This opening chapter presents a summary view of the Japanese tax system as it stands today. This description will aid in understanding the change recommended by our mission, to be set forth in Chapter 2 and following.

A. Total Tax Yield

The Japanese tax system, national, prefectural and municipal, will produce about 780 billion yen in the twelve months ending March 31, 1950. This is approximately 9,500 yen per person, man, woman and child. A household of five, which is not far from the average size, pays, on the average, 47,500 yen in taxes, directly and indirectly. The average monthly wages of male employees in manufacturing is slightly more than 9,000 yen. Hence it would require about five and a half month's pay of one such average worker to meet the average household's tax bill; but this comparison exaggerates the tax. Families commonly have more than one income earner. Moreover, hardly anyone pays the "average tax"; the tax system as a whole is probably progressive enough so that the average family pays something less than the average tax. Another way of looking at the family's average tax of 47,500 yen is to compare it with the family's average expenditure on tobacco. The total spent by Japanese consumers on tobacco products, chiefly cigarettes, is slightly less than 160 billion yen a year. If it is assumed that there are some 16 million smoking families, the average is nearly 10,000 yen a year per family. Most of this expenditure itself goes in tax, or rather profit to the government tobacco monopoly, but the point is, these consumers are willing and able to spend almost 10,000 yen a year, per household, for the sake of consuming tobacco, compared with 47,500 yen they are willing to have their representatives vote in taxes.

Compared with government expenditures for the current year, this tax total is in one sense large, in another sense, not so large. The expenditures in the national government's general account will be slightly more than 500 billion yen this year, not counting in "expenditures" either the grants given to the local units for them to spend, or debt retirement. Local expenditures will be about 380 billion yen, including local expenditures financed by borrowing and grants from the national government. Hence total government expenditures excluding expenditures in the national government's special accounts, and national debt retirement, will be about 880 billion yen. This is 100 billion yen more than the total tax revenue, but the difference is more than made up by current revenues other than taxes: fees, rents, and other miscellaneous current revenues, both national and local, and among the localities, some 40 billion yen, it seems in the so-called voluntary contributions which the hard-pressed localities have exacted from their citizens. When these revenues are taken into account, there is a surplus of about 60 billion yen in the national general account, which will be used for debt retirement, and a deficit of 18 billion yen in the local accounts, to be met by borrowing. Altogether, then, current revenues will be exceeding current expenditures, under the budgets as planned last spring, by some 40 billion yen.

But this is not the whole story. The Counterpart Fund is one of the national government's special accounts. Its revenue is obtained from the sale, to Japanese consumers and business men, of goods imported under the program of United States aid to Japan. This Fund will contribute at least 60 billion yen toward retirement of the national debt, and perhaps as much as 80 billion yen to outlays for equipping railways, the telephone system, and other sectors of the economy that are renovating and expanding their capital equipment.

In terms merely of the current year, then, the total tax yield is adequate, but not strikingly large, compared with current outlays. But in terms of change from the policy of past years, the tax yield is very large. Several years of inflation, when current revenues ran far behind current outlays, are now being succeeded by a year of a super-balanced budget. This sudden change was an essential part of the stabilization program. It was none the less a notable achievement, rarely matched in the annals of stabilization efforts. This does not, of course, imply that the current tax yield is more than it should be. The danger of further inflation in Japan is still a real one. Moreover, some deficits may be discovered in the special accounts that will partly offset the surplus noted above.

Practically all of the national debt is held by the Japanese banking system. Retirement of the debt by taxation means that money is taken from the public and is put into the commercial banks or the Bank of Japan. The initial effect of debt retirement, in the current Japanese situation, is therefore to take money out of circulation. To be sure, the banking system may then expand its loans to business and consumers, but there is noting in the mechanism of debt retirement itself that guarantees that this result will follow. Debt retirement through taxation is therefore deflationary, and is indeed intended to be so. Again, it is an essential part of the stabilization program. The same is true of debt retirement through the Counterpart Fund.

The question that remains for future years is, how rapidly should the debt retirement program be pursued? Too rapid a debt retirement could damage the economy by excessive deflationary pressure. Any quantitative estimate of where this point might be lies outside the scope of our report. Studies in this field should, however, be initiated and continued on a permanent basis, so that an informed judgment could be passed on this question at any given moment.

