The Need for Structural Reform to Reduce the National Burden

Overview

At the general election, the people of Japan showed their overwhelming support for further structural reform. Of all the reforms on the menu, the greatest task is the realization of a small and efficient government. However, at least for the present, reforms that go so far as to cut social security services (pensions, medical care, etc.) have not been approved and, if anything, the general view is that the effort should go into maximizing efficiency in areas other than social security. But is such a Grand Design practical? This article investigates trends in recent years in the major developed nations with a view to determining the likelihood that the Grand Design can be accomplished.

The investigation covers seven countries, consisting of the five leading developed nations of Japan, the United States, the United Kingdom, Germany, and France, plus two countries from Northern Europe -- Sweden and Finland - and compares unemployment rates in 2001 and 2004 and national tax burdens in 2000-2001 and 2002-2003 (on a GDP basis).
(i) UK, USA: Both national tax burden and unemployment were low. The level of unemployment in the United Kingdom was joint-lowest among the developed nations, on a level with that seen in Japan. The remarkably sharp fall in the national tax burden in the United States is due partly to a rise in nominal GDP in conjunction with economic growth and partly to income tax cuts implemented under the Bush administration.
(ii) France, Germany: The national tax burden in both countries stood at 40-45%, higher than in the United States or United Kingdom but lower than in Finland or Sweden, standing between the level in those two countries and employment conditions are extremely harsh, with unemployment running high.
(iii) Finland, Sweden: The national tax burden and unemployment were both high in Finland, as in France and Germany. In Sweden, unemployment rose to 6.4% in 2004. Furthermore, given the effects of a rise in government-sector recruitment and measures to promote the employment of young people in reducing unemployment, the real unemployment rate is around 10%.

The rising unemployment and economic stagnation experienced in France and Germany and in Finland and Sweden are due to the hollowing out of domestic industry due to an exodus of domestic and foreign capital. In the past, the correlation between economic growth potential and the level of the national tax burden has been weak, and the prevalent view has been that they were not necessarily linked. However, developments since 2000 suggest that this view no longer valid. It now appears that the turning point in the fortunes of the real economy occurs when the national tax burden reaches a level of around 40%. Moreover, if international competition between systems - measures to reduce the tax burden on business enterprises, etc. - escalates, it is possible that this critical level will fall still further.

Turning to Japan, in 2002, with the national tax burden at 26.2% of GDP, unemployment fell to the middle of the 4-5% range. At first glance, there would appear to be no major problems. However, the Ministry of Health, Labour and Welfare Forecast of Social Security Payments and Burden of May 2004, and other documents suggest that, given (i) the latent national tax burden due to the fiscal deficit (7.9 points as a ratio of GDP), (ii) the rise in the cost of social security due to birthrate decline and population aging (set to rise by 5.1 points as a ratio of GDP by fiscal 2025) the national tax burden is likely to rise to 39.1%, or nearly 40% by fiscal 2025. Moreover, given that social security-related costs in the major economies of Western Europe are still higher than those in Japan, it is possible that the rise in costs in Japan will increase even beyond the forecasts.

In summary, there appears to be a significant risk that Japan's national tax burden will eventually reach the critical level of 40% at which the economy is likely to fall into a severe slump. Moreover, given that competition between systems at an international level is expected to intensify still further, account should be taken of the possibility that the critical level of 40% for the national tax burden may fall in the future. In this light, there is no disputing the need for structural reform geared to the realization of small and efficient government. If anything, the task now facing the government is (i) having explained to the people of Japan, in clear terms, the change in circumstances which means that it is no longer possible to avoid a discussion of the need or lack of need for pensions, medical care and other social security services and the scope for cutbacks, and secured their approval for such a discussion, (ii) to place all public services, without reserve, on the table and assign an order of priority, and (iii) to make a speedy decision on their feasibility and any systemic changes required, the level of service to be provided if judged feasible, etc., in other words, how to generate a powerful motive force with which to drive forward the reform program as a coordinated whole, and how to maintain that motive force in the medium term. Now is the time for the Koizumi administration, having won overwhelming support from every sector of the population, to show leadership.

For more information on the content of this report, please contact: Hidehiko Fujii the Japan Research Institute, Limited.

Tel: 03-3288-4263
E-mail：fujii.hidehiko@jri.co.jp