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