These remarks, however, must not be considered as countenancing any immediate relaxation of the efforts being made to keep inflation in check. The immediate task is still that of holding the barrier against further inflation.

B. Tax Yield and National Income

Is the total tax revenue large, or small, compared with the national income? This is one of the questions most commonly asked in any general discussion of the Japanese tax system.

It is, however, a question that must be rephrased before an answer can have much meaning. The tax revenue does not simply vanish. It is paid to Japanese workers and business men in return for goods and services that they produce and turn over to the government, to be used for the collective benefit of the people. The greater the tax revenue, the greater the amount paid to those who supply the government, and the greater the volume of collective services supplied to the people. Viewed this way, how can any given level of taxes be said to be too high or too low?

There are some criteria, to be sure. But upon examination they are seen to run not in terms of taxes alone, but in term of taxes and the accompanying expenditures -- with one exception, to be noted. One criterion is that taxes are excessive if a large part of the money is wasted in supplying unneeded services, or in supplying needed services in an inefficient manner. In this case, it is not so much the taxes as the expenditures that are excessive. Another criterion is that, although the expenditures are needed and are efficiently supplied, some of them may not be needed so badly as to justify the strains and stresses that develop in the tax system through its efforts to raise the last few billion yen of revenue. In that case, it is better to forego that particular government service and decrease the tax revenue. But here it is a matter of degree, and the question cannot be settled by looking at the tax system alone. Sometimes the need for the government service is so compelling that it is necessary to impose terrific strains on the tax system. War and great natural disasters provide illustrations.

Conceivably, the government might attempt to take so much in taxation, and supply so many services to the individual free of charge, or at a low subsidised price, that the reaction of some people might be: Why work? If I work I pay taxes, and if I do not work I still benefit from the government's free services and subsidies. If enough people adopted this philosophy the economy's total output might decline. But this possibility has never materialized to any noticeable degree, so far as we are aware. Certainly, Japan is not at that point. We have observed no lack of willingness to work in this country.

Willingness to risk money, to invest in risky undertakings, is sometimes said to be impaired by modern tax systems to a point where total production in the community declines. The evidence is not clear on this point; the big post-war investment boom in the United States occurred at a time when tax rates were still exceptionally high, though it may have been a hope of future tax reduction that sustained the boom. In any case, this issue does not primarily involve the total amount of tax, but rather the kinds of taxes used.

We must conclude, therefore, that an appeal to the ratio of taxes to national income is not likely to give an answer to the question, are taxes too high in Japan? Still, the computation is worth making. If the Japanese ratio is found to be much greater or much less than the United States or British ratios, an investigation into the causes of the differences would prove useful.

But here we encounter another difficulty. There are no estimates of the national income of Japan that are accurate enough for this purpose, and there will be none until a series of sample censuses have been taken, censuses of production, of wholesaling, of retailing, and family expenditures. This should not prove very costly, since the complete-enumeration type of census, like the population census in the United States, is not needed. But it will take a great deal of technical skill (including the services of experts in the practice of sampling) and an appreciable amount of time before these raw materials for the national income estimate have been extracted and refined.

The students of national income in Japan have done what they could with the inadequate data at hand. The ingenuity they have exercised is impressive. The result seems to be that the national income of Japan is probably at least three trillion yen, and may be a good deal more - perhaps several hundred billion more or even in excess of a trillion more.

National taxes, for the fiscal year 1949-50, are estimated at about 630 billion yen (including 120 billion yen profits of the tobacco monopoly), and local taxes, at 150 billion yen (not including some 40 billion yen of "voluntary" contributions, which are really irregular local levies). The total of taxes, 780 billion yen, is 26 percent of 3 trillion yen. Since the national income may be larger, while it is unlikely that actual tax collections will substantially exceed these estimates, the ratio of taxes to national income in Japan for the fiscal year 1949-50 may in fact be no more than 20 percent or so.

In the United States, total federal, state and local taxes are estimated at 58 billion dollars for 1948, and the net national product, at 244 billion dollars. The ratio of taxes to net national product is 24 percent.*1 Net national product is a better concept than national income, for the present purpose. It is usually somewhat larger than national income. It is national income plus indirect taxes, which are removed in the process of computing national income, and minus subsidies to business.

