The Tax-Cut Tonic Tokyo Needs
By Brian Bremner
When do the parachutes open? That's pretty much the question at the Tokyo Stock Exchange these days, given the free-fall in the benchmark Nikkei index. It's down 25% since early June, and on Oct. 10 it set yet another record low of around 8,400. The last time Japanese stocks were trading at the level was -- gulp! -- 1983.
Macabre stock traders chalk it up to the so-called Takenaka Typhoon. On Sept. 30, Prime Minister Junichiro Koizumi surprised just about everyone in Japan by naming his top economic adviser, Heizo Takenaka, to the additional post of Financial Services Minister. That makes Takenaka Japan's top bank regulator. He's promising to quickly and forcefully clean up the loan books of Japan's banks, deluged as they are with bad debts. And the short-term impact could further jolt an economy already being whacked by deflation, jittery consumers, and weakening exports.
Stocks of heavily indebted construction companies and retailers, plus Japanese blue chips, such as supermarket chain and baseball club owner Daiei and auto maker Isuzu Motors, experienced a sharp sell-off. So have major banking groups such as Mizuho Holdings and UFJ Holdings, which have a high concentration of big, troubled corporate borrowers.
It's all a bit rich, given that the markets have been screaming for a decisive bank cleanup for years. Of course, in the short term, doing such a salvage job will probably mean some big bankruptcies, a spike in Japan's already record 5.4% jobless rate, and accelerated deflation. But if coupled with tax cuts, extended jobless benefits, and loose fiscal policy, this need not be a disaster. Long range, Japan will surely be better off with a healthy banking system. It's just that part about getting over the hump between point A and point B that's freaking everyone out.
Later this month, Koizumi is set to unveil a new round of policy changes, including a tax cut of about $20 billion. The idea is to offset some of the pain the economy will doubtless experience as the banks work through the loan books and restructure or cut off Japan's corporate zombies. But the Prime Minister needs to be thinking far more ambitiously. Japan can't really fix its banks -- burdened by $600 billion to $800 billion in dud loans, according to most analysts -- without a lot of government stimulative spending to ease the suffering.
The economy is far too weak for a cold-turkey approach on the banks. Japan could see its jobless rate double, to about 10%, and experience perhaps its worst recession in postwar history. To avoid that, Koizumi has to go slow on bank reform. But then, Japan will never get a sustained recovery going with a chronically sick banking system. No how, no way.
DON'T SWEAT THE DEBT.
Japan has a way out, though. First, it needs to put aside for the moment its fixation with budget deficits. Yes, Tokyo's red ink is out of control. A decade-long spending binge on public works and various and ineffectual tax cuts and loan programs have pushed Japan's total outstanding debt to around 140% of gross domestic product, the highest in the industrialized world.
That needs to be dealt with, but not now. Japan is lucky in one respect: Foreign investors own only a tiny slice of government debt, and Japan still has a large savings pool to draw from. Interest rates are at near-zero levels, so servicing that debt is manageable for the moment. So the country can afford to put that issue aside for another day.
Instead, Koizumi needs a massive tax cut to get the economy growing again while he addresses the bank crisis. What sort of tax cut would really get consumers spending? The best idea I've heard comes from Harvard economist Martin Feldstein.
Last year, he floated the idea of suspending Japan's consumption tax for a two-year period -- but with a proviso. When the buzzer rings after two years, the tax that affects all consumer purchases and services would be doubled to 10%. Japanese consumers would have a massive incentive to spend now, particularly on big-ticket items such as cars, consumer electronics, and the like.
A big burst of consumer spending, which drives about 60% of economic growth in Japan, would get the economy rolling and give the Koizumi government a window to do some heavy-lifting on the banking system. Corporate profitability would get a boost and so, probably, would Japanese stock prices. That lost tax income would put even more pressure on the government's finances, but a growth spurt would also bring in more revenues with other taxes.
Another idea Feldstein backs would be to offer a two-year investment tax credit to turbocharge capital spending -- a big driver of economic growth. The same logic of front-loading spending -- the knowledge that the party ends at a set date -- would also be a powerful incentive.
ONLY BOLD WILL DO.
With any luck, Japan's economy would revive, the banks would be out of intensive care, and a fair amount of corporate-earnings momentum would offset the bite when these incentives are phased out. Then Japan could pull together a multiyear program of spending cuts and tax hikes to gradually work down the budget deficit to more manageable levels. That's a lot easier to do in a growing economy than a stagnant one.
Japan has no easy exits from its current economic mess. But without something bold like the Feldstein plan, it's hard to see it returning to the sunny uplands of economic prosperity. Japanese consumers and businesses need to feel the urge to splurge as never before.
Bremner, Tokyo bureau chief for BusinessWeek, offers his views every week in Eye on Japan, only for BusinessWeek Online
Edited by Douglas Harbrecht