Abenomics Litmus Test Looms as Pressure Mounts on Taxes

Prime Minister Shinzo Abe faces rising pressure to expand tax relief for Japan’s companies after the longest slump in business investment since 2009, setting up a potential battle with the Finance Ministry.

Officials will unveil tax breaks for capital spending in coming months, according to all 17 economists in a Bloomberg News survey -- a step Finance Minister Taro Aso has backed. Aso opposes a broader cut in corporate tax rates, even after a slide in investment since the start of 2012, and his ministry has a history of shielding revenue.

With analysts at banks from HSBC Holdings Plc and Mizuho Securities Co. to Royal Bank of Scotland Group Plc predicting limited impact from steps such as accelerated depreciation allowances, lobbying may intensify for stronger action. At issue for Abe is sustaining confidence in his recipe for ending Japan’s stagnation while addressing concern about the nation’s fiscal sustainability.

“Cutting corporate tax rates will require strong political clout,” said Shigeki Morinobu, a former director of the Ministry of Finance’s tax bureau. “It’ll be a litmus test for Abenomics.”

The Ministry of Economy, Trade and Industry said last week that lowering the effective corporate tax rate is an “important issue,” while Abe’s coalition partner, the New Komeito party, said that reductions could counter the blow to the economy from a sales-tax increase planned for April.

Investment Reports

Business investment fell for the sixth straight quarter in the April-June period, according to preliminary gross domestic product data released by the Cabinet Office. A separate finance ministry report yesterday showed capital spending in the second quarter was unchanged from a year earlier.

The Topix index of stocks jumped 2.4 percent as of 1:45 p.m in Tokyo today, extending this year’s advance to 33 percent, as weakness in the yen and signs of strength in the global economy boost the outlook for exporters.

Japan’s corporate tax rate of 35.6 percent includes local and national components and compares with 25 percent in China and 17 percent in Singapore, according to the finance ministry. Organization for Economic Cooperation and Development data show Japan has the second-highest rate of member nations, after the U.S. The rate is now 38 percent because of a three-year increase to fund reconstruction after a 2011 earthquake and tsunami.

Economic Metabolism

At HSBC, economist Izumi Devalier says that lowering the levy could help increase the metabolism of the economy, encouraging investment by overseas companies and fostering start-ups and innovation. Finance Minister Aso has argued that a reduction would be ineffective because 70 percent of companies don’t pay corporate income tax.

“The Ministry of Finance looks at tax cuts like a temperance campaigner views booze sales,” said Jeff Kingston, professor of Asian studies at Temple University in Tokyo.

The Bloomberg poll showed analysts divided on when or if the government may cut the corporate income tax rate. Most saw a move within the next two to three years, with some saying it could come as early as March next year. Others saw no cut in the forseeable future.

Abe’s Liberal Democratic Party vowed to make a “bold” reduction in its campaign for the upper-house election in July, and the prime minister said July 4 he wants to discuss a cut to make Japan more competitive.

Political Capital

Already facing opposition from interest groups in areas such as health care and agriculture to changes planned under the Abenomics banner, Abe may need to consider how consumers grappling with higher prices from a sales-tax increase would react to extra aid for companies, and how much political capital to invest in pushing through such a move.

The finance ministry convinced then Prime Minister Noboru Takeshita to support a 3 percent sales tax in 1988 despite the potential for electoral damage, according to former METI official Jun Okumura, who now works for Eurasia Group.

Abe’s predecessor Yoshihiko Noda, who had served as finance minister, abandoned his Democratic Party of Japan’s pledge to not raise taxes by pushing through legislation for the first increase in the sales levy in 15 years. The move contributed to Noda’s ousting by Abe in December.

“As the money-keeper, MOF is able to bully other ministries,” said Koichi Nakano, professor of politics at Sophia University in Tokyo.

Growth Strategy

Abe’s growth strategy aims to get investment back to a pre-financial crisis level of about 70 trillion yen ($712 billion) per year from about 63 trillion yen in the fiscal year ending March 2013.

Measures to encourage capital spending may cause only a “marginal frontloading” of investment, according to Takuji Okubo, a former Goldman Sachs Group Inc. economist who’s now at Japan Macro Advisors in Tokyo. Long Hanhua Wang, an economist at Royal Bank of Scotland in Tokyo, said the effect of any tax relief for capital spending “won’t be that big.”

Nomura Securities Co. said last week that a corporate income tax cut of 10 percentage points during the fiscal year starting April would offset most of the negative effect on the economy from raising the sales tax in two stages to 10 percent in 2015 from 5 percent now. At the same time, it would damage government efforts to tackle a ballooning national debt, making a later reduction preferable, Nomura said.

Company Clamor

“We want corporate taxes in line with other nations,” Hiroshi Tomono, chairman of the Japan Iron and Steel Federation and president of Nippon Steel & Sumitomo Metal Corp., said in July. In an interview, Teruo Asada, chairman of Marubeni Corp., Japan’s biggest agricultural commodities trader, said that the levy is “still very high.”

A 10 percentage point cut in the corporate tax rate would lift gross domestic product growth by 1.1 percentage points in 10 years, according to estimates by Toshihiro Nagahama, chief economist at the Dai-ichi Life Research Institute in Tokyo.

Three panels have a pipeline to the prime minister on taxation and each has a different agenda, according to Robert Feldman, head of Japan economic research at Morgan Stanley MUFG Securities Co. A Liberal Democratic Party committee uses the tax system as a political device; a government panel sees it as revenue tool; and the economic and fiscal policy council -- a gathering of policy makers, business leaders and economists -- sees a method for aiding economic growth.

“Abe has to make the decision on corporate tax cuts in the end,” Feldman said. “He’ll be torn by people from both sides and he’ll just have to go with his gut at some point. I think he’ll lean toward a tax cut.”

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