In Great Britain the estimates for 1948 show total national and local taxes to be 4,327 million pounds sterling, while the net national product is 11,325 million pounds sterling. Hence the ratio of taxes to net national product is 38 percent. *2 The interest on the national and local debt was 600 million pounds sterling. Subsidies required 515 million pounds sterling. Debt interest is not included in net national product. If there were no debt interest, as is almost the case in Japan (relatively) and if taxes were reduced correspondingly, the British ratio would be 35 percent.

Again, the reader must be cautioned against attempting to infer much from a comparison of these ratios. The conclusion that we draw from them is essentially a negative one, namely, that there is no evidence in these data that the Japanese tax total is unusually large. And in view of the low per capita income in Japan, the tax total is probably not to be considered unduly small.

*1 Derived from Survey of Current Business, February, 1949. P.10

*2 Derived from National Income and Expenditure of the United Kingdom, 1946 to 1948. Cmd. 7649, p.6 (gross national product at market prices), p.17 (depreciation), p.21 (corporate additions to tax reserves) and p.22 (taxes paid). The tax figure includes social security contributions. It includes corporate tax liability which is 165 million pounds more than corporate tax payments. The tax total is without subtracting subsidies.

C. National, Prefectural and Municipal Financial Relations

If the expenditures of the national government's general account and its Counterpart Fund and the expenditures of local governments are added, the total, as planned for the current fiscal year, is about 960 billion yen. This excludes debt retirement. It also excludes, from the national account, grants to local governments, otherwise there would be double counting. If net debt retirement is included, total outlay rises to 1,060 billion yen.

Two-fifths of the 960 billion yen expenditures is made by the local governments. This is not a large fraction, especially when it is recalled that the national government supports no armed forces and has only a minute debt charge. Moreover, there are many quasi-governmental or business activities carried on by the national government, which are not included in the general account or in the Counterpart Fund outlays. The national railroad system is one example. On the other hand, the fraction of two-fifths will tend to increase as the national government follows its announced program of spending much less on price subsidies.

A large part of the local expenditure is financed by grants from the national government. When the comparison is put on the basis of amounts of current revenues collected, the relative importance of the local government is seen to be less than the expenditure figures would indicate. Tax revenue, plus miscellaneous current receipts (but excluding the Counterpart Fund receipts), will be about 920 billion yen, if the local "voluntary" contributions are included, or 380 billion yen if they are excluded. Of this total, 705 billion yen is collected by the national government. Thus the localities collect only about one-fifth of total current revenues. The ratio is smaller, if Counterpart Fund revenues are included in current revenues. Comparisons with other countries are difficult, because of differing governmental structures. In the United States, the states and localities are collecting about one-fourth of the total federal, sate, and local tax revenue. The federal demands for revenue are large because of the great outlays on national defense, payments to veterans, interest on the national debt, and aid to foreign countries, including Japan. These four items alone account for three-fourths of total federal expenditures.

The degree of local autonomy in Japan is somewhat lower than the ratio of one-fifth would suggest, when it is recalled that the national government limits the local governments by specifying the kinds of taxes they can impose, and the maximum rates they can set.

D. Direct and Indirect Taxes

The ratio of direct-tax revenue to indirect-tax revenue is a rough indication of the extent to which the people are conscious of their tax obligations. It also usually shows whether the system as a whole is reasonably fitted to individuals' differing degree of ability to pay. Direct taxes can be so fitted, in general; indirect taxes, usually not.

Direct taxes are those which are not intended to be passed on by the initial taxpayer to others, through an increase in his selling prices, or wages, or a lowering of his purchase prices. The intent of the legislator is not doubt often frustrated by events, but for present purposes of an approximate evaluation, the correspondence between intent and result is close enough.

The national direct taxes are the personal income tax, the corporation income taxes, and the estate and gift tax. All the other national taxes, including the profit from the tobacco monopoly, may be counted as indirect taxes. For the local taxes, classification is more difficult, but the inhabitant's tax may be considered entirely direct, and the house and land tax, and also the enterprise tax, half direct and half indirect. All other local taxes, with negligible exceptions, may be counted as indirect. Under these classifications, almost exactly one-half (51 percent) of the total 780 billion yen tax revenue in Japan is from direct taxes, and one-half from indirect taxes. The national ratio is 54 percent direct taxes; the local ration, only 37 percent direct taxes.

