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firms. However, this is still an understatement of the

magnitude of tax incentives due to hidden incentives that are

not included by the MOF in special tax incentives. Firstly,

there is the provision for capital gains, interest and dividends

as part of the basic income tax law. Second, the

fractionation of individual income tax into separate classified

taxes loses a great deal of revenue and greatly reduces the

progressivity of the nominal rate structure, particularly at the

top brackets. Third, business expenses as special

depreciation accounting and deduction for part of social and

entertainment expenses are also not included. Fourth,

housing subsidy and low interest loans to executives are not

regarded as special tax measure. Fifth, the official estimate of

revenue is constantly low, so therefore, the special tax

measures are estimated low. Another feature of the Japanese

growth economy was the annual tax-cutting policy due to the

fact that GNP rose by an average of 15% a year between

1950 and 1960. The reason for the annual cuts were due to

the fact that Japan had a highly elastic income tax reaching

2.0 in the 1960s meaning that for every 10% growth in GDP

that would be a 20% growth in revenue. The Japanese

government did not use the money in the expansion of

government or counter-cyclical to obtain stable growth.

Social welfare was also limited for the insistence on

investment into growth and export. The tax cutting policy is

to keep the revenues to national income constant at around

20%. This was maintained between 1955 to 1965. This was

targeted at the individual income tax while both corporate

income tax and indirect taxes showed varying changes over

time. Corporate taxes increased much more frequently while

indirect taxes were raised to adjusted for the rise in

commodity prices. The result of the tax cutting and keeping a

lid on the growth of the public sector coupled by the lowest

expense on defense in the developed country was the lowest

tax rates in the developed country. Therefore, this permitted

the rapid increase in private demand. As mentioned above,

the tax system stresses simplicity instead of equity with the

result of benefiting business and professionals rather than the

employee. First, the Shops Mission suggested the "blue

return" system which is a self-assessment income tax for

small to medium size businesses. The benefits of the blue

return include basic deduction for blue return, special

deductions for wages of family members working in the

same company, and special tax-tree reserves for employees’

retirements, allowance for bad debt etc. These special

treatments reduce the tax burden of the family small business

firms. Secondly, there is the issue of withholding tax system

for wage and salary incomes. More than 80% of individual

income tax is withheld at the source. Although withholding is

applied to interest, dividend, and other income, the largest

portion of withheld taxes relate to employment income. As

seen in Figure 3, the income of salary earners is almost fully

identified by tax authorities while self-employed and farmers

have much an advantage in taxable income. This is often

referred as the "ku-ro-yon", 9-6-4 ratio of salaried workers,

self-employed and farmers. The third issue is the anonymous

and fictitious accounts. Banks accounts could be opened

with seals rather than signatures and banks make no attempt

to identify the seals. By creating a number of these tax-free

treatments, the wealthy was able to abuse the system.

