Japan: Lower Public Debt, Structural Reforms Critical, says IMF

Japan must consolidate its fiscal position, says IMF

Recovery has started after earthquake, but uncertainties remain

IMF advocates modest increase in consumption tax to pay for recovery

“Japan needs to implement fiscal and structural reforms to strengthen the resilience and growth prospects of its own economy if it is to continue with its existing important, positive role,” said Mahmood Pradhan, the IMF mission chief for the northeast Asian country.

Japan’s public debt is over 220 percent of the country’s GDP in gross terms―the highest level among advanced economies. In their “Article IV” report on the state of the Japanese economy, IMF economists proposed reforms to bolster confidence in public finances, including reining in social security spending, increasing the country’s tax revenue, and boosting growth through structural reforms.

An uncertain near term

Economic activity has started to recover following the March earthquake and tsunami, but a high degree of uncertainty remains with the recovery dependent on the easing of supply bottlenecks, a stable long-term supply of electricity, and the recovery of sentiment.

Reconstruction spending is likely to further increase Japan’s sizable public debt, and the report predicts GDP growth is likely to slow to -0.7 percent this year before rising to 2.9 percent in 2012.

The IMF report suggests reconstruction spending could be financed by a modest increase in the consumption tax from 5 to 7–8 percent in 2012, with a greater and continued increase up to 15 percent thereafter. This is also needed to bring down Japan’s high level of public debt.

“Bringing down public debt over the medium term will require a sustained and significant adjustment of the primary balance,” says the report.

Reform of taxation

Given the limited scope for spending cuts, fiscal adjustment depends on limiting existing spending and finding new sources of revenue. Tax revenues could provide one such source.

This island nation has one of the lowest tax revenue levels in the world—about 17 percent of GDP—and this gives the northeast Asian country ample space to use taxes as a way of consolidating the country’s fiscal position.

The country’s authorities have already outlined plans to double the sales tax to 10 percent by the mid-2010s to help meet its target of halving the primary deficit (in percent of GDP). This...