Japan Likely to Scale Back Plan to Cut Corporate Taxes on Deficit Concern

Japan may scale back a plan to cut the corporate tax rate by 5 percentage points because of concern it will increase the government’s deficit, a move that could limit growth in companies’ profits and investment.

At this stage, even a cut of that magnitude in the effective rate “is difficult,” Vice Finance Minister Fumihiko Igarashi said yesterday in Tokyo after a meeting of the government tax panel. “We’ll consider a reduction that’s within the scope of the revenue that can be secured.”

Japan’s effective corporate tax rate is about 40 percent, one of the highest among Organization for Economic Cooperation and Development nations. A tax cut that isn’t large will cap companies’ profit gains in the short term and may prompt them to move out of Japan seeking lower costs in the longer term, said Naoki Iizuka, senior economist at Mizuho Securities Co.

“5 percentage points is still a very small cut -- what’s really necessary is a cut of about 15 percentage points,” said Iizuka. “If the government can’t manage to cut the rate by even 5 percentage points, there’s no point to pursuing this at all.”

Corporate executives including Hiromasa Yonekura, head of the business lobby Keidanren, have called for a tax cut to make companies more competitive against international rivals. Slowing global demand, sluggish exports due to a strong yen and expiring government stimulus measures prompted companies including Toyota Motor Corp. to reduce production in October.

Lost Revenue

The Finance Ministry has calculated that a 5 percentage point company tax cut will decrease revenue by between 1.4 trillion yen to 2.1 trillion yen ($25 billion). The ministry has pushed for measures to lower Japan’s public debt, which is about twice the size of its annual gross domestic product.

The Trade Ministry, which has proposed a cut of around 5 points, has said that the lost revenue can be made up in coming years. A ruling Democratic Party of Japan project team has called for a corporate tax cut that isn’t offset by widening the tax base, to ensure economic growth.

The Finance Ministry has proposed ending a naphtha tax waiver and tax breaks on corporate research and development to make up for the lost income. Trade Minister Akihiro Ohata said last month he’s “firmly” opposed to taxing naphtha, saying that other countries don’t tax it either.

Japanese companies have also been hit by more than a decade of deflation. Price declines weigh on companies’ earnings.

Deflation End

Bank of Japan board member Miyako Suda said the nation probably won’t overcome deflation in the year starting April, an outlook that conflicts with the central bank’s forecast of moderate inflation in the year.

“Chances of overcoming negative core consumer prices in the next fiscal year aren’t high,” Suda said today in a speech in Yamagata, northern Japan. “It will take a while to beat deflation.”

Suda said that risks for the economy may linger as the yen’s advance against the dollar clouds the outlook for growth. Reports in the past week have shown exports rose at the slowest pace this year and factory production declined for a fifth month, evidence that points to the economic expansion weakening in the final quarter of 2010.

“Given the strong yen and deterioration in corporate and consumer sentiment, there’s a high risk that the temporary weakening in the economy will be sustained,” Suda said.

Strong Yen

Exporter earnings are threatened by the yen’s strengthening of more than 10 percent this year. Nikon Corp., the Japanese maker of cameras, lenses and chip-making equipment, this month cut its full-year operating profit and revenue forecasts, citing a stronger yen.

Asian Development Bank President Haruhiko Kuroda said that while the strong yen won’t affect exports right away because of a time lag in the impact, it will hit company profits and spending plans by reducing overseas earnings in yen terms.

“Yen appreciation instantly affects the profit situation of the corporate sector,” Kuroda said today at a news conference in Tokyo. “That would affect significantly plant and equipment investment by the corporate sector.”