Fiscal reform and government debt in Japan: A neoclassical perspective

• Published in: Review of economic dynamics 2016-07, Vol.21, p.201-224
• Main Authors: Hansen, Gary D., İmrohoroğlu, Selahattin
• Format: Article
• Language: English
• Subjects: Expenditures; Fiscal sustainability; Government debt; Government spending; Growth model; Growth models; Income taxes; Japan; Output; Public expenditure; Stabilization; Studies; Tax increases; Tax rates
• ISSN: 1094-2025; 1096-6099
• DOI: 10.1016/j.red.2015.04.001

Past government spending in Japan is imposing a significant fiscal burden that is reflected in a net debt to output ratio near 150%. In addition, an aging Japanese society implies that public expenditures and transfers payments relative to output are projected to continue to rise until at least 2050. In this paper we use a standard growth model to measure the size of this burden in the form of additional taxes required to finance these projected expenditures and to stabilize government debt. The fiscal adjustment needed is very large, in the range of 30–40% of total consumption expenditures. Using a distorting tax such as the consumption tax or the labor income tax requires either tax to rise to unprecedented highs, although the former is much less distorting than the latter. The extremely high tax rates we find highlight the importance of considering alternatives that attenuate the projected increases in public spending and/or enlarge the tax base.