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    « Obama's $858 Billion Tax Cut Bill : $55 Billion Plus For Special Interests | Main | New Lawsuit Against DOD & VA Re: Sexual Abuse In US Military »
    Tuesday
    Dec142010

    Japan To Slash Corporate Tax Rate: Desperate Measures For Desperate Times

    In an effort to resuscitate the Japanese economy, PM Naoto Kan yesterday announced that the corporate tax rate in Japan (which is at present 40%) will be cut by 5% starting next fiscal year (April 2011). This move had been debated in Japan for many months and was initially opposed by the Japanese Ministry of Finance (MOF). But the Ministry of Economy, Trade and Industry (METI); which had been pushing for lowering the corporate tax rates for quite some time now, seems to have finally won the argument. 

    PM Naoto Kan, Image Source:WikiCommons

    Japan's long standing, and seemingly unending battle with deflation is what most Western nations would consider their worst nightmare right now. Back in the early 1990s, Japan went through an economic crisis, and recession similar to what the US and the European countries are experiencing right now.

    The 1980s saw an impressive surge in the Japanese economy to the extent that it was widely speculated at the time that if this phenomenal growth continued unabated then it was just a matter of time, before Japan overtakes the US as the #1 economy in the world. Unfortunately for Tokyo and fortunately for Washington, such predictions never materialized. 

    The spectacular crash of Japan's asset price bubble (which included a stock market bubble and a real estate bubble), in the late 1980s and early 1990s, was followed by decades of economic bad news. Japan never quite recovered from that crash. The asset price bubble continued to deflate as if in slow motion over years, getting hit even harder each time the global economy took a downward turn.

    Deflation technically means that the annual inflation rate is below zero, or in simpler terms, it indicates that prices of all goods and services have fallen. People tend to spend less in deflation just as in inflation but for different reasons. Economists suggest that as the value of goods and services declines, people tend to hold on to their cash, waiting for better bargains.

    When people spend less, it inevitably leads to less demand and excess supply of goods and service; which in turn creates a decline in manufacturing, shutting down of businesses and factories, stagnant or sinking wages and rising unemployment. This sets in motion a vicious cycle, since an unemployed and or underemployed population tends to resist spending money even more.

    Japan's social problem of lower birth rate - less younger people in the workforce combined with burgeoning older, retired population - is an additional drain on the Japanese economy.

    And then there are the problems brought on by a strong yen. Chronic deflation in the Japanese economy has caused the yen's relative purchasing power to increase over the years, thus making it stronger. During the recent global recession, as the US and other major economies have cut their short term interest rates to near zero, it has made the yen even stronger against the USD. Earlier this summer the yen reached a 15-year high against the USD.

    When the currency is strong, the nation's exports become more expensive for foreign buyers and as such the exported goods are less competitive (and less desirable) in the global market. To illustrate this point, let us imagine a hypothetical scenario where in scenario A) 50 yen= 1USD (stronger yen) , and B) 100 yen= 1USD (weaker yen). If the US is going to export something from Japan worth 1USD, in scenario A it gets goods worth only 50 yen in exchange for one USD whereas in scenario B the same dollar buys twice as much. The US is more likely to invest in Japanese exports in scenario B. So, a weaker currency helps to boost a country's exports. A strong yen is hurting Japanese businesses and manufacturing that rely on exports. 

    On a side note, this is the basis for the primary allegation against Beijing about it's artificially undervalued yuan (Renminbi or RMB), that the weaker RMB makes PRC's exports cheaper in the international trade. RMB is estimated to be undervalued possibly by as much as 40% right now. If China would let RMB rise, it's exports would subsequently suffer, which could have disastrous consequences on the export driven Chinese economy.

    Getting back to Japan's fiscal woes, in September 2010, for the first time since 2004 Japan officially intervened in the currency markets to deliberately weaken the yen against the USD, by selling off ¥2.12 trillion ($25 billion) between August 28 and September 28. However that measure did not bring long lasting success. Yen weakened against the USD for a few weeks and then grew stronger again. At present the yen is in the 82-83 range against the USD, and it has been estimated that for Japanese businesses to make profit in their exports, the yen needs to be close to 92 against the USD. 

    A strong yen also impacts adversely the repatriated profits of Japanese businesses which make profit overseas and bring them back to Japan. A stronger yen makes them lose money in that transaction. Going back to the same example given above: in scenario A (stronger yen), a Japanese person/business entity earning 1USD overseas gets only ¥50 back in Japan by transferring that money home; whereas in scenario B (weaker yen) he/it gets twice as much. This type of transactional loss thus further reduces the cash flow into the country.

    It has long been argued by many that Japan's historically high corporate tax rate has caused not only many local companies to move off-shore but it has been a hindrance to attracting foreign multinationals to Japan. At one point the corporate tax rate in Japan was even higher (50%) than what it is today (40%), but compared with other nations like South Korea (24%), China (25%), UK (28%) and Germany (29%), 40% is still too high.

    Japan's debt stands at a historic high right now (close to 200% of the GDP or more than ¥900 trillion); which is at least partly due to all the economic stimuli the government kept injecting into the economy to stop the fiscal bleeding after the asset bubble burst in the 1990s. The newly proposed corporate tax rate cut is estimated to cost the Japanese economy anywhere between ¥1.4 trillion to ¥2.1 trillion ($16.8 billion to $25.2 billion) in lost tax revenues. So far the MOF has been able to identify alternate sources to secure only ¥650 billion to make up for this huge loss of tax revenues, which still leaves a sizeable gaping hole to fill. 

    According to the METI, the lower corporate tax rate could raise the Japanese GDP by ¥14.4 trillion ($172 billion) over the next three years. However as is often the case in life, the gains generally remain aspirational for a relatively long time; while the losses tend to become real much sooner.

    ~ Gauri  

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