This 50-50 ratio for the entire tax system is not particularly remarkable; it indicates a position somewhere between what might be expected under the older types of tax system and the one that has developed in the United States under pressure of war. In 1947, about 70 percent of total federal, state and local tax revenues came from direct taxes (income tax, personal and corporate; death and gift taxes; half of property tax; social security taxes; automobile license taxes). Of the Federal government revenue, 80 percent was from direct taxes. Data for the fiscal year ending June 30, 1948, for the Federal government show 82 percent of the revenue from direct taxes.

The most striking difference between the United States and Japan, in the indirect tax field, concerns the tobacco tax revenues. In the United States, in 1947, total federal, state, and local taxes on tobacco amounted to 3 percent of total tax revenues. In Japan, the profit of the tobacco monopoly for 1949-50 (estimated) is 15 percent of total national and local tax revenues (including the monopoly profit). In the direct tax field the biggest difference concerns the corporation income tax. The collections in Japan for 1949-50 may be about 50 billion yen, or only 6 percent of total tax revenues. In the United States in 1947, federal and state income taxes on corporations accounted for 19 percent of the total.*1

Data for Great Britain for 1946, the latest year for which detailed information is at hand as this is written, indicate that, of total national and local tax revenue, about 56 percent was from direct taxes and 44 percent from indirect taxes, under the classification used above.

*1 All figures for the United States are derived from data supplied by the Tax Institute, New York, and from the Treasury Bulletin of the United States Treasury.

E. Pattern of Direct Taxes

The pattern of direct taxation in Japan has certain features that deserve attention.

An unusually high percentage of the total direct tax revenue comes from taxes on personal income. The total of direct-tax revenue is nearly 400 billion yen, as estimated for 1949-50. The national tax on personal income accounts for 310 billion of their amount. The inhabitant's tax, yielding 23 billion, is a local tax largely on personal income. A large part of the local enterprise tax, which may produce 52 billion yen this year, is based on the profits of unincorporated business enterprises. Altogether, it appears that more than 350 billion yen, or nearly 90 percent of the total direct-tax revenue, is accounted for by taxes on personal income, including in personal income the profits of unincorporated business concerns. The corporation income and excess profits taxes account for about 8 percent of the direct-tax revenue, in the budget estimates as drawn up last Spring. Actual collections, from this source, however, may reach 50 billion yen this year. The estimated yield of the estate and gift tax is only 2 billion yen.

In part, these figures reflect the great role played in Japanese business life by the small and medium-sized business man, who is not in a position to incorporate, or does not want be. In part, they probably reflect a relative failure of the tax administration to cope with corporate accounting or with the lack of it.

They also reflect the extraordinarily small part played in Japan today by taxes based on property. Besides the estate and gift tax, there are the local house and land tax, which will yield only 14 billion yen this year, the real property acquisition tax, 12 billion yen, and a few very small imposts like the local automobile and cart taxes. All told, property taxes in Japan today produce less than 30 billion yen, out of a total 780 billion yen tax revenue -- about 4 percent. Since in every country property has long been recognized as a suitable base for taxation, this ratio is one of the strangest in the present Japanese tax system. It has led us to recommend several measures for increasing the role to be played by property taxes.

The Japanese tax system resembles that of the United States and Great Britain in subjecting all types of income to the same scale of rates under the income tax -- in contrast to the French and Italian practice. Nevertheless, the income tax law does tax property income more heavily than wage and salary income. It does so partly by granting a large earned income credit to wage and salary workers and none at all to farmers and unincorporated business men. Moreover, if national and local taxes are considered together, it is seen that business income is taxed considerably more in total. The unincorporated concern pays the national income tax and the local enterprise tax. The income of concern is considered as part of the individual's income for purposes of the inhabitant's tax. This is true for both commercial-industrial concerns and farmers. The corporation's income is subject to national corporation income tax, national excess profits tax, and local enterprise tax. The dividends from a corporation are taxed as income in the hands of stockholders, but some relief is given in the form of a credit. The cumulative tax on a corporation's income, from the corporation, excess profits, and enterprise taxes runs to 63 percent of the income in a great many cases (one hundred yen of corporate profit may be taxed at 18 percent under the enterprise tax, and the remaining 82 yen at 55 percent under the combined rates of the corporation income and excess profits taxes). This is in addition to be the tax the stockholder will have to pay on any distribution of dividends.

