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Our tale continues:
May 18, 2008: Japan: Tax Hikes are
No Fun
May 11, 2008:
Japan: Now What Are We Going To Do?
April 21, 2008:
Japan -- WTF is Going On Here?!?
April 13, 2008:
This Is So Not Like Japan
Prime minister Obuchi
actually had some haphazard but significant growth-boosting tax cut policies.
At this point, the government was flailing around for anything at all that
might work, even (gasp! horror!) cutting taxes. Temporarily of course --
because, for some reason, it was always believed by the bureaucrats and
politicians that taxes were going to be raised to the moon, just as soon as
the economy pulled itself together. Property-related taxes were lowered
somewhat, and a 20% "temporary" tax discount was implemented.
Basically, you got to the last line on your income tax form, and reduced the
figure by 20%.
Koizumi made some
interesting bureaucratic reforms, mostly related to government spending
(especially public works spending financed by the postal savings system).
None of this had much growth effect. However, by then the BOJ was
implementing its "quantitative easing" policy, which was having
some effect. Also, the dollar itself was beginning to decline in value. This
allowed monetary conditions to become reflationary in Japan, and eventually
inflationary, but in a pleasant way. Koizumi happened to be in office at the
time, and enjoyed the benefits. Also, he promised not to raise taxes while in
office, and kept his promise. Not very suprisingly, people wanted him to stay
in office as long as possible.
Shinzo Abe followed
Koizumi's departure in September 2006. Abe made some interesting moves toward
a lower corporate tax rate, which encouraged investors. This trend has
apparently fizzled out, however. Indeed, the situation for corporations has
gotten somewhat worse. Something like 40 deductions and exemptions are being
phased out, including the deduction for corporate entertainment spending. I
judge this to be a more substantial change than it may appear. Japan's
corporate tax system worked for many years, despite high headline tax rates,
because it had been punched full of holes in the form of deductions,
exemptions, rapid depreciation, etc. (In the 1950s and 1960s, it was
intellectually fashionable to have high tax rates, and the Japanese leaders
seemed to think that they should not be too much of an exception in this
regard.) One such exemption was corporate entertainment spending. Upper
income tax rates are quite high in Japan, hitting as high as 88% in the late
1980s. In addition, payroll-type taxes apply to all income earned, so the
effective rate was over 90%. Not surprisingly, high level corporate
executives never had very high salaries. They were effectively paid in perks,
such as company-paid housing, company-paid transport, large numbers of
beautiful young women about the office, and bottomless expense account budgets
which in turn supported the incredible profusion of restaurants and clubs for
which Japan's large cities are known. Top income tax rates have fallen
somewhat since then. The top rate is now 50%, but that is after payroll taxes
which now consume about 24% of income. MOF especially seems to regard the
"loopholes" that were created to allow the economy to function
despite high official rates as a diminution of their duly-earned largesse.
Today, Japan has the highest effective corporate tax rates in the developed
world. The U.S. official rate is also about 40% (higher than just about
everyone in Europe), but careful tax planning has reduced the effective rate
to 17% for the top 275 companies, according to one study. So, now it's the US
that has punched its tax code full of holes, as is practically inevitable in
a democracy with headline rates that are too high.
You will remember from
our quick history sketch last week that the opposition parties, primarily the
DPJ, have only gained significant popularity when they have proposed tax cuts
against the LDP's tax hikes. The opposition won their first Upper House
majority victory in 1989 on a platform of eliminating the brand-new
consumption tax. In 1993, the opposition managed their first Lower House
victory on a platform of tax cuts. Since then, the opposition has mumbled and
grumbled about mostly pointless "reforms," most of which are
actually not much different from those of the reformist wing of the LDP such
as Koizumi.
The DPJ won its second
Upper House victory in July 2007, on the basis of its policy of -- tax cuts!
(The DPJ's withdraw-from-Iraq policy also helped.) Helllloooo politicians? Is
this so hard to figure out? In December 2007 (the traditional season for
planning the next year's tax changes), the DPJ laid out its (still not very
impressive) plans. This is how the Nikkei Weekly described it:
The opposition DPJ came
up with its own fiscal 2008 tax reform guidelines on Dec. 26. The guidelines
made by the DPJ's tax research commission focus on cuts and differ markedly
from the position of the ruling coalition. . . .
Tax breaks for capital
gains and dividends are set to expire at the end of 2008 and March 31, 2009,
respectively. The DPJ proposes restoring the original 20% tax on stock
capital gains, while keeping the lower 10% rate on dividends as a way to
encourage more individuals to buy stocks.
