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Taxation In Japan Essay, Research Paper

The role of taxation in the transformation of the Japanese

Economy Introduction Before the Meiji restoration under the

feudal Tokugawa Shogunate, taxation was mainly a tool for

warfare and military power. The system was highly

regressive and pressed lightly on the rich and profit-earners.

It was calculated to preserve a very unequal distribution on

incomes and to stimulate the accumulation of private capital.

This tendency somehow continued and was magnified before

W.W.II when direct taxation was introduced for a more

equal and balanced system. However, the Meiji restoration

did bring with it tremendous changes to the tax system and

the use of the revenues. The Japanese government has since

had an active participation in the economy, yet not

controlling it directly but rather through market mechanisms.

It took responsibility for promoting economic growth by

using incentives and taxes collected in an effective way. The

often cited goal of taxation in western countries that was

equality was often sacrificed for the goal of economic growth

in order to prevent being colonized, then to pursuit the desire

to become an imperialist nation and then for pride and

export. The role of government and its fiscal policies played

an important role in the transformation of the Japanese

economy through the periods of Meiji restoration, before

W.W.II and post W.W.II period where taxes respectively

shifted from land taxes to internal indirect taxes to income /

direct taxes. (Fig 1) Period of Meiji Restoration During the

first years of the Meiji reforms, the government had serious

financial difficulties with tax revenues inadequate for its

massive commitments. In 1873, land reforms gave tittles to

landowners and customary tenants, freed the transfer and

sale of land from feudal restrictions and imposed tax

obligations equal to 3 per cent (which was lowered to 2.5%

in 1878) of the value of land. In addition a 30% local surtax

was imposed on the land taxes. These heavy land taxes were

used to provide monetary compensations to the old ruling

class for the termination of their feudal incomes in kind and

to finance the new administration which introduced new

education and to support its military. The agricultural sector,

and in fact the peasants, therefore bore the great bulk of the

cost to Japan’s modernization. The land taxes contributed to

over 70% of the central government’s revenue during the first

decade of the Restoration. Since the capital needs of

agriculture were small even after the landlords devotion to

the improvement of agricultural techniques and introduction

of winter drainage, the increasing savings and surplus of

landlords were transferred out of the primary sector into

other sectors. The fiscal system as a whole was heavy in

absolute terms yet highly regressive. The burden was

constantly on the agriculture sector, even when

non-agricultural sectors were growing at a phenomenal rate.

As seen in Figure 1, under indirect taxes, before the turn of

the century, the excise taxes played a prominent yet second

to land taxes at about 20% of the government’s total

revenue. These included taxes on soya, sugar, textiles and

government monopoly profits in tobacco, camphor and salt.

The combined effect of the land taxes and consumption

taxes was heavy taxes on both peasant and consumer and a

lighter burden for the landlord and industrial-merchant

classes. The income tax did not appear until 1887 and the

business tax which was the corporate tax did not come into

effect until 1896 and at a low flat rate of 3%. The result was

the subsidizing of the manufacturing and service sector at the

expense of the primary sector. To strengthen the incentives

for reinvestment and accumulation of productive wealth was

strengthened by the absence of inheritance and real estate

taxes before 1905 and a relatively low rate thereafter. The

role of the family and the firm that existed also as a closely

bound unit also made the saving, transferring form generation

to generation and development favorable. Therefore, the

Zaibatsus, the conglomerate oligopolies could charge

monopoly prices and concentrate on exports. At this time,

between the 1870-1900, there was the traditional export

expansion of silk and other produces, coupled with mild

primary import substitution. Tariffs and revenue on foreign

trade were also low at the time due to the fact that the

Japanese government was under the influence of foreign

countries and autonomy of tariffs was not until 1899.

However, this tradition had little change even after the

gradual regaining of autonomy. This was a very different

from the path followed by other developing countries which

usually place heavy taxes on trade because they are the

simplest and easiest form of taxation. Japan, by not following

the easy path and concentrating on export substitution and

land taxes for internal revenue creating a thriving export of

primary goods before the 1920s. Period before W.W.II The

era of the land taxes ended in 1908 and was followed by

indirect taxes, mainly on alcoholic beverages and tobacco. It

was not until 1935 that income taxes on individuals and

corporations became the most important source of total

revenues. The modern tax form only took form in the 1940

to prepare for the wartime economy, the whole tax system

was thoroughly overhauled to base on direct taxes. The

individual tax was a scheduler tax, under which different

sources of income were levied by different tax rates. It was

supplemented by a progressive comprehensive tax which

applied to an individual’s aggregated income above a specific

amount. On the other hand, the corporate income tax was

imposed on corporate income at a flat rate of 18%. The

commodity tax was introduced in 1937 mainly to collect

revenue for wartime expenses, and the tax on alcoholic

beverage was also simplified in 1940. The relative share of

indirect taxes fell as a result of the tax reforms. The 1940

reform also separated the personal income tax from

corporate income tax. This period saw the rise of the power

of the military in the government and influence after the

winning wars of the Sino-Japaneses and Russia-Japanese

earlier in the century and the ailing and corruption of the

civilian government. The government was engaged in

continuous military activities and was penalized with

increased tariffs. However, due to expansion of its own

empire and influence which included Taiwan and Korea,

export suffered little and actually had a 70% increase in

volume between 1929 and 1937. This period also saw

heavy taxes and direct investment of government in industries

resulting in rapid growth of war related industries. This

period ended with the GNP declining from 1939 and 1944.

