Annual Report on Japan' s

Economy and Public Finance

2000-2001

- No Gains Without Reforms -

December 2001

Cabinet Office

Government of Japan

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   Points of Chapter 3
   [Section 1 Expanding Fiscal Deficits]
After the collapse of the bubble economy, fiscal deficits expanded drastically. (The fiscal deficits of the national and local governments combined stood at 8.2% of GDP in FY 1999. Their combined long-term outstanding debts stood at 130% of GDP as of the end of FY 2001.) left arrow Decline in tax revenues due to the long-term economic slump and tax cuts + increase in fiscal spending due to frequent economic measures
Structural budget deficit (the deficit that does not decrease even if the economy picks up) has stood at about 6% of GDP in recent years. In order to reduce the deficit, fiscal reform is necessary.
The primary balance deficits of the national and local governments are on an increasing trend after the collapse of the bubble economy. (The deficits stood at about 5% of GDP at the end of FY 1999)
If the current situation ((a) huge primary balance deficits, (b) long-term interest rates > nominal GDP growth rate) continues right arrow the balance of public bonds will diverge, leading to financial ruin.
According to the government spending (benefit) and the tax burden cost per capita by prefecture, the inter-regional disparity expanded during the 1990s. (The benefit that the five local self-governing bodies with the highest benefit-cost ratios increased 29% while the benefit that the five local self-governing bodies with the lowest benefit-cost ratios increased only 15%.)

   [Section 2 Finance as Seen from the Stock Data of Assets and Liabilities]
The stock data of assets and liabilities of the public sector was estimated in accordance with business accounting principles (accrual basis, current value basis).
For the public sector as a whole, assets came to 2,274 trillion yen, liabilities to 2,422 trillion yen, and net worth to minus 148 trillion yen.
The development of social infrastructure in the 1990s increased relatively significantly with respect to roads, airports, waste disposal, and flood control rather than for school and social education facilities.
The values of four road-related corporations (Japan Highway Public Corp., etc.) and two airport-related corporations (Narita, Kansai) were estimated based on the income capitalization method.
The asset-liability gap (asset valuations-liabilities) of the four road-related corporations and two airport-related corporations were minus 820 billion yen and 140 billion yen, respectively.

   [Section 3 Public Finance as Seen from Lifetime Benefits and Contributions]
The Government' s financial position was assessed by benefits and contributions throughout one' s life.
In the last 30 years, disparities among generations have expanded.
In terms of generational accounting, the "elderly generation" is the net recipient of benefits and the "younger generation" is the net contributor. (Throughout a lifetime, people aged 60 or older receive 57 million yen of benefits in excess of their contribution, while people aged 40 or younger make more contributions that the benefits they receive. The difference between the people in their 20s and the people in their 60s or older is more than 70 million yen.)
The net contribution of the "future generation" will be three times as much as that of the current 20-year-old generation.
Simulation analyses to reduce the heavy burden on the "future generation"
   right arrow In the case when only the future generation makes additional contribution, the necessary additional contribution would be equivalent to a consumption tax rate of 90%. In the case when additional contribution is to be made starting in 2005 not only by the future generation but also by the contemporary generation, the necessary additional contribution would be equivalent to a consumption tax rate of 23%.
   right arrow It is necessary to have the current generations make additional contributions and benefits must be curbed.

   [Section 4 Local Finance Problems ]
Local finances are facing a severe crisis due to accumulated long-term debts.
There are various problems concerning the revenue bases of local public organizations.
(a) National Financial Subsidy that cannot meet the needs of local residents (Subsidies that are in place for more than 25 years account for 43% and those that have been in place since the pre-war or post-war restoration period account for 12%)
(b) Increase in the total amount of the Local Allocation Tax (increase of 42% in the 1990s)
(c) Changes in functions of Local Allocation Tax and efforts to review the way the Local Allocation Tax are calculated (as a financial means to pursue particular public works)
(d) Efforts to increase local tax revenues (strengthening incentives by increasing withheld revenue rates)
(e) Shift in attitude from depending on public funds to issuing local bonds by utilizing more private funds
Basic ideas of local administrative and financial reforms right arrow spending cuts both in the central and local governments, municipal mergers, reduced involvement of the national government in local governments, reorganization and rationalization of state subsidies, fundamental reforms of the Local Allocation Tax system, obtaining of satisfactory local tax revenues including the allocation of tax revenue sources between the national and local governments
Simulation of reforms (identifying effects of spending cuts and transfer of tax revenue sources)
(a) Transfer of tax revenue sources has made major urban cities independent from the national transfers while most small municipalities and especially those in local areas have yet to be successful in improving their financial resources.
(b) Problems in the revenue bases cannot be solved only by transfer of tax revenue sources; spending cuts, municipal mergers, and efforts by local governments to increase tax revenues are required at the same time.

Chapter 3 Overall Assessment of Japan' s Public Finance

   Japan' s fiscal conditions are in a very severe state. Since the collapse of the bubble economy in the early 1990s, slow economic growth and tax cuts have reduced tax revenues, while government spending has expanded on frequent economic stimulus packages and rising social security costs. As a result, the general government budget deficit has continued expanding and reached the worst level among industrial countries. Japan' s birthrate decline and population aging, which has a major impact on public finance, has been faster than in any other country.
   This chapter presents an objective analysis of Japan' s public finance from an economic viewpoint. A multi-faceted analysis is required for determining the state and problems of Japan' s public finance. We would like to discuss the state of Japan' s public finance from three specific viewpoints: (a) consideration of budget deficit, government spending, tax revenues and regional budget balances (flow analysis), (b) assessment of the public sector assets, liabilities and net assets (stock analysis) and (c) demonstration of how present and future generations would benefit from and contribute to public finance (analysis of generational accounting). We would also like to analyze local government finance at stake and explore the direction of local public finance reform.
   Section One outlines the state of Japan' s budget deficit, including an international comparison. Budget deficits usually expand on an economic slump. But they include structural deficits that will not diminish even on a pickup in the economy. We demonstrate that structural deficit accounts for some 80% of Japan' s present budget deficit. We also give the warning that if the present situation continues, Japan' s public finance will collapse, with its outstanding debts diverging unlimitedly. We note that a region-by-region breakdown of government spending and tax burdens indicates that inter-regional disparity has been widening since the early 1990s.
   Section Two outlines Japan' s public finance from the viewpoint of estimated stock data of the public sector assets and liabilities. Stock data of assets and liabilities have been worked out in accordance with business accounting principles. The data include pension and retirement allowance liabilities, which are future payments. The data indicate that the government' s net assets, or gross assets minus gross liabilities, are negative at present.
   Section Three analyzes the state and problems of Japan' s public finance including the social security system from the viewpoint of how people have been benefiting from and contributing to public finance. Contributions include tax payments. The econometric analysis, based on generational accounting, specifies a gap between old and young generations in terms of benefits and contributions, as well as any contributions that generations emerging in the future should shoulder.
   Section Four gives an analysis of the state and problems of local public finance. Japan' s local public finance is faced with a serious crisis. The present system guarantees massive fund transfers from the national government to local governments and has discouraged local governments from making voluntary efforts for regional development. We make it clear that spending reform, institutional overhaul and local tax expansion will be required for creating a new system that will allow local residents to make a choice on the basis of their own decisions and responsibility.
   This multi-faceted analysis points to problems facing Japan' s public finance and specifies the reasons why fundamental fiscal structure reforms are required.

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