European Sovereign Crisis and Its Implications for Japan: Reducing Budget Deficits Without Damaging Recovery

Abstract

Japanese government bond interest rates remains very low in spite of the very large budget deficit and very high debt-GDP ratio of the Japanese government. The Japan’s low interest rates make a stark contrast to very high interest rates in the periphery countries of the Euro-zone such as Greece. This is due to the fact that Japan has an independent central bank, the Bank of Japan, and it can maintain zero-interest policy as long as deflation continues. However, the continuation of the status quo is highly risky because the market confidence in Japanese government is gradually eroding. In order to stabilize Japan’s fiscal deficit, it is necessary to raise taxes on a very large scale without hurting the economy recovery. Gradual increase in the indirect taxes with some fiscal investment stimulations and/or the introduction of Gesell tax (thin tax on the balance of safe assets) are proposed as possible policy options.

Appendix on Gesell Tax

To stimulate the economy by raising taxes, it is necessary to levy tax on all government-guaranteed assets including banknotes. In this appendix, we assume that a 2% tax is levied on such assets.

• (1) Effective target of the tax: all owners of safe assets.

• (2) Implementation of a Gesell tax: this tax is levied by a partial default of government-guaranteed assets. The debt service is cut by 2% by reducing interest payments and the repayment of principal. This debt reduction is treated as tax revenue by the government.

• (3) Taxable assets: all government debt, all domestic currency deposits effectively protected by the deposit insurance system or implicit government guarantee, and all liabilities of the central bank including banknotes.

• (4) Banks’ domestic currency debts are cut by 2%. The profit from debt reduction will be absorbed by the government as tax revenue. As banks will also lose money from government bond investments and the holding of the monetary base, only the net profit from the Gesell tax will be paid to the government.

• (5) Taxation on banknotes will be messy. The ideal taxation method is to replace banknotes with stored value cards such as the Japanese Suica or PASMO, or the Oyster card in the UK. At taxation day, 2% of the remaining value of the card will be taxed. If this taxation method cannot be adopted, the central bank has to print new money and exchange it for old at a fee of 2%.

• (6) The announcement of this tax will stimulate spending before it is introduced. Money will shift from cash and deposits to stocks, corporate bonds and real estate. Banks will try to extend loans by using a monetary base that will be taxed. Inter-corporate lending will be stimulated because receivables are not taxed but cash will be. The domestic currency tends to depreciate against foreign currencies that are not taxed.