Economic Policy Prospects in Shaky Political Times

Farewell to Trillions in Gas Tax Revenue?

The Democratic Party for the People is attracting attention as a new political partner for the Liberal Democratic Party. The DPFP has consistently promoted expansionary fiscal policies prior to the recent election. Party leader Tamaki Yūichiro, for instance, has long advocated the reinstatement of the trigger clause of the gasoline tax.

The trigger clause is a measure to suspend about half of the gasoline tax, which amounts to more than ¥50 per liter of fuel in Japan, when the total price exceeds a certain level for three consecutive months. This trigger clause was introduced in fiscal 2010 to address the rising price of gasoline. Immediately after its introduction, however, the clause was suspended to keep the revenue flowing and finance the recovery from the Great East Japan Earthquake and tsunami of 2011. The DPFP is saying that the trigger clause needs to be restored to reduce the price of gasoline.

The government and the LDP oppose the reinstatement of the trigger clause, arguing that rapid price changes will disrupt the distribution process. However, if the LDP wants the cooperation of the DPFP, this issue is certain to resurface. Should the trigger clause be restored and implemented, central and regional governments will forfeit up to ¥1.5 trillion in revenues, which they will need to replace in some other way.

According to relevant sources, even if the trigger clause takes effect, the price of gasoline will not change greatly for consumers at the pump if current subsidies are not maintained. Should the trigger clause take effect and the gasoline tax be reduced, there may be growing calls to maintain subsidies. In this case, the fiscal burden will likely increase by several trillion yen.

A Possible Hit to JGB Ratings

Another issue raised by the DPFP is abolishing the so-called ¥1.03 million wall. Since an income tax is assessed when annual earned income exceeds this figure, it is said that the ¥1.03 million wall has the adverse effect of causing low income earners to voluntarily limit their working hours.

The figure of ¥1.03 million is the sum of the basic deduction and the earned income deduction. The DPFP is calling for increasing this figure to ¥1.78 million. A major increase in deductions, however, will effectively be a reduction of taxes. Since the basic deduction is applied by many income earners, the Ministry of Finance estimates that the effect of implementing the DPFP proposal could reach ¥8 trillion. This would be a larger effect than the income tax reduction of ¥40,000 per person implemented by Prime Minister Kishida Fumio during his time in office (2021–24).

The debate on fiscal expenditures drags on. When Prime Minister Ishiba Shigeru indicated the need for economic measures on October 4, he stated that last year’s supplementary budget came to ¥13 trillion and that he wanted to carefully draw up and pass an even larger supplementary budget for this year. Both the civil service and politicians believe that this supplementary budget will be sizable and may even reach ¥20 trillion.

Many years of austere main budgets have been followed by large supplementary budgets, accelerating the worsening of public finances. This is despite the prospect that the outstanding balance of government bonds will exceed ¥1.1 quadrillion at fiscal 2024 year-end.

Despite all these matters for concern, though, there seems to be little serious debate on financial resources these days. Interest in how to address the target for restoring public finances to health going forward attracts little interest and is neglected in political circles.

The current target for achieving a positive primary balance by fiscal 2025 is coming into view. This will not, however, be the result of placing public finances on a sound footing. Rather, it will largely be the result of the growth of the nominal economy supported by rising prices.

Whether the primary balance will turn positive will be finally known around autumn 2026, when the fiscal 2025 budget is finalized. The next target being examined by the government is a positive fiscal balance. The primary balance is a measure of whether policy expenditures are being made within the scope of tax revenues. It does not include the interest expense of government bonds. When we consider the future of fiscal management in a world where interest rates matter again, the fiscal balance including this bond-related burden will be significant. There are some who hold the view that the government should not focus immediately on the fiscal balance but should make the achievement of a stable positive primary balance its next target.

Whatever the case, unless politicians begin debating how to rein in runaway public finances while they also debate tax reductions and increased fiscal expenditures, the downgrading of the ratings of Japanese government bonds by credit rating agencies will be only one of the forms of corrective pressure certain to arise.

The Bank of Japan’s Difficult Position

While Prime Minister Ishiba has held a critical view of the BOJ’s “monetary easing of a different dimension,” upon forming his new administration, he announced that he would not revise the 2013 accord reached by the government and central bank, the “Joint Statement” aimed at ending deflation and putting the economy on a sustainable growth track. Moreover, after meeting with BOJ Governor Ueda Kazuo, he went as far to say to journalists that he does not think the current environment calls for an interest rate hike. There are few advocates in opposition parties for the early normalization of monetary policy, that is to say, interest rate hikes. Despite the crushing defeat of the ruling parties in the recent election, the monetary policy environment of the BOJ appears unchanged.

The rate of inflation has exceeded the 2% target for more than two years. Huge fiscal expenditures or the effective reduction of taxes in such a context will accumulate inflationary factors going forward. In addition, politicians preventing the BOJ from increasing interest rates will risk the depreciation of the yen. Should the yen weaken, the Japanese economy will experience further upward pressure on prices. There is little meaning in debating measures to address rising prices if the BOJ is unable to increase its rates.

The BOJ is to blame, however, for July and August 2024 misstatements in its communication with the market that proved disruptive. Governor Ueda has explained that the current policy interest rate is less than a neutral rate (a rate that is neither a loosening nor tightening of policy) and that even if the interest rate is increased, monetary policy would still be one of easing. Politicians, however, do not see this in the same way. How will the BOJ maintain a proper distance with the Cabinet Office and politicians while keeping an eye on the direction of prices? The BOJ will continue to face challenges in steering monetary policy going forward.

Heavy Responsibility as a Trading Nation

Unrelated to the outcome of the recent House of Representatives election in Japan, an event likely to have the greatest impact on the Japanese economy this autumn is the US presidential election on November 5. The Republican president-elect Donald Trump has promised to impose a 60% tariff on imports from China and tariffs between 10% and 20% on imports from Japan and other nations.　

Should a 60% tariff be imposed on China, this will harm the flow of global manufacturing, distribution, and sales, and it will have a huge impact on Japan and other nations. Higher tariffs on imports will cause inflation in the United States, and the Federal Reserve will be forced to raise interest rates. Should this occur, the US economy will slow and the yen will weaken. The world economy will experience a considerable level of disruption.

Prime Minister Ishiba appears to be exploring the possibility of meeting the next US president as early as mid- to late November. Ishiba will bear a heavy responsibility when it comes to persuading Trump not to impose tariffs.

The World Trade Organization, the leading organization concerning global trade, is now practically dysfunctional. Due to US opposition, the members of the Appellate Body, which should be seven, have fallen to zero. The Appellate Body is a key organization for resolving disputes between WTO members, and the current situation risks the forfeiture of global trade rules.

While recognizing the criticism that the promotion of free trade as part of globalization efforts has increased disparities between nations, this cannot be made the basis for impudently ignoring rules and blocking the functions of the WTO through selfish actions. If Ishiba intends to retain his position as prime minister, he will be answerable as the leader of the trading nation of Japan for how he persuades the US president. This persuasion will have great significance from the perspective of preventing the disruption of Japan’s economy. The responsibilities that Prime Minister Ishiba will bear are heavy.

(Originally written in Japanese. Banner photo: A monitor showing the closing price of the Nikkei Stock Average and the yen’s exchange rate when the Tokyo market reacted sharply to the previous day’s election results on the afternoon of October 28, 2024, in Chūō, Tokyo. © Jiji.)