Blind spot in the dispute on increases in consumption tax heated by integrated reform with social security

The debate in the Diet on the consumption tax increase bill is in its final stages. Deliberations between the ruling and opposition parties are focusing on whether or not to adopt bills on integrated reform of the social security system.

Japan's balance of government bonds at the end of fiscal year 2011 was 78.99 billion yen, or 162% as a percentage of GDP. The current administration is leaving things to fate in its reforms to try to restore healthy finances, reduce the balance of government bonds that has expanded to a worldwide scale, and secure pension funds to dispel unease among recipients. But I just wonder whether there is a blind spot within this reform dispute. Aside from the discussions in the Diet, I and some economists have debated the proposals on this problem. I would like to point out the problem of the regressive impact a rise in consumption tax will have on people in the lower income bracket, and to question how relief can be provided to offset the increased burden on the basic household consumption of such people.

Shigeki Morinobu (2009) describes the measures adopted in the 1988 supplementary budget, in line with consumption tax introduction reform, to alleviate the tax burden on elderly households. The measures included rises in temporary welfare benefits (54.3 billion yen) and temporary nursing welfare benefits (10.2 billion yen), and on the tax front, an increase in income tax deductions, an increase in the special tax exemption for a spouse, the establishment of a specified dependent exemption, an increase in the elderly exemption, an increase in the elderly spouse exemption and elderly dependent exemption, and the establishment of a public pension exemption.

In the 1996 supplementary budget, in which it was decided to raise consumption tax from 3% to 5%, temporary welfare benefits (32.1 billion yen), temporary nursing welfare benefits (101.6 billion yen), investment in upgrading funding for elderly and disabled home welfare (50 billion yen), and, in terms of social security action, pension index-linking measures (100 billion yen), senior care measures (300 billion yen), and minimum requirement low-birthrate countermeasures (100 billion yen) were allocated from 1997 resources. Senior care measures (100 billion yen in 1995 and 200 billion yen in 1996) were also appropriated. Other adjustments were included such as increases in the basic exemption, spouse exemption and dependent exemption for low income taxpayers, an increase in the specified dependent exemption, and increases in the elderly spouse exemption and elderly dependent exemption.

Looking at these relief measures for the disadvantaged taken in Japan when consumption tax was introduced and then increased, it seems we have adopted somewhat different methods from the policies of western countries.

HS classification used to alleviate EU standard value-added tax rates

The standard rate of value-added tax, the consumption tax of the EU, is set to only 15% in countries such as Cyprus and Luxembourg but to between 19% and 27% in most other countries (as of January 2012). Value-added tax is 19.6% in France and 19% in Germany. This is a high proportion of the basic consumption of lower income households, taking into account their income and total consumption. Because such standard tax rates would be a large burden on lower income bracket families, reduced tax rates are applied to basic consumption goods and services. The goods and services subject to reduced tax rates in France and Germany are classified as follows, according to the above-mentioned Morinobu (2009) and the EU (2012).

In France, where the standard value-added tax rate is 19.6%, reduced tax rates of 5.5% and 7% are applied to (1) foodstuffs, (2) water supply, (3) medical supplies, (4) medical equipment for disabled people, (5) passenger transportation, (6) books, (7) entrance fees for shows, movies and cultural services in theaters, (8) subscription television and cable television, (9) supply of copyright by authors, composers, etc., (10) provision, building and reconstruction of homes, (11) investment in agriculture, (12) hotel accommodation, restaurants and catering services, (18) waste treatment, road cleaning and garbage collection, with an ultra-low rate of 2.1% applied to (3) medical supplies and (6) newspapers and periodicals.

Germany has a two-tier value-added tax system with a standard tax rate of 19% and a reduced tax rate of 7%. The 7% reduced tax rate is applied to (1) foodstuffs, (2) water supply, (4) medical equipment for disabled people, (5) passenger transportation, (6) books, newspapers and periodicals, (7) entrance fees for shows, movies and cultural services in theaters, (9) supply of copyright by authors, composers, etc., (11) investment in agriculture, (12) hotel accommodation, (13) registration fees for sporting events, (15) services from social welfare organizations, and (17) medical and dental care.

