Austerity or Proactive Fiscal Policy—Japan Has Had the Order Wrong for Thirty Years

The World Is Strange Vol. 12

“Eliminate the consumption tax on food and beverages for two years.”

Many people pinned their hopes on such a tax cut proposal. However, when it came time to actually implement it, strong arguments for caution emerged from the opposition, the Ministry of Finance, and even within the ruling party, citing concerns over funding sources and systemic issues.

For a long time, Japan has been described as a “debt-ridden nation.” The argument is that if government bonds are increased, the burden will be left to future generations. Based on this explanation, the consumption tax was raised, and social insurance premiums continued to rise.

On the other hand, those who support proactive fiscal policy argue that the finances of a government that issues bonds in its own currency should not be thought of in the same way as household debt. Their claim is that if the country does not increase spending, corporate sales and national income will not grow, and the economy itself will shrink.

Both sides have their own logic. Therefore, I would like to think about what the difference is from my own perspective.

The arguments of the austerity camp and the proactive fiscal policy camp

Those who advocate for fiscal austerity say that the balance of government bonds must not be increased any further.

If government bonds continue to increase, interest rates will eventually rise, and interest payment costs will swell. If demand is increased too much, there is a risk that prices will soar and trust in the yen will be lost. If fiscal discipline is lost, politicians might continue to increase spending to gain popularity.

On the other hand, those who advocate for proactive fiscal policy say that thinking of government debt in the same way as household debt is a mistake in itself.

Government spending becomes private income. Public works expenditures become the sales of construction companies and the wages of the people who work there. Money left in the hands of households through benefits and tax cuts moves to the sales of other companies through consumption.

When the two sides face each other, the discussion hardly ever connects.

The austerity camp is looking at interest rates, inflation, and trust in the currency that lie ahead if the government bond balance continues to increase. The proactive fiscal policy camp is concerned with the weakness of consumption, the decline in real wages, and the state where companies cannot invest, which are right in front of us now.

They are looking at different places.

Both fiscal austerity and proactive fiscal policy have merits and dangers. Even if you say one is always right, you will not find an answer.

The question we should be asking is not a binary choice between austerity or proactive fiscal policy, but rather what does Japan need now, and where is it headed from here? isn't it?

Japan's stagnation overlaps with consumption tax hikes

In Japan, a 3% consumption tax was introduced in 1989.

It was raised to 5% in 1997, 8% in 2014, and the standard tax rate was raised to 10% in 2019.

When you overlay that period with the trend of nominal GDP, it becomes clear that the Japanese economy, which had been expanding until the 1980s, entered a long period of stagnation from the mid-1990s, during which the consumption tax rate was raised in stages.

Of course, I do not intend to prove with this graph alone that the consumption tax was the cause of Japan's economic stagnation. Multiple factors have overlapped, including the bursting of the bubble, delays in disposing of non-performing loans, financial crises, the declining birthrate and aging population, the expansion of non-regular employment, and insufficient corporate investment.

However, could it be that the repeated introduction and raising of the consumption tax before the economy had fully recovered from the bursting of the bubble further delayed that recovery?

And looking at this graph, even within the long stagnation, there are periods when GDP temporarily turned upward.

After the Great Hanshin-Awaji Earthquake in 1995 and the Great East Japan Earthquake in 2011, large-scale recovery and reconstruction budgets were injected to rebuild housing, roads, railways, and public facilities.

Of course, earthquakes cause massive losses to human life, livelihoods, and production facilities, and cause economic activity itself to decline. It was not the earthquake that generated growth.

However, the subsequent spending on restoration work, housing reconstruction, and infrastructure development became sales and employment for construction companies, contributing to supporting the economy.

Furthermore, since 2020, nominal GDP, which had been flat for a long time, has clearly been expanding, even while including the effects of rising prices.

During this period, the Japanese government has carried out large-scale fiscal spending of approximately 100 trillion yen as a response to the COVID-19 pandemic, including benefits, subsidies, employment measures, and financial support.

I am not viewing the increase in nominal GDP as real economic growth as it is.
Rising import prices due to soaring resource prices and the weak yen are also factors that push up nominal values.

However, government spending does not disappear from the economy.
It becomes someone's income and a company's sales, supporting employment and consumption.

