Fm: Wall Street Journal
Japan Should Cut Taxes To Spur Investment
By ALAN REYNOLDS
The Bank of Japan just cut the discount rate from 0.5% to 0.25%--a harmless gesture,
but one that has obviously gone about as far as it can.
Japan has low interest rates because money is tight, just as Indonesia or Turkey has high
interest rates because money is easy. Inflation makes interest rates go up; deflation
makes them go down. Interest rates on safe and liquid assets were extremely low in the
U.S. in 1932, but the world economy was not awash with dollar cash. On the contrary,
people were liquidating stocks, land and inventories at distress-sale prices in a mad
scramble for cash.
In Japan today, as in the U.S. in 1932, a shaky banking system has induced a frightened
public to keep less money in banks and more in currency. Banks likewise hold extra
reserves against the risk of a run. This is why seemingly generous increases in bank
reserves and currency (the "monetary base") have had little effect on the growth of
broad money or bank credit. For the year ending in July, currency was up 8.6%, but
broad money was up only 3.5%. In economists' jargon, the "money multiplier" has
fallen. That is no "liquidity trap." It just means that it takes larger injections of base
money to make an impact on broader measures of money.
The slow-motion bank run Japan has been going through could be easily remedied by
having the central bank buy far more securities, through open market purchases or the
discount window, paying for them with new cash. Japanese banks would not necessarily
have to use added reserves to make more loans, but could also put more cash in
circulation by buying securities. A more expansionary monetary policy would directly
meet the demand for liquidity, including currency hoards, thus greatly alleviating the
painful process of asset liquidation.
Why doesn't the Bank of Japan do this? One reason may be the dangerous 1930s
fallacy of thinking that low nominal interest rates are a sign the central bank has done all
it could. Another obstacle to securities purchases is Japan's exaggerated concern that a
genuinely accommodative monetary policy might devalue the yen, infuriating the U.S.
Meanwhile, the government of Japan, threatened with a lower credit rating, is reluctant
to offer deep and permanent tax cuts, which it believes would undermine future budgets.
The resulting policy paralysis is entirely unnecessary, the consequence of viewing
available options only in macroeconomic terms. Japan and its critics look at monetary
policy only in terms of interest rates, and tax policy only in terms of budget deficits. They
need to pick policies from a bigger menu than that, including judicious use of targeted
tax incentives.
Japan suffers from a mixture of real and monetary problems. An effective remedy should
approach both angles. The best place to begin is by improving investment opportunities.
The cheapest and fastest way of reviving Japan's wealth, and thereby its economy, is to
repeal three specific taxes on owning or trading capital that were enacted in 1987-92
for the express purpose of crashing the value of Japanese land and stocks. These taxes
yield no significant revenue, yet they severely depress prospective net returns from
Japanese domestic investment, thus depressing asset values and fostering capital flight.
The first tax mistake took effect in late 1987, when sales of land were subjected to a
capital gains tax of up to 85% if the land had been held for less than two years. Aside
from preventing land from being transferred to more efficient uses, this greatly reduced
the liquidity of land as an asset, and thus depressed land prices.
The second tax blunder was more serious. In 1989, in response to a political
insider-trading scandal, Japan's parliament introduced a new 26% capital gains tax on
stocks. Naturally, this extra tax on future returns made Japanese stocks much less
valuable.
And in 1992, Japan's Ministry of Finance came up with a new national tax on land
values, in addition to local property taxes. According to Hiromitsu Ishi, one of the
leading architects of this new land tax, the objective was "to seek an effective policy
with respect to reducing land prices." Indeed, the value of Japanese land has fallen every
year since this tax was put into place. Since land was an extremely important corporate
asset, the land tax was also quite effective with respect to reducing Japanese stock
prices.
Capital gains in Japanese stocks have been so rare since they became subjected to the
1989 tax that eliminating any capital gains tax on stocks would obviously involve no
revenue loss worth measuring. Revenues would also be unaffected by ending the
prohibitive tax on short-term capital gains from land sales, since that tax was clearly
designed to ban virtually all such deals. The 1992 land tax had the intent and effect of
reducing land values, which means it has actually cost Japan's treasury dearly through its
visibly destructive effects on the banking system and economy.
In terms of primitive macroeconomics, repealing these foolish taxes would not constitute
a tax cut at all, because it would be more likely to increase than to reduce future tax
receipts. Contrary to fiscal macroeconomics, however, the economic value of a "tax cut"
is not measured by how much revenue it loses but by how much efficiency and
prosperity it spurs.
With the repeal of the 1987-92 taxes on owning or trading land and stocks, the value of
Japanese land and stocks would quickly rise. That would boost bank capital and restore
the collateral behind many otherwise bad loans. But many loans are bad only because
the assets behind them went bad after being attacked by maniacal tax "reformers." With
better assets, Japan would have better debts. Ending the capital gains tax on stocks
would also make it much easier for Japanese corporations to raise equity capital,
reducing their currently precarious dependence on bank debt. And consumer spending
would revive, thanks to the famed "wealth effect."
Improved after-tax returns on Japanese domestic investments would repatriate Japanese
capital, and the resulting appreciation of both the yen and Japanese stocks would attract
foreign investment. With capital flows shoring up the yen for a change, the Bank of
Japan could comfortably accommodate any currency hoarding that might still persist.
Once Japan's economy was restored to even reasonably good health, the rest of Asia
would stand an excellent chance of bouncing back. Once Asia's industry recovered, that
would boost sales and prices of oil, metals and other raw materials from troubled
commodity-exporting countries, such as Australia, Canada, Chile, Indonesia and Russia.
And if the world economy was thus returned to some semblance of normality, that could
bolster the sliding stock prices of U.S. companies involved in global production, sales
and finance.
The psychological impact of ending Japan's 1987-92 tax assault on asset values would
be promptly reflected in newly euphoric financial markets world-wide. Japan's
depressing atmosphere of malaise and retrenchment would be turned around in a matter
of weeks, not years.
Mr. Reynolds is director of economic research at the Hudson Institute. |
