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Prepared by Michael Keen.
Some aspects of globalization, it should be noted, point towards higher taxation. Since many countries find taxing foreigners attractive, for example, increased holding of equity in domestic firms by nonresidents may tend towards heavier corporate taxation.
The increased international mobility of tax bases increases the risk that tax-setting by each country pursuing its own interest will lead to collectively undesirable outcomes and, hence, implies a potential case for international coordination. These issues are not considered here.
A full review of the Japanese tax system would need to address a far wider set of issues than touched on here, including: property and land taxation; the level and role of the excises; tax and wider fiscal policy towards energy use and climate change; the tax treatment of SMEs; the proper scope of earmarking; complexities arising from the differing bases of, and interaction between, national and local corporate and personal income taxes; and the financing of local government more generally.
Macroeconomic aspects of alternative fiscal consolidation strategies are explored in Botman, Edison, and N’Diaye (2007).
Dalsgaard (2007) provides a more complete discussion of CIT issues in Japan, including in relation to SMEs.
To see the difference, consider a CIT that taxed only supernormal profit at, say, 30 percent. In this case, the MER would be zero, since profits in excess of the minimum required by the investor can be taxed at any rate and still leave the project worthwhile for the investor: if (and only if) a project would have been profitable in the absence of tax, it is also in this case profitable in its presence. The AER, however, would be 30 percent, this being the proportion of pre-tax profit taken in tax. Such a tax would be non-distorting for investments that could only be located in Japan (because of the zero MER), but—to the extent that the AER is higher or lower than 30 percent elsewhere—could clearly have an impact on those that could be located elsewhere.
The AER is a weighted average of the statutory rate and the MER, the weight on the former being the ratio of the post- to the pre-tax cost of capital, (Devereux and Griffith, 2003).
This comprises the national CIT rate of 30 percent and, giving rise to variation across localities—enterprise and inhabitants tax at prefectural level, and municipal inhabitant’s tax.
Smaller countries are expected to set lower tax rates than large because in considering a rate reduction they have relatively little revenue to lose from their narrow domestic tax base, compared to the large base abroad that they can hope to attract. There are also, perhaps, external benefits to the rest of the world from the maintenance of a relatively high tax rate in Japan, to the extent that a lower rate there would lead others to lower their rates too, aggravating the potential collective inefficiency from tax competition.
Other possible explanations include a secular increase in the share of profits, notably of the financial sector (Devereux and Klemm, 2005), increased volatility of profits (which, with tax payable on positive profits but not rebated on losses, tends to increase expected tax payments; Auerbach, 2005), and/or a greater tax attractiveness of incorporation consequent on lower CIT rates (De Mooij and Nicodème, 2006).
Japan’s CIT productivity of 0.1 was around the median for the countries in Table III.1, and substantially exceeded only by Australia, Canada, Norway and—an exceptional case, with by far the lowest statutory rate—Ireland.
In similar spirit, Denmark is about to restrict interest deductions to the lesser of 55 percent of earnings before interest and taxes, and an amount calculated by applying notional interest to approved assets; and Canada proposes to restrict interest deductions related to income earned abroad.
Forms of ACE have also been used in Brazil, Croatia, and Italy: Klemm (2006) reviews these experiences.
VAT revenue in 2003 was about 2.4 percent of GDP, or around 0.5 percent for each point of the VAT rate.
There are a number of subnational VATs levied by subtraction, most notably the Italian IRAP, but these are levied at relatively low rates (a central rate of 4.5 percent in Italy). The IRAP does allow some modest rate variation across sectors.
Inclusive of the typical prefectural and municipal inhabitant’s tax.
This should be distinguished from the Hall-Rabushka flat tax, which is a form of expenditure tax. Experience with flat taxes as recently adopted is reviewed in Keen, Kim and Varsano (2006).
Indeed the treatment of pensions is rather more generous than this, since contributions are deductible and funds exempt while cumulating, but pensions in payment are less than fully taxable.
The present system has substantial elements of flatness for many taxpayers, around 80 percent of whom pay at a marginal rate of 10 percent. They account, however, for only around 35 percent of PIT revenue.
As an island, it may also be less vulnerable than are countries with long, open land borders to the risk that high excise taxes will be undermined by illicit trade.