Arya News - Roughly US$32 billion in funding a year will become necessary for Japan to lower its consumption tax rate on food from the current 8% to 1% – and to provide low and middle-income workers with benefits equivalent to the 1% tax rate.
TOKYO – No concrete measures were presented to fund the consumption tax cut under the government’s tax reform package, which was approved by the Cabinet on Tuesday.
The government intends to specify funding sources by the end of the year. However, there is growing concern that it will have to rely on issuing government bonds unless it identifies sources that satisfy the market, resulting in further increases in long-term interest rates. This concern will likely become an agenda issue of upcoming Diet deliberations of related bills.
“We will clearly outline the specifics of funding during a process to formulate a budget,” Finance Minister Satsuki Katayama said at a press conference following an extraordinary Cabinet meeting where the package was approved.
She emphasized that the government will review expenditures and revenues from scratch in drafting the fiscal 2027 budget. The government has committed to clarifying alternative funding sources by late December, when the budget bill is scheduled to be approved by the Cabinet.
Roughly ¥5 trillion in funding a year will become necessary to lower the consumption tax rate on food from the current 8% to 1% and then provide low- and middle-income workers with benefits equivalent to the 1% tax rate. The candidate sources for this funding are generated from so-called special taxation measures — incentives to provide tax relief for policy purposes — and the revisions of subsidies.
About 120 such special taxation measures are set to expire by the end of fiscal 2026. However, only three measures are expected to be abolished from fiscal 2027 after ministries and agencies submitted tax reform requests to the Finance Ministry. Similarly, no significant cuts to subsidies were proposed at the preliminary budget request.
The Finance Ministry will begin full-scale budget screening, and backlash is expected from companies and other entities that benefit from such measures or subsidies.
Another candidate funding source is the surplus from Foreign Exchange Fund Special Account, which manages funds for foreign exchange intervention. However, this fund has already being used for defense spending among other purposes, and it remains unclear as to what extent it can serve as a source.
Some members in the ruling and opposition parties are suggesting a corporate tax hike, but this idea has met with strong opposition from the Japan Business Federation (Keidanren), which argues that the hike “would lead to a decline in the international competitiveness of Japanese industry.”
Dwindling flexibility
The secondary market yield on newly issued 10-year government bonds — a key indicator of long-term interest rates in Japan — had been hovering around 1.6% prior to the launch of Prime Minister Sanae Takaichi’s administration. However, it has now risen to around 3% out of concern that the tax cut, among other factors, would deteriorate the country’s fiscal situation.
Tuesday’s package stipulated that the government would “not rely on deficit-financing government bonds.” However, without presenting specific funding sources by the end of the year, long-term interest rates may rise further amid concern over increased government bond issuance.
The national budget sets interest payment expenses based on market interest rates, and rising long-term interest rates put pressure on the government’s finances.
Interest payments under the fiscal 2027 budget have been projected at about ¥16.59 trillion, up about ¥3.5 trillion from the fiscal 2026 initial budget. This increase has constrained fiscal flexibility.
Challenge of ‘Back to 8%’
Another challenge may emerge when the consumption tax rate is put back to 8% in April 2029.
The government plans to implement income-linked payments twice a year in the spring and autumn in fiscal 2029 to alleviate the burden on households. However, putting back the consumption tax rate carries the risk of triggering an economic slowdown through a decline in consumer spending. Back in the administration of former Prime Minister Shinzo Abe, the planned increase of the consumption tax to 10% was postponed twice.
Takaichi has vowed that the rate will be back to 8% after two years, but calls may erupt within the ruling bloc to maintain the reduced rate. Any delay in the tax hike would lead to further fiscal deterioration.