The ruling coalition
seeks to effectively extend the 10% rates through the end of 2010 for capital
gains of up to 5 million yen and for 1 million yen in dividends. . . .
Under the opposition
party's fiscal 2008 guidelines, the consumption tax would be kept at 5%, with
all its revenue used for financing basic pensions. . . .
While the guidelines
state that proposals for tax cuts and hikes are still being assessed, the
overall emphasis on lowering the tax burden is evident.
http://www.nni.nikkei.co.jp/AC/TNW/Search/Nni...231FP8DPJTX.htm
The newspaper also
reported that: "The coalition is well aware that if a tax reform bill
specifies a time frame for raising the consumption tax, the opposition will
vote it down." Those LDP activists who wanted to bring down the
corporate tax rate were apparently stymied by the inability to push through a
consumption tax hike, as if one required the other. They thought it would be
unpopular to lower taxes for corporations while raising them for consumers --
and they're right. A better solution would be to lower both corporate and
individual income taxes.
I like to think that I
was at least a little responsible for the recent interest, subdued as it is,
in reducing the corporate tax burden in Japan. I pitched the tax-cut/growth
solution to a reporter from Nikkei Business (the country's
largest business magazine) back in 2002 or so. He got the idea right away,
and Nikkei Business was soon promoting a 5% reduction in
corporate taxes on their front cover. Also around 2002, I sent a series of
faxes to government, business and media leaders, which illustrated both a)
Japan's very high corporate tax rates compared to those throughout the
developed world, and b) the tendency, especially in Europe, to lower those
tax rates still further. This seems to be the only tax cut idea which has
made any impression on the leadership in Japan.
After a recent tussle
involving road-related taxes, prime minister Fukuda's approval rating dropped
to 21%. Road-related taxes (on gasoline for example) are actually quite
substantial, and are directed into road-building activities. Both political
parties have talked about making this revenue part of the general budget,
which would allow further reduction of the massive road-building pork orgy
that has continued for some decades. So, who's next once Fukuda gets broomed?
Kaoru Yosano is mentioned as a candidate to succeed Fukuda, supposedly under
the "Koizumi reform" banner. However, Yosano looks like a committed
tax-hiker, while Koizumi never was. Not only does he buy into the popular
"raise consumption taxes to double-digit European levels" meme, he
also wants to raise income tax rates to make the tax system more
"progressive." The "supply side" idea that lower tax
rates can lead to an improved economy and improved government finances has a
few fans among politicians, but Yosano isn't one of them. "The claim
that growth will bring in enormous amounts of revenue and solidify the
nation's finances is a grand illusion," he said in February.
To make a long story
short, the LDP has trended toward higher taxes, which is an economic mistake
and also very unpopular with voters. The other parts of the
"Koizumi" bureaucratic reforms, such as reducing the size of the
public works pork fiesta, have been hugely popular. The DPJ has made some
rather weak movements in opposition to the tax hike trend. The DPJ thus
became the best monkey wrench around to throw into the LDP's tax-hike
machine, and voters did so in 2007's Upper House election. As a result,
movement has stopped somewhat, which is frustrating to some but overall a
good thing. Most of the other reforms are not all that pressing, so if the
whole parade is brought to a halt there is no real harm done. Avoiding harm
done is the goal today.
Rather than going on and
on with the convoluted details of policymaking in Japan, which is at least as
depressing as policymaking in the U.S. or any other country, it might be best
to end here with some suggestions:
Lower corporate taxes: Japan's corporate tax
rates are the highest in the developed world, and reducing the various
loopholes and exemptions that allowed companies to function under this
oppressive system isn't exactly helping. Just step up and cut the rate to
20%. Make entertainment deductible again. I've argued that reinvestment of corporate cashflow is one of the primary
sources of capital in an economy, and abundant capital tends to lead to
economic abundance as well. Japanese leaders, back in the high growth days of
the 1950s and 1960s, used to understand this very well -- keep the obstacles
to capital accumulation LOW LOW LOW.
Lower income taxes: The top rate is 50% as it
is, and that does not count the payroll taxes, which are effectively 23.9%.
So, the real effective rate is more like 62%. That might be OK, if it was
applied to income of something like $50 million. A better solution is to just
cut the top income tax rate to about 35% or so. There is an easy way to cut
both the corporate and income tax rates, and that is to eliminate
prefecture-level income taxation, and replace it with some of the income from
the consumption tax.