The tax system became the tool for direct financing in this

period. The military drove the economy and accounted for

27.98% of GNP by the second world war which could be

said as the grand continuation of the feudal Tokugawa

Shogunate military expansion policies. Post W.W.II With the

occupation forces lead by the United States taking over the

government, reforms were held on all aspects of the

government. Immediately after the war, the scheduler tax on

individual income was replaced by a unified tax on an

aggregate basis with graduated tax rates. In order to collect

necessary revenues, a 1% turnover tax was levied on the

basis of the sales amount at every stage of transaction. As

for the long term tax system design, it was also based on the

US system but was also an experimental ground for the

Shoup Mission which was a pioneer in many aspects of the

direct tax. The Shoup reform in 1949 was not the first

reform after the war to the chaotic after-war tax system, but

it has had the most lasting effect on the development of the

Japanese economy. The Shops Report tried to build a

progressive direct tax based tax system with local autonomy

and simplicity that would be permanent and stable. Indirect

taxes were not recommended due to the inequality among

the tax payers, dull the sense of civic responsibility and make

local governments uneasy. However, the Japanese

government regained autonomy during the Korean war and

made modifications such as the resuming taxation at the

national level and sacrificing equity which Shops put at the

utmost priority for convenience of efficiency and

administration. The burden on firms, especially big business

was lowered. This was to give priority to the restoration of

the postwar economy and the promotion of capital

accumulation. Capital gains tax was abolished, under the

missions guidelines and this had a effect of the promotion of

capital accumulation as a national goal. Although partially

successful, the Shoup plan broke away from the military

roots of the Japanese tax system and engaged in a

responsive tax system which was in touch with the economy.

The four major taxes, income, corporate, accession and

consumption taxes all varied to different degrees from the

Shops Mission. However, the four taxes have been

remarkably stable in structure since 1950. The global income

tax system proposed by Shops was modified to a

combination of a comprehensive tax and a scheduler tax.

Instead of aggregating most incomes with progressive tax

rates, some incomes such as capital gains or interest income

were now subject to income taxation or were taxed at

reduced flat rates, separate from other incomes. These tax

concessions were intended to stimulate savings and income

and to improve the welfare level among specific taxpayers.

As for corporate income taxes, a split-rate system rather

than a uniform one in which a single rate is imposed on a

whole corporate income. This was similar to the one used in

West Germany in which retained profits and dividends were

taxed at different rates. Numerous tax measures have made

the corporate income tax extraordinarily complicated. As for

the accession tax on transfer of wealth proposed by Shops

Mission was replaced by a combination of inheritance and

gift taxes. Consumption taxes, in contrast to the general

modification of direct taxes remained unchanged since the

Shops Mission and there has been no general consumption

tax in Japan until April 1989. Therefore, Japan depends its

revenue from taxes on income and corporate income taxes,

which is the highest among OECD countries. Social security

contributions which are equivalent to payroll taxes also play

an equally important role in the raising of taxes. Japan is also

the only advanced country that does not impose a general

consumption tax. In 1985, of the total tax revenues collected

in Japan, 45.8% came from individuals and corporate

income taxes, 30.2% from social security contributions, 14%

from taxes on goods and services, 8.6% from property tax

and 1.1% from inheritance and gift taxes. Before the 1973

oil shock, the government engaged in a tax system with

incentives to promote exports, private savings and

investment, housing and technological development to

promote economic growth. These measures were included in

the Special Tax Measures Law and was formulated to

prepare a list of most of the incentive provisions applying

mainly to individual and corporate income taxes. As seen in

Figure 2 and Table 1, the corporate revenue lost to these

special tax measures but declined in importance after the mid

-1970s. The special tax measures was around 12.6 and

13.2% of total income tax revenues in the late 1950s fell to

8-9% in 1961-1962 then rose to 12% in 1965 and then

gradually declined to 5.0% in the early 1980s. The special

measures could be classified into tax exemptions and credits

and tax deferrals like accelerated depreciation and tax-free

reserves. These exemptions targeted specific industries such

as steel and machinery and also developing technological

innovation. The six main objectives of the tax incentives are

outlined the Ministry of Finance (MOF) as promotion of

saving; promotion of environmental quality and regional

development, promotion of natural resources, promotion of

technological development and modernization of industrial

equipment, strengthening of the financial position of firms and

other incentives. As seen in Table 2, the greatest decline in

importance is promotion of export and foreign investment

which included special deductions of export income from

taxation and accelerated depreciation for export orientated

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