1. The Need for Comprehensive Social Security and Tax Reform

The year 2011 turned out to be a tough one for the world and for Japan. In order to contend with the financial crisis and global recession stemming from the bankruptcy of Lehman Brothers in the fall of 2008, developed countries implemented large-scale fiscal stimulus and relaxed monetary policy. As a result, a crisis situation was avoided but with their economies not yet fully on a recovery path, the debt crisis in developed countries was exacerbated - evidenced in particular by the European debt crisis. In addition, the situation has brought a super strong yen to Japan. Rating agencies also downgraded government bonds of the countries with deteriorating fiscal positions one after another, and this practice has been continuing in 2012. Downgrading of government bonds naturally leads to higher long-term interest rates, thereby further deteriorating the finances and economy of a nation. Preventing such deterioration requires not only measures to counter the impending debt crisis but also fiscal consolidation.

Furthermore, developed countries face the challenges of aging societies and must establish social security systems that enable people to live with peace of mind. Moreover, while developed countries cannot hope for high economic growth, they are called upon to establish sustainable social security systems and at the same time to implement fiscal consolidation.

On January 6, 2012, the Democratic Party of Japan government officially decided on a draft proposal to promote comprehensive social security and tax reform as an urgent task, fearing that the nation's accumulated debt of 1,000 trillion yen would translate into a debt crisis with the additional burden of recovery from the Great East Japan Earthquake. According to the draft proposal, this reform aims at the simultaneous achievement of securing stable funding and a sound fiscal position in order to strengthen and maintain social security functions. Although the intention is agreeable, there are many concerns, which I will examine below.

2. Problems in the draft proposal for "Comprehensive Social Security and Tax Reform"

The outline of the draft proposal on "Comprehensive Social Security and Tax Reform" is shown in Chart 1. In the following section, I will point out four (4) issues of concern in the draft proposal.

(1) The draft proposal does not show a picture of the future social security system; for example, the specifics of fund-raising and system design for the new pension system - combination of earnings-related pension and minimum-guaranteed pension - and the New Medical System for the elderly aged 75 and over. Details of the system design for the priority areas of pension, medical service, long-term care service, and parenting are not yet determined, either.

(2) The conditions for a Consumption Tax rate increase could prove to be political hurdles in the course of realizing a Consumption Tax increase. The conditions are: (i) drafting the law based on consultation with opposition parties; (ii) checking economic indicators, such as growth rate and price movements, before raising the tax, with a clause for suspension of the tax increase in the draft law; and, (iii) trying to pass laws to reduce the number of Diet seats and salaries of national public servants.

(3) It is quite difficult to simultaneously achieve the securing of stable funding for social security and fiscal consolidation. In the Fiscal Management Strategy decided in June 2010, the government set a target that, as for the primary balance, the ratio of deficit to GDP shall be halved from that in FY2010 by FY 2015, and that the surplus shall be achieved by FY2020. Achievement of this target is difficult, however, because revenue from a Consumption Tax would be about 2 trillion yen less than the original estimation as the timing to increase the Consumption Tax rate to 10% would be delayed by half a year from April to October 2015. In addition, the Consumption Tax rate will have to be increased to around 15-17% in order to put the primary fiscal balance fully in the black; in other words, fiscal consolidation is extremely difficult.

(4) The draft proposal includes significant improvement in benefits relying on a prospective Consumption Tax increase, but on the other hand, the proposal postpones painful reforms. Some measures were originally planned but are not in the draft proposal; they include "fixed payment upon medical consultation," to ask additional payment from outpatients of 100 yen each visit, and an increase in payments at doctors' office - which have been kept at 10% of the total cost for people 70-74 years old - to 20%.

3. Tax Reform Proposal Putting Consumption Tax Increase First While Deferring Fundamental Issues

The substance of the draft proposal makes it clear that it is not a fundamental tax reform, but rather, it places Consumption Tax increase first while deferring fundamental issues. I will comment here on major taxes.

(1) The Consumption Tax Rate Increase and its problems

The Consumption Tax rate will be raised gradually, first to 8% on April 1, 2014, and then to 10% in October 2015. However, there is no explicit explanation as to why the rate will be 10% in 2015. In order to mitigate the regressivity of a Consumption Tax, lump-sum payments and refundable tax credits are proposed, but specifics are lacking, such as the size of the proposed measures or the threshold for low-income earners. Moreover, as for the introduction of an identification number system as a precondition, it is not clear how to prevent the invasion of privacy.

(2) The strengthened redistribution function of individual income tax/inheritance tax and its problems

It is proposed to levy the maximum marginal tax rate of 45% on high-income earners with income of more than 50 million yen from January 2015. This would, however, cover only 30,000 super rich people. Progressive taxation should be strengthened to be applied from income levels over 18 million yen. It is reasonable to propose that the basic deduction for the Inheritance Tax be reduced by 40 percent, and the highest marginal tax rate (currently 50%) be raised to 55%.

(3) The government's draft proposal has not specified concrete changes for Corporation Tax reform other than reducing the Corporation Tax rate by 5%.

4. Conclusion: Promote Real Comprehensive Social Security and Tax Reform

The draft proposal for "Comprehensive Social Security and Tax Reform" advocates the simultaneous achievement of securing stable funding and a sound fiscal position in order to strengthen and maintain social security functions. It does not, however, layout a grand design for the social security system, it is ambiguous about mid- and long-term cost estimates, and securing necessary stable funding is difficult; therefore, the simultaneous achievement of fiscal consolidation is deemed difficult. In addition, it relies almost entirely on revenue from the Consumption Tax, and it remains merely tax reform that places the Consumption Tax increase first while deferring fundamental issues. We need to promote a real Comprehensive Reform of Social Security and Tax.