The ruling Liberal Democratic Party (LDP) and its junior coalition partner Komeito have finally reached an accord to keep the consumption tax on fresh foods, beverages, and processed food products at the current rate of 8 percent when the tax rate is raised to 10 percent for all other items come April 2017.
We have continued to argue that the European system of lower value-added tax rates, which applies to a wide range of items considered daily essentials, could be a helpful model, considering the reasons for introducing a reduced tax rate and the true purpose of the consumption tax. While the latest ruling-coalition agreement can be considered a step toward European-style taxation, many unresolved issues remain.
For example, in many European countries, rates of value-added tax -- the equivalent of Japan's consumption tax -- are upwards of 20 percent. Moreover, most countries adopted reduced tax rates from the very beginning for food products and other daily necessities. There are more than a few European countries that apply a reduced- or zero-tax rate to water bills, health care, clothing, children's items and cultural and educational materials.
According to the European system, reduced taxes originate from the dual goal of reducing taxes on everyday essentials out of consideration for low-income individuals, and making the consumption tax system sustainable.
The consumption tax in Japan is a valuable source of funds for social security spending, which continues to balloon as the ratio of the nation's elderly population expands. Under such circumstances, it's hard to believe that raising the consumption tax from the current 8 percent to 10 percent will be sufficient; a phased hike in the consumption tax is likely unavoidable.
This being the case, it is vital that a lower tax rate -- which alleviates the sense among the public that they are being overburdened by taxes -- be applied more widely to include daily essentials in addition to food products. We hope that the coalition does not end the discussion, but segues into more in-depth debate.
The ruling coalition is reportedly moving toward applying a lower tax rate on newspapers. In Europe, lower tax rates are applied on books and other items, based on the widely accepted rationale that "knowledge" should not be taxed. It would be ideal for Japan, too, to implement a tax system that reflects this line of thinking.
The decision made on the range of products eligible for the lower tax rate is expected to reduce the government's tax revenue by approximately 1 trillion yen, compared to what it would collect if the reduced tax rate were not instituted. This means that funds must be scraped together elsewhere to make up for the deficit. Ruling coalition politicians have thus far said during talks that they will be able to secure 400 billion yen. While the government has over a year to find a way to make up for the shortfall, the prospects for procuring 600 billion yen remain unclear.
Toward the end of their discussions, the coalition parties wasted time on whether to designate restaurant meals as being eligible for the reduced tax rate. That was valuable time that should've been used to debate the issue of how to secure funds to make up for the lack of tax revenues resulting from a reduced rate. The ruling coalition's agreement stated that both parties will "take responsibility to secure stable and permanent financial resources," but we need more reassurances than that. A review of how we spend consumption tax revenues on social security items like pensions and health care -- lifting the taboo on tinkering with them -- is essential.
Health care costs, for example, can be reduced by more widely adopting generic drugs. While the share of generic drugs in Japan is upwards of 40 percent, it's still low compared to the 70 to 90 percent share in other industrialized nations. According to some calculations, the government could cut back on at least 1 trillion yen in spending if it raised the share of generic medications to 80 percent or more by fiscal 2020.
Since consumption tax revenue comprises just a portion of the funds allocated to social security, however, it is ridiculous to fixate on the argument that if consumption tax revenue were reduced, we would have to make up for it by slashing social security funds. Many other avenues, such as allocating non-consumption-tax revenue to social security, or cutting back on non-social-security-related spending, should be explored. Increasing taxes on cigarettes, an argument that has emerged in the past, is just one possibility. Levying an additional 1 yen in taxes per cigarette can create revenue of 150 billion to 170 billion yen, according to some estimates. This is something that must be deliberated in talks on tax system reform planned for fiscal 2017.
From a different angle, reducing certain tax privileges granted to small- to mid-sized companies, in which they are permitted to keep some of the consumption tax paid by consumers, would also result in securing more government funds. In European countries where reduced tax rates are well-established, business operators are required to submit detailed invoices that indicate tax rates and taxed amounts on items so that the companies can be taxed accurately. In Japan, too, the invoice system is crucial in reducing the breadth of consumption taxes that small- to mid-sized companies are allowed to keep, and in promoting the appropriate payment of taxes.
In its agreement, the ruling coalition decided to require business operators to issue invoices. However, the adoption of this system will take place in two phases. For four years from April 2017, an abbreviated version of the invoice system that resembles the current system will be launched, and the more detailed invoice system will not become compulsory until April 2021.
The problem lies in the generous tax breaks given to small- to mid-sized companies. Companies with sales of 10 million yen or less will continue to receive tax breaks, and once the consumption tax hike goes into effect, their cut of the consumption tax paid by customers is expected to grow. Companies with sales of 50 million yen or less will be allowed to calculate their annual tax payments based on an estimate of the ratio of items subject to a reduced tax rate that will make up its total sales, based on 10 days' worth of sales. This is a system that could very well inflate the amount of consumption taxes that eligible companies can keep.
Some estimate that even under the current system, up to 600 billion yen in consumption tax is being retained by companies. It only seems natural to move toward reducing this sum, instead of increasing it. Consumption tax paid by the public must make its way to government coffers, and be used to fund social security needs.
The decision to place a reduced tax rate on all food products, with the exception of meals eaten out, has made it fairly easy to distinguish what will be subject to the 10 percent consumption tax and what will remain at 8 percent, come April 2017. The additional administrative work required of companies is not expected to be that heavy a burden. The government should map out a plan toward cutting back tax-related privileges given to small- to mid-sized companies, and implement the invoice system sooner than is currently planned.