Japan: “Never Mind”

August 16, 2013

Earlier this week Reuters and Bloomberg reported that Japan was looking into lowering its corporate income tax rate. The alleged plan was to lower the rate from 37 percent to as low as 25 percent in exchange for a three percentage point increase in the sales tax.

I argued that this swap would be a good, pro-growth reform. A preponderance of the research on the relationship between taxes and economic growth suggests that corporate taxes are much more harmful to economic growth than sales taxes.

Two days later, Japanese officials have changed their mind. According to Reuters, “Earlier this week, reports suggested a corporate tax cut could be offered to ensure Abe could push through the sales tax rise and still encourage business investment. But on Thursday (last night for Americans) ministers denied Abe had ordered them to study the idea.”

Officials are worried that it would not have the desired result because only thirty percent of corporations pay the tax currently. They also seem to be concerned with its revenue effect.

Instead, officials may consider “tax breaks to encourage capital spending.”

Unfortunately this plan is not as good as the first idea floated by the Japanese.

Pursuing targeted tax breaks is bad tax policy. These temporary handouts typically do not encourage any additional economic activity. Rather, corporations will shift a planned investment to the period during which the temporary incentive is available. You may see more activity during the tax break, but that activity was likely going to occur anyway. It’s like banning alcohol sales on Sunday to reduce overall consumption of alcohol. Sure you reduce the sales of alcohol on Sunday, but what is stopping a shopper from purchasing Sunday’s alcohol on Saturday? This is a shift rather than a real change in economic activity.

The fact that only thirty percent of Japanese corporations pay the corporate income tax leads me to believe there are already many targeted corporate tax breaks available, or at the least, the corporate tax base is very narrow. If a rate reduction for the few corporations wouldn’t help economic growth, would tax incentives for these same corporations be any better?

As for the revenue effects of such a tax cut, it is reasonable for them to be concerned about losing money when they are 1 quadrillion yen in debt. However, this concern misses an important point. Yes, simple arithmetic dictates that reducing the amount corporations have to pay in taxes will reduce revenue. Yet, a reduction in the corporate rate—as they admit—will spur some economic growth. This growth will lessen the impact that the rate reduction will have on reduced revenue. Our research has shown that (in the United States, at least), lowering the corporate tax rate to 25 percent will actually increase total government revenue by $20 billion. Similar effects would be likely in Japan.

Even more, this could be a good opportunity to reform their corporate tax base. It is concerning that they are relying on only 30 percent of all their corporations to pay the entire corporate tax burden while the rest pay nothing. In order to reach certain revenue goals it is almost necessary to have such a high rate when you are only taxing a few corporations. If they were to broaden the base by subjecting more corporations to taxation, they could likely lower the rate to a more competitive level without losing much revenue.

Japan has some big economic issues that they need to overcome. Their high corporate tax is only one of them. However, they should reconsider their position and perhaps think more about the issue. A lower corporate tax rate, especially with a broader base, would be very beneficial for the country’s economic prospects.

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