Therefore, although the tax system structure was not

prominently regressive, the legislative side make the

wage-earners pay a higher price of taxation for the reason of

simplicity to businesses as proposed by the government. Tax

Structure and Economic Development In the period since

the Meiji Restoration, there has been government transfer

and tax incentive from the peasant and wage earners to

business to stimulate growth. Japan has had phenomenal

growth in the past hundred years, however, the question is

that if there is a direct relationship between tax structure and

economic development. In Table 3, y/N stands for per

capita real GNP with N as the total population, Ag/Y is the

agricultural products’ share in GNP with Ag as the output of

the primary sector, M/Y or (M+X)/Y as the openness of the

economy where M and X stand for import and export

respectively. As seen in Table 3, there is a significant

correlation between y/N, Ag/Y and T/Y between

1885-1944. Before the war, the agriculture sector still

played an important role in taxation structure. This is often

referred to as the dual sector and where the taxes in the form

of land taxes were charged heavily in taxation. There is also

no correlation between the postwar period of 1951-86 but

y/N and T/Y are still significantly related. As from

1951-1986, openness provides a better index than the other

two variables mentioned 25 years before the prewar period,

and it becomes even more significant in explaining T/Y for

the postwar period. Therefore, there is a correlation

between the openness of the economy, which is imports and

exports and the taxation structure. However, one could

emphasize the passive nature of the evolving tax system , in

which one could even say that the major determinant of tax

structure change is the structural change in the economy itself

during the process of economic development. When we

consider Table 4, where Tl is land taxes, Ti is indirect taxes,

and Ty income taxes on individual and corporate income. It

shows the relationship (R2)that land taxes made up the

principal shares revenue in 1885-1898 while indirect taxes

made up 1899-1935 and incomes taxes from 1936-86. This

proves the time division as mentioned above. However,

more importantly, as y/N increases, Tl/Tn and Ti/Tn

decreases. The relative importance of land and indirect taxes

faded when growth increased. As for the openness (M/Y or

(M+X)/Y) can be explained from the opposite signs in Ti/Tn

before and after the war (3.101 to -1.808). The negative

correlation after the war showed that openness was no

longer effective in increasing the indirect tax base at this level

of economic development and that the declining importance

of indirect taxes happen to have a close bearing with the

openness in a growing economy. That leaves us with Ty/Tn

dominantly affected by y/N, with the relative share of income

taxes rising in the course of development. The supply-side

point of view emphasizes the link between savings and

investment with I=S+(T-G) with net export as zero. As taxes

revenue were greater than government expenditures before

1975, investment from saving could be maximized. With net

exports as positive, it would also help on investment in the

country. As seen in Table 5, there was constant government

surplus before 1975. Therefore, it was only 1975, that the

government could continue the role using taxes to promote

investment and growth. As deficit grew, it would eat into the

savings and therefore investment. This was also the

tax-cutting policy which was before 1975 to prevent the

overburden of the tax payer with their high elasticity of

personal tax revenue. The growth can be shown using the

formula k=sx-(n+d)k which means for an increase in capital

stock savings has to be larger than depreciation. The

Japanese government promoted savings through tax cuts and

tax incentives and also allowed increased depreciation under

tax laws more rapid growth. Studies of the impact of the

special tax measures on Japanese economic growth are, for

the most part, inconclusive. There is virtually no relation

between the special tax measure to promote household

savings and the rate of private savings. Many of the special

tax measure were used in industries that were not regarded

as strategic from the standpoint of growth, such as the textile

industry which received favorable treatment but grew

relatively slowly. As mentioned above, though, the initial

depreciation allowances were used widely for expansion and

modernization in such strategic industries as steel and

machinery. Therefore, except for the stimulus in these

industries, the special tax measure did not have a substantial

effect on investment and growth. Although the tax system

and its effect on the economy is inconclusive, tax system may

affect economic activity in several ways. First, fro business

and managerial incentives, the regular salary earners with tax

withholding has a fully taxable income. As for the business

innovator and risk taker, the rewards are scarcely taxed by

the tax system which permits the tax-free accumulation of

capital gains and requires only modest tax payments on other

property incomes. As for management incentive, the typical

manager obtains his satisfaction through prestige of job,

expense of account which is often easily deductible under tax

laws. Implicit tax exemption fro unrealized capital gains

derived from undistributed corporate earnings permit the

manager to accumulate large amount of corporate wealth.

Second, the effect on economic stability, Japan with its high

elasticity on income taxation could be used for the stabilizing

effect of the economy to cushion the economic bumps.

However, the Japanese government has reduced the tax rate

and used monetary policy for short-run stabilization. As for

the effects on saving and investment, gross savings increased

from about 25% of GNP in the mid-1950s to about 40% in

the 1970s. Increase of the stock of capital is important for

growth because it raises productivity directly and permits the

adoption of newer and more efficient technologies. The

national budget with its surpluses added to the national

saving and helped to provide the margin of resources needed

for the production of large and growing volume of investment

good. Government savings also averaged above 40% of

private savings even with the annual tax reductions. This was

due to the systematic underestimation of tax revenues. The

policies to promote private investment such as accelerated

depreciation makes bankers more willing to make loans.

Therefore, the tax incentives made have had an indirect

effect on investment and growth. Finally, the simple fact that

the low tax rate in Japan may be the prevailing explanation

for the high rate of private saving and investment in Japan.

