Setting sun

National Review, July 20, 1998 by Alan Reynolds

Unlike deficit spending, monetary policy can indeed "stimulate demand," speeding up growth of nominal GDP. But that alone will not solve the longer-term problem of chronic stagnation. Central banks can print money, but they cannot print entrepreneurship, enthusiastic workers, or investments in new technology and skills.

Longer-term growth is a matter not of "macro" tinkering, but of "micro" incentives. At a minimum, Japan must cut its corporate tax rate and highest individual tax rates by 10 to 20 points. This would merely bring rates down to the level of the U.S. or Britain. The 1992 tax on land ownership should be abolished and the capital-gains tax on land transactions greatly reduced, so as to minimize the paralyzing lock-in effect. The tax on securities transactions must be eliminated immediately, not phased out.

The government frets over the need for revenues to pay Social Security pensions to a rapidly aging population. But growth of revenues depends almost entirely on growth of the economy, and new taxes added from 1989 to 1992, including a VAT, are not helping Japan's economy to grow. Revenues from the individual and corporate taxes have plummeted since 1991. The collapse of retail sales after the April 1997 increase in the VAT surely reduced income-tax revenue more than could possibly be made up by the VAT itself.

Part of Japan's pension problem arises from the fact that the tax treatment of Social Security is too generous, while the tax treatment of private pensions is not generous enough. Not only are workers' payments into the Social Security system tax-deductible, but their eventual Social Security pensions are tax-exempt. Either would be fine, but not both. Meanwhile, contributions to private plans are taxed both on the way in and on the way out. If the tax treatment of private pension savings were only half as generous as the tax treatment of Social Security, then the next generation's precarious reliance on the tax-financed scheme would be diminished.

The pressure for such dramatic, structural reforms is building. Shoichiro Toyoda, chairman of the Keidanren, recently urged the government to "embark on a drastic review of income and corporate taxes." My bet is that it will, if only because the alternatives have already failed.

Alan Reynolds is Director of Economic Research at the Hudson Institute, and Senior Editor of the Institute's American Outlook, the next issue of which includes a detailed history of the Japanese tax system.