In certain respects this extra taxation of property income tends to offset the failure to tax the capital value of property, but the offsetting action is uneven and largely fortuitous.

F. Pattern of Indirect Taxes

In general, the Japanese tax system has succeeded in avoiding the taxation of the necessities of life, with the exception of clothing (tax on production of textiles). In common with most tax systems, chief reliance is placed on tobacco and liquor. The large proportion of the total that is contributed by the tobacco monopoly's profit has already been mentioned. The liquor tax revenue, which may amount to 70 billion yen this year, is not quite 60 percent of the revenue from tobacco. This is the reverse of what is found in the United States. There, the total federal, state, and local taxes on tobacco are less than half of the proceeds of the liquor taxes, without including in liquor taxes the profits of several state monopolies of liquor distribution. In Great Britain, in 1946, the ratio was more like that in Japan, the customs and excise taxes on drink being only 83 percent of the customs and excise duties on tobacco. In 1948 the ratio was down to 70 percent. Great Britain is a special case, however, in view of the foreign exchange problems raised by tobacco imports. In terms of total tax revenue from all sources, the Japanese liquor tax supplies 9 percent of the total. In the United States, the proportion is about 6 percent, not counting state monopoly profits. In Great Britain (1948) it was about 10 percent.

The Japanese indirect tax system contains some of the highest rates known anywhere. The tax on admissions to theatres, including moving picture shows, is 150 percent. The excise tax rate on a few luxury items is 100 percent of the manufacturer's price, and there are several more taxed at 80 percent.

In practically all countries customs duties are much less important than they used to be, relative to other revenues, but in Japan they are actually negligible. They are estimated to yield only 300 million yen this year. There has been a virtual suspension of customs collections, pending revision of the duties.

Japan has a general sales tax, in the form of a 1 percent transactions tax (general turnover tax). Unlike most countries that have such a tax, however, Japan gets relatively little revenue from it. The tax is estimated to yield about 45 billion yen this year, not quite 6 percent of total national and local tax revenues. Exemptions and inadequate enforcement appear to be the explanation, in addition to the moderateness of the rate.

G. Administration

There is general agreement that tax evasion is an important problem in Japan. Estimates of how much revenue is being lost vary widely. We get the impression that total tax revenues might increase anywhere from 25 percent to 100 percent, if all taxes were fully enforced according to the law as it now stands. Most of the discussion of evasion centers on the self-assessed part of the personal income tax. However, such evidence as we have found indicates that the problem is also important for the liquor tax, the transaction tax, the corporate income tax, the commodity excises, and probably also is most of the local taxes. Only the tobacco monopoly profit appears to be close to 100 percent of what it should be. The reasons why evasion exists and the possible remedies are discussed in various places throughout this report.

A far-reaching reform of the Japanese tax administrative organization and personnel has been in progress since the latter part of 1948. It has had the benefit of guidance and advice from officials of the United States Treasury and Internal Revenue Bureau, and from the Military Government (now, Civil Affairs) teams throughout Japan. This program has been developed by, and carried out under the supervision of, the Internal Revenue Division in the Economic and Scientific Sections of SCAP in Tokyo. The importance of this reform, and the measures necessary to insure its continuation, are discussed in Chapter 14. The details of administrative reform are, however, outside the scope of this report.

Some of the tax laws could be simplified; the publication of Finance Ministry regulations interpreting the law could assist the taxpayers; and the tax forms could be made easier for the taxpayer to fill out, if the changes in law recommended later in this report are adopted.

The local governments have not been given the assistance in administering their tax laws that the national officials have received. In fiew of the added responsibility in tax matters that local units should undertake, such assistance would be especially significant.