Has the introduction of these reduced value-added tax rates in Europe created a squeeze on the tax revenue of those countries? So far as can be seen from the comparison of consumption tax indexes below, the average tax revenue as a percentage of GDP in all OECD countries in 2009 was 33.8% compared with 26.9% in Japan, showing that the burden on Japan is comparatively low worldwide. Also, the same tax revenue ratio but excluding social security was 24.6% on average among OECD countries compared with 15.9% in Japan. Tax revenue per head in Japan is also 20% less than the OECD average, and Japan's taxation burden remains 60% that of France and 70% that of Germany.

Even if reduced tax rates for consumption like those in EU countries are introduced in Japan, we can see from a comparison of the proportion of total taxes made up by consumption tax and of consumption tax as a percentage of GDP that Japan has an extremely low taxation burden ratio.

International comparison of consumption tax indexes (2009)
	Japan	France	Germany	OECD average
Tax revenue as a percentage of GDP	26.9	42.4	37.3	33.8
Tax revenue ratio as a percentage of GDP (excluding social security)	15.9	25.7	22.9	24.6
Taxation on goods and services (5000) as a percentage of GDP	5.1	10.8	11.1	10.7
Percentage of total taxes made up by taxation on goods and services (5000)	19.1	25.1	29.7	32.5
Consumption tax (5100) as a percentage of GDP	4.5	10.3	10.7	10.1
Percentage of total taxes made up by consumption tax (5100)	16.9	30.4	24.4	30.6
Taxation on general consumption (5110) as a percentage of GDP	2.6	7.1	7.5	6.7
Percentage of total taxes made up by taxation on general consumption (5110)	9.6	16.8	20.1	20.0
Percentage of total taxes made up by value-added tax (5111)	9.6	16.1	13.5	---
Tax revenue per head (shown in US dollars)	10,697	17,752	15,035	12,747
Notes, This table was created by the author based on Tax Revenue Statistics 1965-2010, OECD (2011).
Classification codes 5000, 5100, 5110 and 5111 are the OECD's uniform classification standards.

HS classification codes to identify international transactions should be introduced

How should the goods and services subject to such tax rate reductions be selected? In fact Japanese seem unaware that the EU adopts HS classification to decide how to apply reduced taxation rates. The HS classification is a database of internationally traded commercial products, a unified system of product names and classification, in the form of a list of codes. It is maintained by the WCO (World Customs Organization), established in 1952, in order to expedite international treaties (HS treaties) connected to a unified system of rules and product names and classifications related to WTO (World Trade Organization) agreements on rules of origin and customs valuations. At present, the HS Code List is adopted by 206 countries and regions and contains the goods and service codes used by WTO member countries when reporting, as they must, their concession tax rates. HS codes play an extremely important role in distinguishing economic transactions worldwide and form an international public tool that has been utilized in talks on the liberalization of trade between many countries and regions. The HS Code List currently defines categories that enable the identification of more than 200,000 goods and services.

This HS classification has been adopted in the EU reduction system for value-added tax application. If Japan introduced an EU-type reduced tax, for example, work would be needed to narrow down the target goods and services using HS classification. Basically the work would not need to be especially complicated as HS codes already exist and are used in customs clearance. However, because the aim is to alleviate the burden on the basic consumption of lower income households, the task of narrowing down and selecting would obviously require social consensus on the content of Japanese consumption. There is still enough time left to prepare for this, considering when the new consumption tax is to be introduced.

References:

Shigeki Morinobu (September 2009) "Thoughts on countermeasures for consumption tax regression [Shouhizei no gyakushinsei taisaku wo kangaeru]", Audit Studies, No.40
EU (January 2012) Implemented Value-Added Tax Rates of EU Member States [EU kameikoku no jikkou fukakachizeiritsu]