Japan: WTF is Going On?!?

Japan: WTF is Going On?!?

April 20, 2008


Japan’s economy has been rather disappointing over the past few years. Let’s break it down using our 1-2-3 method.

#1) Have there been any significant tax changes?

#2) Have there been any significant monetary changes?

#3) Are there other significant factors we’ve missed?

We can take care of #2 and #3 first, since the tax changes are what I want to focus on here.

#2) Monetary conditions are highly reflationary/inflationary. There has been some economic progress now that the burden of monetary deflation has been lifted … but not enough. This improvement in monetary conditions should provide a bigger boost than we’ve seen. Interest rates remain very low, which should be a plus. On the forex side, the yen has been rising somewhat recently against the dollar, but not so much against the euro. There has been some “competitive disadvantage” from this yen rise, but still not quite enough, in my opinion, to explain the rather poor showing of the economy and stock market.

#3) Other factors. Japan, for the most part, has not participated in the property/silly credit bubble seen in most of the developed world. Banks, however, do have some exposure here, and will take some losses. Trade with China et. al. has been a two-way street. Imports of consumer goods has been matched by exports of capital goods, for the most part, resulting in closely matched trade accounts.

#1) Tax changes. The trend is clearly up. Here is a summary of tax code changes I’ve been able to put together thus far.

Payroll taxes UP
2004-2017 increase payroll taxes by 0.354% each year, total from 13.6% to 18.3%.

Comment: This is a “two-sided” tax, just as in the U.S. So, the real increase is 13.6% (employee) + 13.6% (employer) = 23.9% effective to 18.3%+18.3%=30.9% effective. That’s a big rise, from an already high base. Also, in Japan there is NO upper limit on income subject to the payroll tax. This has been ticking up for a few years now already, a steady worsening of macro conditions in Japan. This tax was around 7.5% in 1970.

Capital gains and dividend taxes on equities UP
2001: Abolishment of 1.05% gross option postponed 2yr to 1 April 2003
2003: Dividends taxed at “reduced rate” of 10% by withholding for five years. Afterwards, dividends taxed at 20% by withholding.
2003: Capital gains on listed stocks taxed at 10% for five years.
2007: Abolish the current reduced tax rate at 10% for capital gains and dividends starting January 2009. (Move to 20% rate.)

Comment: Capital gains taxes on equities were traditionally untaxed in Japan, as is also the case in Germany, Singapore, South Korea and other places. This changed in 1989, with the introduction of a 20% capital gains tax, but also an alternative tax of 1.05% of the gross sales price. So, if you had capgains of more than 5% or so, you tended to pay the 1.05% alternative, as that was cheaper. MOF has been trying to implement a capital gains tax for decades. It appears that in 2003, the 1.05% alternative was eliminated, but a special 10% capgains rate was applied. Effectively, the capgains rate went from near-zero to 10%. At the beginning of this year, it appears that the change to a 20% capgains rate will be made effective by January 2009. Also, it appears that taxation on dividends has effectively gone up, via the hard-to-avoid dividend withholding tax.

Taxes on interest income UP
2002: Exemption of interest income on Maruyu deposits (for elderly) to be reformed in January 2006 and applied to only those owned by disabled persons etc. Effectively eliminated.

Comment: Interest income in Japan was traditionally tax free, or nearly so, by use of a number of various loopholes. It appears that the last of these loopholes are being eliminated. This likely means that interest income is now taxed as regular income.

Land -related taxes DOWN
2001: Long-term holdings of land capgains taxed at 26%.
2001: Suspension of application of the additional tax on capgains on sales by corporations, 10% for short-term and 5% for long-term. Extended to 31 Dec 2003.
2002: Registration and License tax for “qualified fireproof high-medium rise building and its premises” reduced to 2.5% from 5%.
2003: Registration and License tax reduced to 1% for FY2003-FY2005, 2% afterwards.
2004: Capgains on long-term land and housing reduced to 20% from 26%.

Comment: The problems in Japan’s property industry can be traced in part to an explosion of property-related taxes beginning in 1988 (in the Tokyo area) and spreading to the rest of the country by 1991-1992. These super-high taxes began to come down somewhat in 1998. The trend has been for property-related taxes to ease a bit lower, but they are still much higher than was the case in the 1980s.

Inheritance taxes DOWN
2003: top rate cut to 50% from 70%

Income taxes UP
2003: Spousal allowance of Y380,000 max to be abolished.
2004: Public pension deduction abolished
2004: Exemption for elderly (Y500,000) abolished
2005: “rate of tax credit reduced from 20% to 10%” Ceiling on tax credit reduced from Y250,000 to Y125,000. Local inhabitants tax reduced from 15% to 7.5%. Ceiling reduced from Y40,000 to Y20,000.
2006: “Remaining half of across-the-board tax credit abolished.”

Comment: Income tax rates generally fell during the late 1980s and 1990s. For now, the rates appear to be stable, but effective taxes have been heading higher via elimination of various deductions. The “across-the-board tax credit” was a tax cut from around 1998. Basically, you figured your taxes by the normal means, then, on the last line of the return, you reduced the figure by 20%. That’s pretty big. In 2005, this reduction was cut to 10%, and in 2006 it was eliminated. In effect, your taxes rise by 25%, not a small figure. If you combine the payroll tax hikes PLUS the elimination of exemptions PLUS the elimination of the tax credit, that adds up to some significant income tax hikes over the past five years or so.

But, perhaps most important, the trend of tax discussions in Japan has taken a rather worrisome turn. I expected this from years ago — that, faced with the huge debts and the large number of retirees, the government would trend toward much higher taxes. This won’t work in practice. In practice, the private economy must pay for everything, including the government and retirees. Who or what else could pay? The more you raise taxes, the worse the private economy functions, and thus the less capable it is of generating the surplus and abundance that can pay for retirees and government programs, or debt service.

The crazy bureaucrats at the Ministry of Finance have been trying to implement a European-style double-digit consumption tax since the late 1970s. Why, I don’t know. It’s some sort of weird Moby Dick project for those clowns. From 1950 to 1989, there was no sales tax in Japan. Guess what — no disasters happened. In 1989, the first one was implemented, at a 3% rate. At the time, the government was running a surplus. There was no practical reason for such a tax.

Recently, the politicians have been talking about raising the consumption tax (now 5%) to 11%-17%, with the next hike possibly in April 2009. Yowza.

The likely result of all this: economic underperformance. When combined with inflation, as is likely going forward, the likely result will be some serious economic deterioration. The result of that, as long as the present political approach to taxes continues, will likely be higher taxes. As the private economy deteriorates (high or rising taxes and monetary instability), it is less and less able to afford niceties like nursing care. The more the politicians raise taxes, the more the private economy would deteriorate. In the end, Japan may end up like Italy, with an excellent cultural heritage but a depressed economy.

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John Williams, of shadowstats.com, has offered one issue of his paid newsletter for public consumption. He was persuaded by Howard Ruff of the Ruff Times. Worth a peek.

Shadowstats special issue on hyperinflationary depression