H. Equity

A tax system can be successful only if it is equitable, and the taxpayers must realize that it is equitable. Tax equity is partly a matter of administration of taxes according to the law, and partly a matter of fairly drawn tax laws. The details of equity in administration we leave to the administrators, but the assurance that there is equity in the provisions of the tax law is one of the main objects of our work. We have often encountered surprise at the emphasis we place on the search for equity. But no one remains in the tax filed for long without realizing that nothing be recommends will stand up unless it meets the test of fairness in the distribution of tax burden. This means, first, that the system must be free of discrepancies in tax treatment that are obvious to anyone as being unjust -- once they are pointed out. The difficulty is, of course, that many of these discrepancies are hidden below the surface. They are noticeable not by the public at large but only by those who are directly concerned. Sometimes even the latter do not clearly understand the issues. Equity also means that the tax system must satisfy the deep, widespread feelings of the people as to what is fair. Here, of course, it is much more difficult for the tax student to be sure that his recommendations are right. He must estimate what the prevailing feeling is with respect to the distribution of income, wealth, and economic opportunity, yet he cannot be expected to abandon completely whatever ideas of his own he may have on these subjects. In any event, it must be pointed out that without some ideas of equity as a guide, a tax mission is lost. It can usually find at least a dozen different combinations of taxes for raising a given total of tax revenue, all of them administratively practical, and none of them likely to hamper total production in the economy much more than the others.

The Japanese tax system as it now stands satisfies the demands of equity fairly well - on paper, and in broad outline. In practice, and in details of the various tax laws, the story is different. The present personal income tax, for example, is inequitable in practice because the law is fully enforced on some taxpayers (wage earners whose tax is withheld from their pay) and not on others (many unincorporated business enterprises), while on still others more is taken than the law permits (some business concerns, under arbitrary reassessment). The personal income tax law itself is inequitable in many of the details -- for example, the extent to which the co-living household principle is invoked for joint returns, and the unduly large differential in favor of the wage earner against the small businessman and farmer that is caused by the 25 percent earned income credit.

Thus the Japanese tax system is suffering from an accumulation of defective practices and provisions. No one of the defects is enough by itself to cause much trouble, but in total these faults are an impressive source of discontent, and even danger. It is as if a bridge across a large river, located at an appropriate place, and constructed of the correct materials, had been made almost unusable by a large number of small errors in the determination of the proper size of the girders at each of dozens of points. Our report is essentially an engineering study, one that gives attention to a considerable number of details. Unless the detailed recommendations are adopted, the broader recommendations in themselves cannot be of much help.

In formulating these specific suggestions, we have kept continually in mind the basic conflict between simplicity and equity. We have tried to strike a reasonable balance, leaning often to simplicity at the expense of more refinement in equity. Modern economic life is so complex that an extremely simple tax law will soon be felt as intolerably unfair, even by the most casual taxpayer. Our view is that, for the large numbers of individuals who are paying direct taxes for the first time in their lives, simplicity should govern, when there is doubt. This is especially so with respect to the tax return form and the method of computing the tax. But for the well-to-do taxpayer, whose economic interests are complex, we are not inclined to give much weight to mere simplicity. Such a taxpayer can be expected to take the trouble to keep a full set of accounts. He should be able to understand the sometimes intricate details of the law that are designed to afford him protection against unjust taxation without at the same time opening legal loopholes of avoidance. And for business corporations, a very considerable degree of complexity may be justified, if that is necessary to avert injustice and undesirable economic results.

I. Economic Stability

Japan has just passed through a period of extreme monetary instability. Moreover, like other countries in which industry is important, it faces possible waves of employment instability -- booms and depressions. The tax system should exercise a stabilizing influence so far as is consistent with a reasonable degree of success in its other objectives. Once truly effective administration of the income tax is developed, the steep progressive rates of that tax should act as a powerful barrier against any resumption of inflation. Conversely, if the public's purchasing power declines as the result of increasing unemployment, many individuals will drop below the income tax exemption levels or at least fall to lower rate levels. The tax demands on their purchasing power will thus become automatically lightened, and the government, meanwhile, will necessarily resort to borrowing, including the creation of money through the banking system. These principles of cycle-sensitivity of a tax system are generally recognized in public finance circles, though not yet, perhaps, by the public at large. The necessity of having a tax system that automatically contributes in these ways to economic stability is one of the reasons for our recommendation that a sharply progressive personal income tax continue to play an important role in the Japanese tax system, and that the scope of indirect taxation be narrowed where possible.
There are many refinements in this field that could be discussed in this report. But it seems better to defer consideration of them to a later time, when the foundations of the new system will have been firmly laid. Use of the tax system as an instrument of counter-cycle policy must be limited for the time being by the special emphasis that must be placed on problems of tax administration.

[# end of Chapter 1]