What the post-earthquake recovery and reconstruction and the response to the COVID-19 pandemic showed was perhaps the function of fiscal policy, where the government can support corporate activity, employment, and household budgets by increasing spending when the economy has been hit hard.

Why was the burden increased when the economy was weak?

The consumption tax is not a tax that only falls on people with high incomes. It is not a tax that only applies when companies make a profit; it is a burden that extends widely to daily shopping.

In a country where consumption has been weak for many years, if you continue to place a burden on consumption, people will refrain from shopping. If corporate sales do not grow, wages and investment will also be suppressed. If wages do not increase, consumption will become even weaker.

Originally, taxes should have the role of not only collecting revenue but also adjusting for economic overheating or cooling.

When demand becomes too strong, supply cannot keep up, and prices are rising rapidly, it makes sense to absorb money from the market through tax increases or spending cuts.
Conversely, when companies and individuals are not spending money and demand is insufficient, it is necessary to return money to the economy through tax cuts, benefits, and public investment.

Of course, you cannot change the tax rate every time the economy moves a little.

However, if consumption and wages have been sluggish for decades,shouldn't we have rebuilt the economy first before increasing the burden?

When former Prime Minister Shinzo Abe postponed the consumption tax hike to 10%, he cited the possibility that a tax increase could dampen personal consumption and jeopardize the escape from deflation as his reason.

The government was also aware that tax hikes cool down consumption.
Nevertheless, Japan has repeatedly increased the burden before the economy had sufficiently warmed up.

It is not just the consumption tax

It is not just the consumption tax that has increased the burden on households.

The national burden ratio, which indicates how much of their income citizens pay in taxes and social insurance premiums combined, has risen from the 38% range in fiscal 1990 to 45.7% in fiscal 2023.

When the fiscal deficit is added as a future burden,the potential national burden ratio has reached 49.8%.

Moreover, this figure basically only includes taxes and social insurance premiums. There are other burdens that citizens are required to pay by the system, even if they do not carry the name of a tax, such as administrative fees, various usage charges, and surcharges added to electricity bills.

These are no different from the money that leaves the pockets of everyday people.

Despite such an increase in the burden, neither real wages nor personal consumption have grown sufficiently over the past thirty years. Should that fact not be questioned more?

Has the increased tax revenue enriched our lives?

General account tax revenue, which was 57.7 trillion yen in fiscal 2016, increased to 75.2 trillion yen in fiscal 2024.

This means it has increased by more than 17 trillion yen in less than ten years.

In recent years, tax revenue has also continued to exceed initial projections.

According to government responses, when comparing the adjusted budget with the final settlement, actual tax revenue has exceeded projections for four consecutive years since fiscal 2020. The total for the four years exceeds 14 trillion yen.

There are various factors behind the upward deviation in tax revenue, including corporate earnings, income, consumption, prices, and exchange rates.

Just because it exceeded projections does not mean one can immediately conclude that too much tax was collected. However, if real wages and personal consumption remain sluggish while tax revenue continues to increase, would that not be a reason to review how the increased tax revenue is used and the level of the national burden?

The government explains that even if tax revenue increases, it must still issue government bonds because there are expenditures such as social security costs, local allocation taxes, defense spending, and national debt servicing costs.
The increased tax revenue has not simply vanished; it is being used for some policy or administrative service.

What I want to ask is,whether that spending has truly enriched the lives of the people and the Japanese economy.

Regarding government spending, regardless of whether it is for domestic or overseas purposes, it is necessary to disclose the purpose, amount, beneficiaries, and results for each project, and to review those with low effectiveness.

Why was it started, how much was spent, who received it, and what were the results? Is there a mechanism in place to consider abolition or reduction if the results are not visible?

Before thinking about whether to increase or decrease the amount of spending, isn't this verification necessary?

What we should look at is not just how much tax revenue has increased.
It is whether, as a result, the economy has grown and the lives of the people have become more prosperous.

Tax cuts leave money in people's hands from the start

When tax cuts are requested, the question of "where will the funding come from?" is always raised.
Some also argue that "benefits are more realistic than tax cuts for which permanent funding sources cannot be shown."

However, benefits and subsidies also require funding.
Why is it that only with tax cuts do people think that the reduced tax revenue must be covered down to the last yen by other permanent funding sources?

For benefits, the government collects money once, decides on targets and conditions, and distributes it through a formal process. This process incurs administrative costs, and some people inevitably fall through the cracks of the eligibility criteria.

