Standard Life Investments

Weekly Economic Briefing

Japan & Developed Asia

Heart to heart


Due to its early industrialisation and high life expectancy, Japan is more advanced in the ageing process than many other nations. The ratio of old-age dependents to the working population is projected to double between 2010 and 2050, necessitating a significant rise in public expenditure and transfer payments. The consequences for Japan’s fiscal sustainability are severe, with a 30-40% increase in consumption taxes estimated to be required to stabilise the nation’s debt. The most obvious solution to tackle this dependency issue is to reduce the benefits provided to retirees. However, Japan’s public spending as a percentage of GDP is already rather low, in part due to the 2004 pension reform. At this time, the government introduced a measure known as the ‘macroeconomic slide’ which reduced benefits in response to a decline in the working age population and a rise in life-expectancy. A bigger problem is Japan’s low tax revenue as a ratio of GDP (see Chart 8).

Tax lite Corporate contributes more

These tax collection woes in part reflect the nation’s economic stagnation. While the nation’s effective tax rate has been reduced to below 30% in financial year 2016, the calculated tax amount for Japan’s SME sector, which contains the highest number of loss-making firms, is just 14.7% compared to 58.6% for those over ¥1 billion in size. Household income dynamics are even more alarming, with personal income as a share of GDP nearly half the Organisation for Economic Cooperation and Development (OECD) average. However, the most significant outlier in Japan’s taxation make-up is the contribution of indirect taxes. The OECD estimates indirect taxation represents around 30% of total tax revenue, one of the lowest ratios in the developed world. Of course, raising taxes is often more politically painful than cutting spending. This has certainly been the case in recent years, when the Abe government has twice delayed its plans to raise the VAT to 10%, from 8%. Given Abe’s sensitivity to his popularity rating, we suspect he will continue to bury Japan’s problems. A more open discussion on Japan’s fiscal future would be welcome.

Elsewhere in developed Asia, expectations are high that fiscal authorities will be more supportive in 2017 despite considerable demographic headwinds lurking in the future. This partly reflects the prospect of more Fed rate hikes but also concerns about the rapid pace of household debt accumulation. While the logic is compelling, what is the likelihood of this occurring? In Korea, the Ministry of Strategy and Finance’s 2017 budget plans calls for a 3.7% rise in spending, worth only a 0.6% increase once the supplementary budget is added in. At the same time, it has pencilled in a 6.0% rise in government tax revenues. This partly reflects the government’s upbeat outlook for growth, but also the recent upswing in effective corporate tax rates (see Chart 9). In aggregate, this points to a fiscal tightening of 0.6 percentage points of GDP relative to the 2016 budget. Of course, these figures reflect the work of a ministry operating under a ‘lame-duck’ presidency. With a decision expected on Park Geun-hye’s impeachment by April and a general election to follow on soon after, a new government headed by poll leader Moon Jae-In looks increasingly likely. Will that usher in a change? Moon’s Liberal Party bias is more fiscally supportive, and with debt-to-GDP at just 39.3% there is plenty of firepower. However, Korea’s troubling long-term demographics caution against a major fiscal stimulus.

Govinda Finn, Senior Japan Analyst