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Top>Opinion>The Direction of Financial Restructuring


Hiroshi Mifune

Hiroshi Mifune [Profle]

The Direction of Financial Restructuring

Hiroshi Mifune
Professor of Public Finance, Faculty of Commerce, Chuo University

Budget screening

The first half of the third round of budget screening was carried out by the Government Revitalization Unit at the end of October. This round of budget screening focused on reviewing and prioritizing forty-eight national government programs in eighteen special accounts. This resulted in a decision to abolish four special accounts (including the special account for social capital improvement programs), merge three other special accounts (including the special account agricultural mutual aid reinsurance), and review another ten special accounts (including the special account for earthquake reinsurance). A decision was also made to abolish eight programs (including the super levee program) and to review another forty programs.

Budget screening began as one of the key policies of the DPJ government, with Round One being carried out in November last year and Round Two taking place in April and May this year. Round One targeted 449 of the roughly three thousand programs that are run by the national government, while Round Two looked at 151 programs being implemented by independent administrative agencies and public interest corporations.

The purpose of budget screening is to come up with sources of funds that can be appropriated to new programs, by identifying waste, and by scaling down or abolishing existing programs. The DPJ's manifesto includes new programs such as child allowances, free high school education, and individual-household income compensation for farmers growing staple crops, and the cost of these programs is expected to reach a total of 促16.8 trillion by 2013.

However, the three rounds of budget screening were only able to come up with savings worth about 促3.3 trillion, a far cry from the 促16.8 trillion target. It is now clear that it will not be possible to secure sources of funds for new programs simply by cutting waste.

A large deficit and a small government

With these new programs included in this year's general account budget, the annual expenditure for the national government came to about 促92 trillion, up 4.2% over last year. Annual income was entered as 促37 trillion from tax revenue and 促44 trillion from national government bonds. This is a deficit budget, with tax revenue only accounting for about 40% of annual income, and nearly 50% being covered by national government bonds. Moreover, the other 10% of annual income is covered by buried treasure in the form of transfers from reserves, and so if we regard these transfers as loans, then about 60% of annual income is made up of debt, an extraordinary budget situation that is unparalleled in history.

The total outstanding long-term debt for both the national government and local governments has been estimated at 促862 trillion for the end of 2010. This amounts to 181% of GDP. This is much higher than any of the other major industrialized nations. Even in Greece, whose financial crisis destabilized the euro system, the ratio of long-term public debt to GDP is about 125%. It must be noted that Japan's finances are in an extremely serious situation.

The fact that Japan's public finances are in a critical situation with a massive deficit may have become common knowledge for most Japanese citizens. However, it seems that people may not be generally aware that the Japanese government is a small government. Let's verify this by comparing Japan with other OECD member countries.

For Japan, the ratio of general government spending to GPD in 2007 was 37.1%, the fifth lowest of the twenty-eight comparable OECD nations (where general government is a concept of government that includes both national and local governments, but not publicly managed enterprises). At the same time, in 2007 Japan's national burden ratio (the ratio of citizen's incomes to the total of tax revenues and social insurance fees, which is an index that indicates the size of the burden on citizens) was the fourth lowest of the twenty-eight comparable OECD nations. In 2005, the proportion of public servants as a percentage of the workforce was 5.3%, the lowest of twenty-six comparable OECD nations. These figures show how the scale of the Japanese government is quite small.

Pressure to increase spending versus financial restructuring

We can also see that the Japanese government is quite small by looking at individual expenditures. For example, social security payments are increasing as the population ages, but the level is quite low compared to other countries. In 2003, the ratio of social security payments to GDP was 17.7%, the seventh lowest of twenty-nine comparable OECD nations.

Similarly, the ratio of public spending for education costs to GDP in 2005 was 3.4%, the lowest of twenty-nine comparable OECD nations, and the levels of public spending for childcare and childhood education are also quite low compared to other countries. The ratio of public spending for families and small children, which has a close relationship with measures for addressing falling birthrates, is also extremely low compared to other countries.

At the same time, looking at the budget for science and technology we see that the proportion of government spending taken up by research costs is much lower than in Western nations, much lower even than in China and South Korea.

Just looking at these figures, we say that at present the quantitative levels for policies for addressing the aging population and falling birthrate, as well as the education policies and policies for invigorating science and technology, are all inadequate, and that Japan will have to increase its public spending if it is to aim for a level equivalent to major industrialized nations. We can also expect costs associated with social security to increase automatically as the population continues to age. In any case, we can only expect the pressure for increased annual spending to become even stronger in the future.

Against these trends, Japan's public finances are in dire straits, with a massive deficit as we have already seen, and so rebuilding public finances is an urgent challenge. So, how can the government proceed with financial rebuilding in the midst of these kinds of pressures to increase spending?

Generous welfare and low taxes are incompatible

In the European Union, moves toward restructuring public finances are already accelerating, triggered by the Greek financial crisis. Also, at the G20 meeting in June, the participating countries agreed to halve their financial deficits by 2013. However, Japan was treated as an exception because, unlike Greece, almost all Japanese national government bonds are held in Japan, and so it has been allowed to pursue its own financial rebuilding plan, which involves halving its primary balance (with respect to GDP) for both the national government and local governments by 2015 (where primary balance is an index that indicates whether annual spending other than the cost of servicing government bonds can be covered by annual income other than income from government bonds). This can be described as an international commitment by Japan to restructure its public finances.

Japan's primary balance for this year is a deficit of about 促24 trillion. Ignoring economic growth for the time being, halving this 促24 trillion deficit over the next five years will require that 促2.4 trillion be cut from the deficit every year. That this cannot be achieved simply by cutting waste is clear from the results of the budget screening process discussed at the beginning of this article.

One conceivable way of restructuring public finances is to come up with huge cuts to annual expenditure, as is being done in the United Kingdom. However, if we take into account the fact that Japanese annual spending-whether for welfare or education, are at low levels compared to other countries as discussed above-then the government will have to be careful not to cut spending in these areas.

The reason why such an enormous public deficit has been able to accumulate is that the cost of the government services we receive cannot be covered by the taxes and social insurance fees that we pay. The moral that generous welfare is incompatible with low taxes is something that we need to take to heart, and we need to think about the direction of restructuring public finances by increasing the burden on citizens. The government also needs to strictly abide by the principle of pay-as-you-go, always securing sources of funds whenever new programs are introduced.

As the footsteps of financial insolvency draw nearer by the minute, let's hope that the government can make some wise decisions.

Hiroshi Mifune
Professor of Public Finance, Faculty of Commerce, Chuo University
Born in Okayama Prefecture in 1949
1974: Graduated from the Faculty of Economics, Yokohama National University
1979: Received doctorate from the Department of Economics, Hitotsubashi University
1979: Assistant on the Faculty of Commerce, Chuo University before becoming a full-time lecturer, assistant professor, and finally a professor, in 1990.
His current research interest is the effects of the aging population on public finances and social security.
His publications include Public Economics [Koukyou Keizaigaku] (co-author, Toyo Keizai Housha, 1998), New Developments in Financial Decentralization [Bunkenka Zaisei no Shin-tenkai] (co-author and co-editor, Chuo University Press, 2007) and New Developments in Financial Globalization [Global-ka Zaisei no Shin-tenkai] (co-author and co-editor, Chuo University Press, 2010).