On the other hand, tax cuts allow money to remain in the hands of households and businesses from the beginning.
Benefits may be suitable when targeted support is needed for specific individuals, such as in cases of disaster, unemployment, or illness. However, if rising prices and increased burdens are affecting society as a whole, methods to broadly lighten the burden through tax cuts, not just benefits, should also be considered.

Benefits or tax cuts?

The question should not be which one requires funding, but which one can support households and businesses more quickly and fairly.

Thinking of government bonds as the same as household debt

When advocating for fiscal austerity, it is explained that the national debt, when divided by the population, is a debt that children and grandchildren will have to repay.

"The debt per citizen exceeds 10 million yen. Do not leave this for the future."

These are words I have heard many times. However, there is a major question regarding this figure.

It is not the case that every citizen bears a 10 million yen obligation to repay national debt. It is merely a figure obtained by dividing the government's liabilities by the population, and it does not take into account the assets held by the government.

When talking about a household mortgage, would you show only the loan amount and ignore the house and savings? For the government as well, it is necessary to look at a balance sheet that includes not only liabilities but also assets.

In the "National Financial Documents" for the end of fiscal year 2024 published by the Ministry of Finance,
the nation's assets are 783.4 trillion yen and liabilities are 1483.3 trillion yen.

It is true that liabilities exceed assets.
However, this is quite different from the image of "Japan being unable to make ends meet due to debt."

The net debt after deducting assets is approximately 699.9 trillion yen.
If this is divided by the population, it comes to about 5.64 million yen per person.

The sense of crisis one feels changes significantly depending on which figures are presented.

Furthermore, in consolidated financial statements that include independent administrative agencies and others,
assets are 1,044.9 trillion yen and liabilities are 1,574.7 trillion yen,
meaning the difference narrows to approximately 529.7 trillion yen.

How fiscal health is perceived changes depending on what scope is considered the government.
Of course, this does not mean that because there are assets, the government can issue as many bonds as it likes.

It is not as if roads and land can be easily sold to repay government bonds.
Even so, is it not far too one-sided to divide only the government's liabilities by the population and say, "This is your debt"?

Government bonds are not repaid with taxes every time they reach maturity.

In the first place, the mechanism of government bonds is different from a household mortgage.

The government does not repay the entire principal from that year's tax revenue every time a government bond matures. In many cases, they are managed by issuing new bonds to refinance the debt.

This is not a special method unique to Japan; it is common for countries that issue government bonds to maintain their debt by refinancing it as it reaches maturity.

However, this does not mean there are no constraints on government bonds.
If interest rates rise, interest payment costs increase. If demand exceeds supply capacity, inflation will occur, and if confidence in the currency is lost, it will also affect the value of the yen.

Therefore, I do not believe that government bonds should be issued without limit.

Even so, it is also wrong to look only at the size of the outstanding government bond balance and think of it as "debt that must be fully repaid," just like a household budget.

The evaluation of government bonds cannot be determined solely by the amount issued.

It depends on what that money was used for.

What is important is what the government bonds were used for.

If they are used for investments that increase productivity, the renewal of aging infrastructure, science and technology, education, child-rearing, energy, and national security, then that expenditure does not leave only debt for the next generation. Assets such as roads, bridges, schools, and research facilities, as well as the productivity generated by them, will also be left for the next generation.

However, in Japan, priority has been placed on curbing fiscal spending, and even government infrastructure development and investment in growth sectors have been squeezed.

Japan's public investment declined significantly from the late 1990s to 2012.

While roads, bridges, tunnels, and water and sewage systems built during the period of high economic growth are all aging at once, sufficient funds were not allocated to investments for fostering new industries and technologies.

If spending is reduced, the fiscal deficit for that year looks smaller.
However, infrastructure that is not renewed becomes old, and technologies that are not nurtured are overtaken by overseas competitors.

If research and education expenses are cut, even if it does not show up in the numbers immediately, it will create a gap in productivity ten or twenty years later.

If the economy grows in scale and income and tax revenue increase, the burden of debt becomes relatively smaller. Conversely, if you shrink the economy itself by cutting spending, even if you manage to slightly curb the balance of government bonds, you also weaken the power to generate tax revenue.

I believe that the austerity policies pursued thus far have not only cut government waste but have also withered the investments necessary for Japan to grow.

