Overview

Amidst calls for a radical reform of Japan's tax system, interest is growing in a system of "refundable tax credits" as a policy response to the increasing number of low income earners, typified by the "working poor". Refundable tax credits have been introduced in the United States and many European countries in recent years. A key characteristic is that they involve using the tax system not only for its traditional purpose of tax collection, but also to make cash payments, which fulfill similar functions to social security benefits.

In theory, refundable tax credits have a number of advantages over other policy measures designed to increase disposable income, in that (i) they allow the use of information held by the tax authorities, (ii) there is little stigma attached to receiving them (iii) they make it possible to avoid unemployment and poverty traps. However, while refundable tax credits are indeed attracting interest in Japan, one cannot help feeling that the discussion is still in its early stages. With a view to contributing to a more in-depth discussion, this report considers, with the aid of macro- and micro-level calculations, the general design of a system of refundable tax credits or, more specifically, of "refundable working tax credits", and sets out to identify the issues that may be encountered when such a system is introduced.

The design and results of the calculations relating to the refundable working tax credits are as follows. It was assumed that the recipients would be the 10.23 million persons with a salary income of ¥2 million or less as identified in the "Survey of Private Sector Wages and Salaries". Two cases were envisaged, in which the average amounts received per person would be ¥100,000 and ¥300,000 (per annum). At a macro level, the total amount of credits would be, respectively, ¥1.0 trillion and ¥3.1 trillion. One of the most likely sources of funding would be a review of employment income deductions, which account for the greater part of income deductions. However, the calculations made in preparing this report suggest that it should be possible to secure funds of the order of ¥1.0 trillion or ¥3.1 trillion, even without the implementation of radical reforms such as the imposition of a fixed amount for employment income deductions or their abolition, simply by revising the deduction rates used to calculate employment income deductions and setting a ceiling.

From a micro perspective, the economic benefit to households assuming refundable tax credits of ¥100,000 per person and a single-person household with a salary income of ¥1 million would be go from zero tax paid and zero refunds under the present tax system to zero tax paid and ¥100,000 of refunds after reform. For a household with a salary income of ¥2 million, it would go from ¥101,000 of tax paid and zero refunds under the present system to ¥1,000 of tax paid and zero refunds after reform. The combination of reductions in tax paid and refunds would boost disposable income by ¥100,000 in either case. In the case of a household with an income of ¥10 million, although the reforms would reduce employment income deductions, the effect of the tax credits would be smaller, and the amount of tax payable would rise by ¥82,000.

This report confirms that the introduction of refundable working tax credits would be possible in fiscal terms, but also reveals that many problems would have to be overcome when the system was introduced. Its five main findings are as follows.

(i) The setting of basic policy targets

The normal procedure would be to decide in advance who is to receive support, and how much, and then move on to a discussion of the choices and combinations of policy measures. To date, however, there has been almost no discussion concerning the setting of policy targets. For example, the government should set specific targets, such as reducing the relative poverty rate of 15.3% (OECD estimate) to the OECD average within 5 years.

(ii) A discussion of choices and combinations of policy measures

In terms of realizing policy targets, refundable tax credits are only one measure and choices and combinations of policy measures should be discussed as a total package, along with minimum wage increases and social security benefits. In fact, the United States, among other countries, has clearly set out a strategy for boosting the disposable income of low income earners using a combination of the minimum wage and refundable tax credits.

(iii) The establishment of integrated implementation systems linking national and regional levels

Having an accurate and integrated picture of income levels is an essential condition for the introduction of refundable tax credits. The first step would be to strengthen cooperation between the National Tax Agency, which collects personal income tax, and municipal governments, which collect individual local inhabitants' tax, to integrate collection systems, and to consider the introduction of a taxpayer identification number system.

(iv) An integrated review embracing not only personal income taxation but also other tax items

In recent years, there has been talk of the need to increase the consumption tax rate in order to cover the cost of population aging, but besides reviewing the income deductions and brackets applied in personal income taxation and changing the tax rates, refundable tax credits could be effective as a regressive measure.

(v) An integrated reform of the tax and social security systems

This is desirable for three main reasons: (i) It must be possible to establish a unified picture of how the tax system and social security system together affect disposable income. Needless to say, disposable income means income after the payment of personal income tax and social security contributions. Therefore, if a system of refundable tax credits were introduced, raising the level of social security contributions without reference to the tax credits would end up canceling out the economic benefits of tax system reform. (ii) The levels of refundable tax credits and social security benefits must be compatible. For instance, the disposable income of a person working full-time should not be lower than the level of social security benefits. (iii) Where the tax system and the social security system are used for similar purposes, their compatibility must be ensured, and further, they should be consolidated and integrated. For instance, if refundable child tax credits were to be introduced, it would be necessary to consolidate and integrate "child allowance" and "child support allowance", which are cash payments to households with children.

Thus, the issues to be overcome before a system of refundable tax credits can be introduced cut across many dimensions - central and local government, tax system and social security system, systems and implementation. Japan must consider these issues and, as can readily be imagined, the process will take time. Unlike the current economic and employment crises, which require fast-acting policy measures, these issues must be addressed in a slow and painstaking manner.

For more information on the content of this report, please contact Kazuhiko Nishizawa, the Japan Research Institute, Limited.

Tel:03-3288-5052
E-mail：nishizawa.kazuhiko@jri.co.jp

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