Abe needs to improve collection if he's going to lower corporate taxes.

Photographer: Chris McGrath/Getty Images

Japan's Tax Cuts Don't Go Far Enough

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The avoidance of taxes, John Maynard Keynes wrote, is the only intellectual pursuit that still carries any reward. Don't executives in Japan know it: Even with national debt skyrocketing, more than 70 percent of companies here still pay no corporate taxes.

It makes one wonder what Prime Minister Shinzo Abe is thinking as he promises to slash the roughly 35 percent corporate tax rate. Granted, Japan's rate is unreasonably high: China's is 25 percent, while Singapore (17 percent) and Hong Kong (16.5 percent) are in a completely different league. The government hopes that lopping at least 3.3 percentage points off corporate levies by next year will encourage Japanese executives to increase investment and thereby boost growth. Investors seem enthusiastic. Abe's pledge Wednesday to expedite the cuts ignited the biggest Nikkei rally since 2008.

QuickTake Remaking Japan Inc.

The logic behind the move, however, seems shaky. Thanks to the weak yen (down 33 percent since late 2012), big Japanese exporters are enjoying record profits. Yet instead of pouring that money into fresh capital investments or wage increases, they're hoarding $2 trillion of cash. Before they spend more, executives need to have confidence in long-term growth -- that if they fatten paychecks now, they won't regret the decision five years from now. There's little reason to believe lower taxes will ease their doubts. 

Similarly, consider the perspective from abroad. In theory, lower taxes should make Japan more competitive and thus encourage multinational companies to take another look at the country. But Japan's low productivity, high costs, aging population and weak English skills remain major turnoffs. Despite the plunge in the yen, Japan hasn't seen a major investment from abroad or inbound mergers-and-acquisitions attempt since Abe took office. Fundamentally, Japan's rigid and bureaucratic economy lacks appeal for long-term investors.

To change such perceptions, Abe needs to do more than cut rates. He must loosen labor markets to phase out the growth-killing seniority-promotion system, reduce trade tariffs and liberalize immigration. He also must cut red tape to encourage entrepreneurs to start new, innovative companies -- in other words, unleash the "animal spirits" Keynes championed.

If he's going to go ahead and lower taxes, too -- something he's been talking about since last year -- Abe also needs to improve collection under the new rates, lest they add to Japan's national debt. Companies have simply become too creative about making profits look like liabilities. Tax inspectors, meanwhile, are too worried about corporate failures to dig deeper. "The taxman," says strategist Nicholas Smith of CLSA, "needs to put the fear of God into companies, like the nice people at America's IRS, so that companies know their days of taking liberties are over." 

Indeed, simply enforcing laws already on the books could help push companies to raise wages, too. Rulings dating back to 1967 protect "non-regular" workers, a fast-growing share of which are women, from discrimination in wages, benefits and career advancement. Yet in his high-profile push to encourage more women in the workforce, Abe has concentrated on setting targets for companies to hire more women, particularly as managers. As Richard Katz of the New York-based Oriental Economist Report noted in a recent report, managers comprise only 6 percent of all company employees. So even if more women won such roles, the vast majority of them would remain under-incentivized to enter the labor force. Katz's bottom line: "If Abe really wants to promote gender equality and to raise workers' wages, the answer is: enforce the law."

Abe certainly deserves credit for seeking out new ways to enliven Japan's corporate sector. He might have more success, though, if he made better use of the tools already at his disposal. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
William Pesek at wpesek@bloomberg.net

To contact the editor responsible for this story:
Nisid Hajari at nhajari@bloomberg.net