Has Japan's 'lost thirty years' not been a period where we not only kept demand cooled but also neglected the investments needed to create the next phase of growth?

Should we really be thinking about what we leave for future generations solely in terms of the government bond balance?

Aging infrastructure, shrinking industries, low wages, and lost technological capabilities will also become burdens for the next generation to bear.

If we only think about not leaving behind debt, without leaving behind assets for growth, we risk handing over a poor country with only slightly tidier books.

The problem was not austerity, but the order

There are times when austerity is necessary.

If the economy is overheating, labor and materials are in short supply, and production cannot keep up even if demand is increased, then it becomes necessary to curb fiscal spending and withdraw money from the market through tax hikes.

However, in Japan, where the economy has not grown sufficiently for thirty years and real wages and personal consumption have remained stagnant, was balancing the fiscal books really the first thing that should have been done?

Because the economy is not growing, tax revenue is insufficient.
Because tax revenue is insufficient, taxes are raised.
Because of tax hikes, consumption decreases, and the economy grows even less.

Japan seems to have been unable to escape this cycle for a long time.

Proactive fiscal policy also has its dangers.

If you continue to increase spending without a plan, it may invite inflation or rising interest rates. Simply having the government spend money does not guarantee growth.
That is precisely why it is necessary to adjust spending and burdens while monitoring the state of the economy.

However, Japan has increased burdens even when the economy was cooling, and has continued tightening before it could recover.

The problem was perhaps not austerity itself, but the order in which it was applied.

First, leave money in the hands of households and businesses through tax cuts.
At the same time, the government invests in areas that will increase future productivity.
Consumption increases, corporate sales grow, wages and investment rise, and the scale of the economy expands.

That is the result of increased tax revenue, and when prices or demand begin to overheat, only then should we consider tightening.

A country that has been unable to grow for thirty years is so afraid of future burdens that it continues to cut current consumption and investment before it has even grown.

Is it not time to change that order?

Changing the order of budget formulation

So, how is the national budget formulation changing to reverse that order?

The "responsible proactive fiscal policy" currently being explored has the potential to significantly change the way budgets have been formulated until now.

The first change is to revise the idea of making a primary balance surplus the absolute goal for a single fiscal year. The primary balance is an indicator that shows to what extent the expenses necessary for policy are covered by tax revenue and the like, without relying on government bonds.

It has been considered a necessary indicator for assessing fiscal sustainability. However, if achieving a surplus for that year is made the top priority, even investments necessary for economic growth will be suppressed.

The second change is to eliminate the uniform ceiling that sets an upper limit on the budget requests of each ministry. Conventional ceilings have played a role in preventing budget expansion and forcing each ministry to set priorities.

Therefore, simply eliminating them will not automatically lead to a better budget. There is a risk that requested amounts will swell by the amount the cap was removed, and spending on ineffective projects or vested interests will increase.

That is precisely why, rather than mechanically suppressing amounts, we must strictly question the purpose and effectiveness of each project.

The third change is to correct the harmful effects of the principle of fiscal annuality, which divides budgets year by year, and to make predictable investments over multiple years in necessary fields.

Fields such as AI, semiconductors, energy, national security, science and technology, and national resilience do not produce results in a single year. For companies to decide on large-scale capital investment, gather researchers, and cultivate talent, it is problematic if they do not know whether the budget will continue into the next fiscal year.
Only when the government shows its policy and support for several years ahead can the private sector invest with peace of mind.

We will shift from budget formulation that decides only the upper limit from the start without thinking about what the money will be used for, to budget formulation that provides sufficient funds for necessary investments and stops spending that yields no results.

I would like to support that direction.

Instead of prioritizing balancing the books for a single year, we will expand the scale of the economy. Instead of uniformly suppressing expenditure, we will invest in fields necessary for Japan's future.
Neither industries nor talent can be cultivated in a single year. We must change to a mindset of cultivating them over multiple years.

I believe this is an attempt to change the order of "cooling down before growing," which has continued for thirty years.

There will likely be pros and cons. I do not think that a proactive fiscal policy will solve all problems. I also do not think that simply increasing the budget will cause industries and wages to grow.

Even so, I do not believe it is right to continue the last thirty years as they have been, where we have increased the burden while the economy has not grown, and even cut necessary investments.

If there is any error in my thinking, please do point it out.

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