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Japan's strangulation by taxation
Friday, 01 July 2011 08:37

Why has the Japanese economy been so weak for so long?  International and Japanese business leaders claim that it is because corporate taxes are as a high as all hell.

 

That was before the triple disaster of earthquake, tsunami and nuclear disaster.  There is little prospect now of any reduction in taxes.  If anything, they will go up!

 

There may be something in this claim about high taxes.  According to the OECD’s tax database, corporate tax rates in Japan are, at almost 40 per cent, the highest of any OECD country.  Japan’s rates are even higher than those of the US, Germany, France and Canada.  What this means is that any Japanese company with a good investment idea should look outside the country to locate the investment.  China is of course just next door, and has a tax rate of just 25 per cent (Brazil’s rate is 15 per cent while India’s is 30 per cent).  This is a very serious problem for Japan which is still very focused on manufacturing, like the case of China.

 

Then there is another issue of carrying forward past losses.  It works like this.  If you make a loss this year or many losses in recent years, you can claim this loss as a tax deduction next year if you make a profit. 

 

This is very important.  If you are a high-tech and capital-intensive company, you may make losses for a while as you get up and running.  This system can also help preserve a company which is going through a patch of hard economic times.  In Japan, it is very important because the corporate sector is carrying some 100 trillion yen in past losses. 

 

But in Japan there is a very strict time limit on carrying forward losses, just 7 years.  So, if you’ve been making losses for the last 10 years, and this year you make a profit, you can only claim as a tax deduction your last 7 years losses.  The rest go up in smoke.  This is in sharp contrast to countries like the US which allow you to carry forward losses for 20 years, and other countries like Germany, France and Australia which have no limitation on the carry forward.

 

Carrying forward of losses is not only relevant to companies with past losses.  It is also relevant to innovative startup companies in sectors like biotechnology, energy or healthcare.  Many of these may not make much of a profit for their first ten years.  But we need them desperately because innovation is the life blood of our economy.

 

So, Japan is desperately in need of tax reform.  It should instantly slash its corporate tax rate to 25 per cent, and allow an indefinite carry forward of losses as the United Kingdom, France and Singapore have done recently.

 

Would reducing tax rates reduce tax revenues?  The evidence suggests no.  High tax rates encourage companies to find ways to avoid taxes and/or hide earnings.

 

There are many other factors which are claimed to hold back investment.  Japan’s labyrinth of regulations and non-tariff barriers is clearly a factor.  And then there are the accusations made of the Bank of Japan’s excessively tight monetary policy which leaves real interest rates and the exchange rate too high. 

 

Whatever the case, Japan’s economic performance has been so weak for so long that the government should push all the buttons.  And bytheway, there is no need to rush into increasing Japan’s consumption tax.  This is the last thing that Japan’s weak domestic demand needs at the moment.

 

Some people are not convinced that Japan’s corporate tax rates are such a problem.  They argue that Japanese business leaders are very often not so concerned about the profitability of their investments or the relevant taxation.  This may be so in some cases.  But it does not serve the economy or society well to have unproductive investment.  The Japanese government should remove corporate safety nets which are also dragging the country down.

 

Coming back to the present, the reconstruction of all the areas damaged by the triple disaster will be expensive.  There is an emerging consensus that it cannot be financed by even further additions to public debt.  What this means of course is higher taxes, though hopefully more on consumption rather than corporate taxes.


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Copyright © 2011 Mr Globalization - Tackling the paradoxes of globalisation. All Rights Reserved.

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