Other Determinants of Tax Structure Development and

Growth The military factor before W.W.II and after was

reduced drastically to less than 1 % of GNP. Before the

W.W.II the figure was around 28% of GNP. This is low in

international comparisons of military expenses-GNP ratio

where it is 6.3% in the USA. Japan has a low level of

welfare commitments. The average transfer payments to

national income in 1961-1970 in various countries was

20.8% in France, 7% in USA with 5% in Japan. By 1984,

the US ratio grew to 15.1% while France went up to

35.2%, in comparison with Japan’s 14%. Another factor is

the savings in Japanese thriftiness. Even at high direct

taxation on the wage earner, the average saving rate was still

between 25% and 40% GNP. This started since the Meiji

Restoration with moral suasion from the government with

slogans like "Let us avoid all luxuries so that we keep up

with the world; truly the development of our national

productive strength has its roots in reverent obedience." This

was coupled with the favorable inheritance tax laws and

capital gains law that made accumulation of wealth feasible

and worthwhile to the family centered Japanese worker.

Future of Tax System in Japan As seen in Table 5, huge

deficits arose since 1975 from the first oil shock and

accelerated due to the second one and amounted to 4.4 %

of the GNP in 1979. This has caused more alarm compared

with other countries with similar levels of debt. The

government was no longer able to cut taxes on personal

taxes and government incentive programs because of their

large losses in tax revenue were cut (Table 1). On top of the

economic repercussions, the original tax system was

repressive and unjust for the stress on simplicity. In 1989,

the Value Added Tax (VAT) was added as the consumption

indirect tax after almost ten years of debate at 3%. Reform

was necessary for between 1975 and 1984, the tax burden

rose sharply in Japan with central government taxes up by

4.1% and local taxes by 2.7% taxes. The dissatisfactions

could be categorized in the difference in tax burden among

taxpayers in which the tax ratio was "ku-ro-yon", 9-6-4 ratio

among workers, self-employed and farmers. Mismatch

between the wage system and income tax structure in which

the wages rose with seniority and taxes also increased

steeply where the middle class need it the most with the

children’s education or for a residence. Therefore the

progressiveness of the income tax for middle-class salaried

workers is too high. The unfairness in taxation on capital

income, as mentioned above is major source of savings and

investment but also is a source of inequitable tax system and

behind the massive account surpluses. The heavy corporate

tax burden which has risked dramatically since the 1970s

have caused much complaint. The outdated indirect taxes

which pose no tax on service is a failure to reflect the

changing consumption patterns. The standard procedure for

the tax reform is to reduce marginal tax rates by broadening

the tax base with the introduction of indirect consumption

taxes. It is also a cheaper and more effective way to

stimulate savings for consumption tax does not tax savings

instead of using special tax incentives. The reform is also

necessary in view of the aging population and its need for

larger social security . Tax preferences for expenses and

depreciation allowance should be reduced to reduce the loss

in tax revenue. A comprehensive tax system will not only will

achieve what Shops Mission’s real goal of tax equity but also

ensure the future mature growth of Japan for with a large

deficit, the previous tax provisions and incentives can no

longer be continued. Japan’s tax system is still midway

between a comprehensive income tax and an expenditure

tax. Change is necessary, but the role of government and

taxation still pose many hard decisions to politicians.

Bibliography 1.Ito Takatoshi., Tax Reform in Japan, The

Political Economy of Tax Reform, The Univeristy of Chicago

Press,1992 2.Ranis G., The Financing of Japanese

Development, Economic History Review April 1959 3.Allen

G.C., A Short Economic History of Modern Japan , 1962

4.Patrick H. and Rosovsky Henry., Taxation, Asia’s New

Giant, 1976 5.Ishi Hiromitsu., Ch 1-3, The Japanese Tax

System, Clarendon Press 1989 6.Ohkawa K. Ranis G.,

Economic Development in Historical Perspective, Japan and

the Developing Countries A Comparative Analysis., Basil

Blackwell, 1985 7.Dornbusch R.,. Macroeconomics – 3rd

Canadian Edition, McGraw-Hill, 1987 8.Shiraishi Takashi,

Japan’s Trade Policies 1945 to the Present Day, Athlone

Press, 1989.

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