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Japan's pursuit of fiscal health remains pie in the sky

Future generations will pay the price for government foot-dragging on reform

Japan's loose finances will postpone burdens to our children and grandchildren

TOKYO -- Prime Minister Shinzo Abe's plan to channel a portion of consumption tax revenue to education spending raises a red flag as it signals an about-face on the government's commitment to improving Japan's fiscal health.

In a Sept. 25 news conference, Abe announced plans for generous investment in youth, including making early childhood education completely free and accelerating plans to expand child care capacity in an effort to clear chronically clogged waiting lists.

"However, we must not pass down the bill to future generations," he declared. Yet his plan would likely do exactly that.

Debt by another name

The government intends to raise the consumption tax from 8% to 10% in October 2019 as part of a 2012 tax and social security reform package, generating just over 5 trillion yen ($44.3 billion) a year in additional revenue. It originally earmarked 1 trillion yen of this for strengthening the social safety net, with the remainder to go toward fiscal consolidation, including paying down debt. Abe now plans to use a portion of the latter funds to pay for his election pledge on early childhood education.

In essence, "that would be the same as using deficit-covering bonds to pay for education spending," said Hideo Kumano of the Dai-ichi Life Research Institute. In other words, the seemingly generous offer in reality is no different from saddling the children with more debt.

Tax revenue covers only about half of the government's 100 trillion yen in annual spending, meaning the rest must be paid for through borrowing. National and local government debt now totals more than 1 quadrillion yen. Japan's ratio of debt to gross domestic product, already far higher than that of any other Group of Seven country, continues to rise.

Central to the 2012 reforms was a pledge to spend all of the consumption tax revenue on social security, even if indirectly. Even allowing that Abe is right about the importance of investing in education, the proposed change in how the funds are to be used seems like an abrupt shift, for the sake of a policy whose benefits remain unproven.

And the plan has spurred parties to compete on offering handouts to voters in this month's general election. Junior ruling-coalition member Komeito's platform includes a pledge to make private high school tuition-free.

No excuse

If the government abandons past promises too easily, lenders will tighten their purse strings. Though Abe insisted that his administration "will not lower the flag of fiscal reconstruction," he acknowledged that reaching the government's goal of a primary surplus by fiscal 2020 "will be difficult."

When this objective -- being able to finance all spending aside from debt-servicing costs with revenue alone -- might actually be met remains unclear.

It would be no surprise if Abe reasoned that this is not the first time Japan has failed to meet its fiscal health goals. But the significance is different this time.

Former Prime Minister Taro Aso gave up on predecessor Junichiro Koizumi's goal of bringing Japan's primary balance into the black by fiscal 2011 because of the 2008 financial crisis. Abe's administration, on the other hand, has fallen short, twice postponing a consumption tax hike despite benefiting from Japan's second-longest postwar recovery.

If a tax hike casts a pall over the economy and ends up reducing tax revenue, as the prime minister has warned could happen, that would render it pointless. But Japan also cannot rely on economic growth alone to solve its fiscal woes. The economy expanded last year, yet tax revenue declined.

There is no shortcut to fiscal rehabilitation. The government must balance growth with tax increases and spending cuts.

You are what you spend

Masato Shizume, a professor of economic history at Waseda University, points to two major turning points in Japan's fiscal management: the 1930s, when the country set out to become a military superpower, and the 1970s, when the welfare state exploded in size. The nation sacrificed economic growth during the former period and relied on outsize growth during the latter. In both cases, by living beyond its means, the government allowed Japan's fiscal health to deteriorate.

"A country's finances reflect its state of affairs," Shizume said. "If a country has the wrong vision, then its future generations will be left to pay for the mistake."

The problems Japan faces are clear. Social security spending has swelled by some 18 trillion yen over the last two decades -- accounting for nearly all of the rise in government expenditures over that period -- even as tax revenue has barely budged. Uncertainty over the country's future will not be cleared up so long as this issue is not tackled head-on.

Japan suffered a fiscal breakdown right after World War II. The lessons of the past are there to be learned.

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