Japanese policy discussions based on an accurate understanding of financial situations: Expectations for the “Laffer Curve”!

Hirokazu Kobayashi

CEO, Green Insight Japan, Inc.

Professor Emeritus and Visiting Professor, University of Shizuoka

I live in a condo adjacent to a JR station with more than 20,000 daily users, and I don’t help but hear the street speeches for the Upper House election. There, stories that make me shake my head are spoken as if they were true, and there are no counterarguments from the audience. I am a scientist, not a politician or a religious figure. Therefore, I have no intention of delving into personal beliefs. However, as a researcher, I would like to organize the data in response to arguments that are not based on evidence.

Question 1: Does the consumption tax fund social security expenses?

The total social security expenses for this fiscal year amount to 140.7 trillion yen, equivalent to US$970 billion. The breakdown is as follows: pensions: 44.4%, medical care: 30.8%, long-term care: 9.9%, children and childcare: 8.5%, and others: 6.4%. The funding sources are as follows: insurance premiums: 59.8% (contributions from insured individuals: 31.6%, contributions from employers: 28.2%), public funds: 40.2% (national taxes: 27.7%, local taxes: 12.5%) (Social Security Benefits and Burdens, Ministry of Health, Labour and Welfare, 2025). On the other hand, 24.9 trillion yen, equivalent to US$172 billion, of this year's consumption tax revenue will be used for social security ("Please Explain Consumption Tax," Ministry of Finance, 2025). This amounts to "24.9 trillion yen / 140.7 trillion yen = 17.7%". What is noteworthy here is that Japan is unique among countries that have a strongly linked consumption tax as a dedicated tax to social security. This is because, when the consumption tax was introduced (1989) and raised (1997, 2014, and 2019), there was strong opposition from the public, so the government explicitly stated that it would be used for social security in order to gain public understanding for the tax increase. Since social security is ascribed to individuals, many countries cover the costs with insurance premiums paid by individuals. In conclusion, the claim that the consumption tax covers all social security expenses is incorrect.

Question 2: Is Japan one of the world's most indebted countries?

In corporate finance, the “profit and loss statement (PL)” is referred to as the “primary balance (PB)” in national finances, and its improvement is emphasized. When measured as “gross debt / nominal GDP,” the smallest country is Canada at 107.7%, while Japan stands at 240.0% (IMF, 2023). Who does Japan owe its debt to, as represented by Japanese government bonds (JGBs)? Bank of Japan (BOJ): 52.0%, banks, etc.: 12.7%, life and non-life insurance companies, etc.: 17.5%, public pensions: 5.9%, pension funds: 3.0%, overseas: 6.4%, households: 1.4%, others: 1.1% (Breakdown of holders of government bonds, etc., Ministry of Finance, 2024). In other words, lending and borrowing are largely confined within the country, resembling a structure like family-based lending. Here, the JGBs held by the BOJ are similar to the printing of banknotes by the BOJ, and their economic effect is equivalent to supplying currency to the market. Although this carries the risk of causing inflation, the term “national deficit” is not appropriate. The above represents the current state of liabilities, i.e., the debit side (liabilities) of the balance sheet (BS). What about the “assets” side of the BS? According to the Japanese government's “Consolidated Balance Sheet,” the total assets as of the end of the 2023 fiscal year were 1,049 trillion yen, equal to US$7.23 trillion (Summary of Consolidated Financial Statements for Fiscal Year 2023, Ministry of Finance). Additionally, the assets of the BOJ, which can be considered a subsidiary of the government, were reported as 756.4 trillion yen, US$5.22 trillion, as of the end of the 2023 fiscal year (Financial Statements for the 139th Fiscal Year, BOJ). On the other hand, total liabilities amount to 1,474 trillion yen, equivalent to US$10.2 trillion (as of fiscal year 2023), with assets and liabilities roughly balanced. Japan's net foreign assets (government, corporations, and individuals) are reported to be 1,338 trillion yen, equivalent to US$9.23 trillion (International Investment Position of Japan, Ministry of Finance, 2022). Japan has maintained the title of the world's largest “net asset holder” for 31 consecutive years (Japan Times, May 27, 2022). In other words, Japan as a whole can be described as the world's largest creditor nation.

When did Japan become a PB-focused (austerity-driven) country? In 1997, under the Hashimoto administration, the “Fiscal Structural Reform Law” was enacted, establishing the Public Finance surplus as the most important indicator of fiscal soundness. Subsequently, under the Koizumi administration (2001–2006), “Painful Reforms” were strongly promoted, including budget cuts and achieving a PB surplus. In 2006, the “Fiscal Consolidation Goals” were established, solidifying PB supremacy as an explicitly stated national objective. From this point onward, fiscal management that took into account the nation's balance sheet (total assets and liabilities) was virtually no longer discussed. Since 1997, Japan has been mired in a negative economic spiral, with its real GDP growth rate ranking last among the 38 advanced economies. Policy discussions based on such situations are urgently needed.

American economist Arthur Laffer (1940-) proposed the Laffer Curve, leading to the Laffer Effect, in the 1970s. This theory posits that “tax cuts → increased disposable income → expanded economic activity → increased tax revenue.” As an example of this theory in practice, Ireland reduced its corporate tax rate from 40% to 12.5% between the 1980s and 2000s, resulting in a sharp increase in foreign direct investment and employment, as well as expanded tax revenue. In Japan, the effective corporate tax rate (comprising national taxes and local taxes) was approximately 50% in the 1990s, but it was gradually reduced. In 2012, the rate was 39.5%, and it further reduced to 29.7% by 2024. As a result, corporate tax revenue increased from 9.3 trillion yen (US$64 billion) in 2010 to 11.0 trillion yen (US$76 billion) in 2015 and 17.9 trillion yen (US$123 billion) in 2023. While factors such as the recovery from the Lehman shock and the COVID-19 pandemic should also be taken into consideration, it can be argued that the decrease in tax rates led to an increase in corporate profits, which in turn resulted in increased tax revenue.

When economic trends are factored into this discussion, the relevant indicators become the “tax cut multiplier” and the “tax revenue elasticity.”

Tax cut multiplier = Increase in national income (or GDP) / Tax cut amount

Tax revenue elasticity = Change rate in tax revenue / Change rate in GDP

The Ministry of Finance asserts that the tax cut multiplier < 1 and the tax revenue elasticity ≈ 1. Pro-fiscal stimulus advocates maintain that the tax cut multiplier > 2 and the tax revenue elasticity > 2. Satoshi Fujii (Professor, Kyoto University: 1968-), who advocates for proactive fiscal policy, presents the above values based on the correlation between Japan's GDP and tax revenue to date, and these values are compelling.

The operation of a nation involves revenue and expenditure, which is similar to the management of a company. Companies face competition from other companies and invest in technological development and work efficiency improvements to strengthen their competitiveness. Similarly, a nation is exposed to international competition in the production of both tangible and intangible goods, necessitating the development of resources and technology. In a capitalist society, if the welfare of the people is to be pursued, the nation should not avoid investment in strengthening its international competitiveness and security.