Thoughts of the Tax Issue: A Reflection on the Debate Between Katz and Miyao

Craig Freedman (Professor, Macquarie University)

To a certain extent Richard Katz and Takahiro Miyao may be speaking at cross purposes. Richard Katz seems more intent on discussing how the Japanese tax system ideally should change, while Takahiro Miyao is more focused on the feasibility of tax changes given the existing political constraints. I have nothing to add to the discussion of the exact positions of the relevant players within the Japanese government. I can point out that any attempt to pin down a political position is necessarily difficult. It is usually to the advantage of a political actor to maintain a certain cushion of strategic ambiguity surrounding any stance they may choose to adopt. I will steer clear from directly commenting on the merits of either the position adopted by the Ishi, Shiokawa, or Takenaka, but instead respond to some more general themes raised in the debate.

There is a fundamental difference between the US and Japanese economy. The US is faced with chronically low savings while the savings rate in Japan has led to a continuing deficient level of aggregate demand. Given that fundamental difference, the potential gains from a more efficient tax system (from an economist's theoretical standpoint) can be easily overstated. Without strong empirical evidence to the contrary, I would be surprised if the same tax structure when applied to these two quite different economies would have comparable effects. Moving toward a flatter tax system in Japan would then seem to make limited, if any sense, given that one of the current issues is to expand, rather than discourage private consumption. (It can also be easily argued that a flatter income tax system in the US was driven more by political considerations than any economic logic. This at least seems to be the case with the cuts favoured by the current Bush administration.)

In the same way, slicing corporate income taxes, at least in the short run, seems less than urgent given the current economic climate. Empirical evidence demonstrates no remarkable sensitivity between such tax rates and corporate investment. It is hardly corporate tax rates, given the ability of many corporate entities to avoid such taxes, which are affecting the existing lack of investment. A better policy might look at ways to encourage investments in new markets, making it less risky to be entrepreneurial by facilitating a flow of funds to these areas of potential demand. In addition, Richard Katz'suggestion to end the double taxation of dividends seems unarguable, not only to prevent firms from sitting on cash, but to change the investing public's attitude to the equity market. For good reasons, a typical Japanese saver views investing in the stock market as too risky, more like a speculative gamble than a long run saving vehicle. This is one of the reasons that Merrill Lynch has so far failed to prosper in Japan. A strong and reliable dividend flow, treated in the same way as interest income might go a long way toward changing basic attitudes. But perhaps the best corporate tax policy would be that which encouraged private consumption demand. Clearly part of the current problem is a lack of investment opportunities, the result of sustained sluggish consumer demand.

Lastly, real estate taxes as well as zoning laws need to change if the housing market is going to recover. As both Katz and Miyao seem to agree, this sector is one of the keys to future economic growth. In the past, the real estate market has been woefully thin due to a combination of taxes and use restrictions. Ostensibly the reason for such incentives was to limit land speculation. (Though a more compelling reason might be found in the groups benefited by such a policy.) Instead, the thinness of the market assisted the asset bubble of the late eighties and early nineties. Here I feel obliged to attempt to clarify one contentious point between Katz and Miyao. Was the real estate market 'normal' during the 'bubble' period? A term like 'normal' does need to be carefully defined, but I don't believe that it is necessarily an empty bit of semantics. My understanding is that the underlying issue here is whether the prices then dominant in the real estate market were sustainable on a long-run basis. The general consensus that these prices reflected a prevailing asset bubble would undercut the implication that such prices were 'normal'. Equally, this doesn't imply that the current prices, the result of severe asset deflation, are in this respect 'normal'. It seems safe to say that at this time, rising real estate prices would assist an economic recovery in Japan.