Lower capital-related
taxes: Sometimes
countries can function reasonably well, despite high taxes in some areas, if
they have lower taxes elsewhere. The U.S. has about the highest
capital-related taxes (capgains, dividends, interest, inheritance) in the
developed world, which is one reason the U.S. economy is a bit sickly despite
having lower income and sales-related taxes. Japan has always had low capital-related
taxes, which helped things along despite high income taxes. In the 1980s, the
last time the Japanese economy really worked properly, capital gains taxes on
equities were zero. Dividend taxes were very high (taxed as regular income)
but taxes on interest income were zero, which is why Japanese corporations
tended to be heavily debt-capitalized and mysteriously not very profitable
(as they took advantage of all the aforementioned exemptions, deductions, and
accelerated depreciation). Property-related taxes, in particular, were much
lower than they are today. An easy solution is to eliminate taxes on capital
gains of all sorts (including property), eliminate taxes on dividends (paid
at the corporate level), make taxes on interest income at low levels of 15%
or less. No taxes on interest income would also be just fine, and seemed to
work well in the past. Inheritance taxes have headed down somewhat, but this
could head lower as well.
No consumption tax hikes: I am not too much of a
critic of the consumption tax, as it is a relatively efficient tax,
generating large amounts of revenue without too much economic distortion --
if the rate is maintained at 5%. I might even be OK with a 10% consumption
tax, if matched with huge tax decreases elsewhere such as a total elimination
of corporate taxation and a reduction of top income tax rates to 20% or so.
No more payroll tax
hikes: Payroll
taxes are scheduled to rise to the moon to finance retirees. The pension and
medical care systems common in developed countries today are likely
unsustainable in their present form. By demographic fact, Japan's government
will have to deal with these issues a bit before other governments. The
simple solution, it seems to me, is to decide on a level of taxation that is
appropriate for a healthy economy, and then use the revenues from that tax in
the most effective possible way. For example, someone could say:
"Today's payroll tax is already very onerous. Further increases will be
self-defeating, as they would lead to economic deterioration that makes it
even more difficult to fund a cushy welfare state." Then, they would use
the income from the tax -- whatever it may be -- as a budget for welfare
programs. This gets out of the "entitlement" system. Japanese
people, in general, are rather more psychologically hardy than their
entitlement-addicted American counterparts, and would be willing to accept
such a change, it seems to me. Actually, even retirees would be better off
with such a change, as the ultimate benefits that can be provided by a
healthy economy are greater than those that can be provided by an unhealthy
one. The total "tax burden" in Japan is around 40%, compared to
about 20% in the high-growth days of the 1960s. That "tax burden"
isn't going to go much higher without serious negative consequences. What are
they thinking: "All of our problems would be solved if we could just get
that up to 50%."??? The politicians of the 1960s had a specific goal of
keeping this "tax burden" below 20%, and cut tax rates whenever the
"tax burden" threatened to rise above that level. They ended up
cutting taxes every year. The result was an explosion of tax revenue.
We have a winner!
Since the late 1980s, the
trend has been toward higher and higher tax rates. Has this produced any
improvement in revenue? Combined with disastrous monetary deflation, the
combination has produced stagnant and falling tax revenue. In fact, in
nominal terms, the government's revenue today is about the same as it was in
the late 1980s! That was twenty years ago! And before the introduction of the
consumption tax.
Chart showing (pink line)
central government expenditures, (blue line) tax revenues, and (green bars)
government bond issuance, in trillions of yen. The first year in the chart is
1983, and the last is 2008 (estimate).
So, you see, when I talk
about the Magic Formula, this is serious stuff.
Reduce public works
expenditure drastically: The FY2008 budget is for 83 trillion yen. Of this,
tax revenues contribute 54 trillion and deficit financing 25 trillion. On the
expenses side, 20 trillion goes to debt financing, and 7 trillion to public
works. However, there is 16 trillion of "local allocation tax
grants," which matches a roughly equivalent amount of public works
spending (15 trillion) on the local level. Thus, the total public works
spending financed by the central government is more in the realm of 22
trillion. See here.
Twenty two trillion yen
is a lot. That is more than the total revenue of the personal income tax
(16.4 trillion), or the corporate tax (16.5 trillion). Can you imagine -- the
entirety of all corporate taxation is funding public works
waste? What if, instead of being destroyed in waste, that capital was
reinvested in the private sector? That might actually be good for the
economy. The stock market would have a big party.
