Economic Survey of Japan 2006: A strategy for fiscal consolidation

 

Contents | Executive Summary | How to obtain this publication |  Additional Information

The following OECD assessment and recommendations summarise Chapter 3 of the Economic Survey of Japan 2006 published on 20 July 2006.

Contents                                                                                                                           

The progress in fiscal consolidation…

Limiting the growth of government spending is the priority in addressing the serious fiscal problem. The FY 2001 Structural Reform and Medium-Term Economic and Fiscal Perspectives set an objective of freezing public expenditure at 38% of GDP through FY 2006, and this target is likely to be achieved. Such spending restraint, which was achieved in part through cuts in public investment, aimed at the goal of a primary budget surplus for the combined central and local governments in the early 2010s. On a general government basis, the primary budget deficit has fallen from 6.7% of GDP in 2002 to an estimated 4% in 2006, with about half of the decline due to structural factors, and the rest accounted for by the economic expansion.

…should be continued to achieve a primary budget surplus…

The Reference Projection for the FY 2005 Reform and Perspectives shows a primary budget balance for the combined central and local governments in 2011. However, a balance would not be adequate to stabilise the level of public debt relative to GDP in the long run if the nominal interest rate on government debt exceeds the growth rate of nominal output. While the economic expansion and an end to deflation may push the nominal growth rate above the interest rate in 2006, assuming that growth remains higher would not be prudent for setting a medium-term fiscal objective. Indeed, population ageing will tend to slow output growth while possibly increasing the interest rate. In sum, stabilising the public debt to GDP ratio is likely to require a primary budget surplus for the general government of between ½ and 1½ per cent of GDP. To achieve this target by the early 2010s would require that the pace of fiscal consolidation accelerate somewhat to around 1% of GDP per year. Achieving such a target would stabilise the public debt ratio sooner and at a lower level. Moreover, it would help maintain public confidence in the government’s fiscal consolidation efforts, thereby limiting the possibility of a rise in the risk premium and preventing a substantial deterioration in the budget deficit.

…based on a more detailed medium-term plan

A credible medium-term plan is also important to sustain public confidence. A number of steps should be taken to improve the Reform and Perspectives:

  • Adopt a ceiling for the government expenditure level through the early 2010s in accordance with the latest Reference Projection. Set specific spending targets by category to show how the ceiling can be achieved.
  • Make the spending targets more binding on the government’s actual annual outlays and introduce a feedback mechanism that shows how the plan will evolve if outcomes diverge from those targets.
  • Ensure the sustainability of the social security fund. The Reform and Perspectives’ target for central and local governments should not be achieved through a deterioration in the social security account.


Furthermore, continued efforts are needed to increase the transparency of the budgetary system, thereby enhancing fiscal discipline and achieving consolidation.

While there is some scope for further cuts in public investment and the size of the government…

Much of the spending restraint to date has been achieved by cutting public investment from 8.4% of GDP in 1996 to 5% in 2004. Given that it still remains significantly above the OECD average of around 3% of GDP, there appears to be scope for further reductions, which should be accompanied by a better allocation of investment to enhance its productivity. However, the rising cost of maintaining existing infrastructure is crowding out new growth-enhancing public investment. It is important therefore to develop a comprehensive plan, in the context of a declining population, to close less useful infrastructure. The government plans to reduce expenditure by cutting the number of central government employees over five years as a first step to halving their total compensation during the next decade. Given the inefficiency of across-the-board cuts, budget savings should instead be achieved by reducing low priority activities and using market testing to determine which tasks can be better performed by the private sector. In addition, increasing efficiency in the public sector, in part by relaxing the rigid employment system, could generate savings. The efforts to reduce spending should be extended to include local governments, public enterprises and government-affiliated organisations, which account for more than 80% of public-sector employment. In any case, the scope for expenditure cuts may be limited by the fact that public-sector employment per population in Japan is well below the level in other major OECD economies, suggesting the need to achieve spending reductions in other areas as well.

Public-sector employment in Japan is relatively low
Employees per 1 000 population

Source: Ministry of internal Affairs and Communications

… public pension and healthcare spending are key to controlling government outlays

Population ageing raises pressure for increased outlays on pensions and healthcare. The FY 2004 reform is expected to keep pension payments constant at around 9% of GDP through the end of the decade by allowing the replacement rate to fall from 59% to 50%. Any slippage from this spending target should be met by a hike in the pension eligibility age, rather than by a further rise in the contribution rate, which is to be increased from 13.6% in FY 2004 to 18.3% by FY 2017. A rising contribution rate risks further boosting the evasion rate, which at 33% for those not part of the employee pension system, is already well above the level assumed in the government’s projections. As for healthcare, a large cut in medical fees and the introduction of a new insurance scheme for those over the age of 75 is expected to help keep spending at around 5½ per cent of GDP through 2010. Much of the expected spending restraint, however, depends on reducing the demand for healthcare by preventing lifestyle-related diseases. Given the difficulty of achieving such savings, additional reforms are needed. The key to achieving higher quality and greater efficiency in healthcare, as well as in long-term nursing care, is to make greater use of the dynamism of the private sector, in part by allowing companies to manage hospitals and nursing homes. 

Fiscal consolidation will require increased tax revenues

Even with these reforms, it will be difficult to reduce government spending as a share of GDP, in part due to rising interest payments. Consequently, achieving the necessary improvement in the government budget position – around 5% of GDP   will require additional revenue. Given that less than one-half of wage earnings are taxed and only one-third of corporations pay income tax, broadening tax bases is important to raise additional tax revenue, while enhancing economic efficiency and growth. In addition, measures to increase tax compliance, such as a taxpayer identification number, would enhance efficiency and fairness, while increasing tax revenue. A hike in the consumption tax rate may also be necessary to achieve fiscal consolidation.

Less than one-half of wage earnings are subject to the personal income tax

1. Share of taxable salaries after deducting various emxemptions. Initial budget base.
2. OECD estimates for 2005 and 2006.
Sources: OECD and Ministry of Finance.

 

How to obtain this publication                                                                                     

The Policy Brief (pdf format) can be downloaded. It contains the OECD assesment and recommendations but not all of the charts included on the above pages.

The complete edition of the Economic Survey of Japan 2006 is available from:

 

Additional information                                                                                                  

For further information please contat the Japan Desk at the OECD Economics Department at webmaster@oecd.org. The OECD Secretariat's report was prepared by Randall Jones, Tadashi Yokoyama and Taesik Yoon under the supervision of Willi Leibfritz.

 

 

 

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