Japan's voters have shown
a preference for tax cuts and spending cuts. Why not give it to them? Reagan
did, and he was the last Republican president worth a damn. Thatcher did, and
she was the last Tory leader worth a damn. Both were very popular. Sure beats
getting incinerated by proposing another consumption tax hike. Japanese
politicians -- helllooooo?
If you add Stable Money to Low Taxes, the result would be
very, very good.
* * *
Buy or Rent?
The New
York Times says that prices have fallen enough that "buying
is conceivable again." Oh really?
Now, these generalized
price/rent ratios tend to be rather off. Often they are single family houses
vs. three-bedroom apartments or something like that. This results in a
price/rent ratio that is higher than you'd find on the ground. You really
have to look at it on a specific-property basis. However, let's just assume
that these numbers are correct.
Is "buying
conceivable again" in New York City or San Francisco? The New York
price/rent ratio is 22.2. San Francisco is 26.1. That means the rental yield
for New York City is 1/22.2 or 4.5%. The 30-year fixed-rate mortgage is
5.85%. That's the best possible rate. Let's just assume you qualify.
Including amortization, it works out to 7.1% per year in mortgage payments alone.
Let's put it another way.
Your rent is $3,000. Your mortgage payment is $4,733. Then, there's the
downpayment, PMI perhaps, insurance, property taxes, maintenance and capital
replacements, and all that other stuff that goes into owning a house. All together,
it probably comes to $7,000 a month or so.
When you own a place,
it's like "renting it to yourself." OK, you're a landlord. You pay
yourself $3,000 in rent, and then you pay $7,000 in property costs. You just
lost $4,000 in a month's time. Rinse and repeat for the next 30 years.
The simple fact is, most
people who pay $3,000 a month in rent can't pay $7,000 to own the same
residence. They can't pay $7,000 under any conditions, because if they could,
they would already be paying $7,000 in rent.
Here's a simple rule:
when the total costs of owning a property (mortgage, insurance, taxes,
maintenance) are equal or less than your rent, then you can
"consider" buying it. The fact of the matter is, properties will
probably get a lot cheaper than that. But, if you bought on that basis, you
would probably do OK.
In the meantime, keep
renting, and with the extra $4,000 a month you're saving, start piling up a
down payment. Because, you're going to need 20% down.
Here's a little rundown
showing what I mean. Your rent is $3,000 and your total costs of ownership
are $7,000 including a $4,733 mortgage payment on a fully-amortized 30yr
mortgage at the best possible rate. The numbers are annualized. Rent is
assumed to rise at 3% a year. Historically, rent has risen roughly in line
with inflation. The mortgage payment stays fixed. Non-mortgage costs also
rise at 3% per year. The money you save by renting instead of owning is put
into a bank account paying 3% per year, called Total Savings.
Notice that the cash
costs of renting are cheaper every year until year 31, when the mortgage is
fully paid off. Then, renting costs more than owning. However, at that time
you've accumulated $2 million in your 3% savings account, which you can use
to pay the difference between renting and owning. Actually, your savings
account is so large at that point that it keeps getting bigger even when you
make withdrawals to pay the rent! At year 50, you're still renting, and you
have $2.8 million in your bank account. The homeowner has a house, which at
10x annual rent, is worth about $1.5 million.
Now let's look at what
happens when you follow my advice, and buy when your total cash costs of ownership are
equal to your rent. This is the way it normally is, because how
are you going to pay more than you're paying for rent? You can't, and
normally your banker is aware of this.
In the first year, the
costs of ownership and the costs of renting are the same. However, over time,
rent rises at 3% a year while your mortgage payment stays the same. Thus,
there is a little savings from owning, which gets bigger each year. The total
savings from owning is expressed in the final column as a negative number,
which is the negative savings from renting. In Year 30, if you had taken the
money you saved from owning instead of renting, and put it in the bank at 3%,
you'd have a bank account worth $490,000, plus you would own your house free
and clear. Then, after that, you aren't paying the mortgage anymore, so the
cash costs of ownership are much lower than renting, and your accumulated
savings really starts to rocket. At the end of fifty years, you own a house
worth $1.5 million PLUS you have $2.7 million in the bank. Can you see why
buying a house has worked out for so many people if they buy at the right
price?
Nathan
Lewis
Nathan Lewis was formerly the chief international
economist of a leading economic forecasting firm. He now works in asset
management. Lewis has written for the Financial Times, the Wall Street Journal
Asia, the Japan Times, Pravda, and other publications. He has appeared on
financial television in the United States,
Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada,
call 800-567-4797.
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