Chapter 4
THE PERSONAL INCOME TAX: RATE AND EXEMPTIONS
A. Introduction.
The personal income tax is by far the most important tax in the Japanese system. In the last fiscal year (1948-49) it produced 191 billion yen. This is more than 40 percent of the total national collections for that year (450 billion yen). In the budget for 1949-50 the income tax is estimated to yield 310 billion yen out of a total of 635 billion yen in national taxes. This is nearly 50 per cent of the total.
The income tax is a mass tax, applying to practically every family in the country. Even though the personal exemption and the credit for dependents have recently been increased substantially, in terms of yen, inflation has concurrently increased the money incomes of the taxpayers.
At the beginning of 1948, the basic exemption of the income tax stood at 4,800 yen. The tax credit for dependents was 480 yen, which was equivalent to an additional exemption of 2,400 yen for taxpayers subject only to the first bracket rate of 20 per cent. Today the basic exemption is 15,000 yen, and the credit for dependents is 1,800 yen, which, for the first two dependents, is equivalent to an additional exemption of 9,000 yen per dependent. For wage earners, these exemptions are, in effect, increased by one-third through the operation of the 25 per cent earned income credit. Hence, a married wage earner with two dependent children pays not tax unless his income for 1949 exceeds 55,000 yen. But the average annual earnings of a fully employed semi-skilled industrial worker in the larger companies is probably not far from 10,000 yen a month, or 120,000 yen a year. A single wage earner with no dependents pays no tax unless his income for 1949 exceeds 20,000 yen. But even a young shopgirl in a retail store in a small city gets 3,000 yen a month or more. Clearly, the income tax is still a mass tax.
Japan is, therefore, embarked on a great project: the development of the personal income tax as the tax that all the people pay for the support of their government. Only the United States and Great Britain, among the other large nations, have adopted this policy and pursued it with a reasonable degree of success. And they have done so only recently, under the impact of World War II. (It is too early to evaluate the results of the post-war reforms in the French, German, and Italian tax system).
Consequently, the most important single question to be answered regarding the present Japanese tax system is this: Should Japan continue in her attempt to make the personal income tax the chief instrument whereby the ordinary citizen supports his government?
There can be no doubt concerning the intrinsic merits of this high aim. The alternative is a return to a system of heavy indirect taxes, which hide from the citizen the amount that he is contributing to government and even make him unaware that he is contributing at all. Government then seems to him something remote, with which he has little or nothing to do except as he asks an occasional favor from it. Moreover, the indirect taxes cannot take proper account of differences in income and wealth, and in family burdens. They are crude machines for distributing fairly the large tax requirements of the modern state. Students of public finance have been urging for many years the reconstruction of tax systems to achieve tax consciousness and justice in the distribution of the tax burden. Japan is now engaged in just such an enterprise.
However high the aim, there is no point in pursuing it if the desire to achieve it, or the technical competence to do so, is lacking. This reform has come suddenly upon the Japanese people -- it dates back no further than 1947. The habits of financial accounting, of keeping books, are far from adequately developed. Tax consciousness can all to easily degenerate into mere tax irritation, especially among those of low and medium income who have never appreciated how great a hidden burden they were carrying through indirect taxation and inflation. And tax irritation leads to tax evasion and a further impairment of citizenship morale. An income tax that is widely evaded and is collected only by arbitrary reassessments under the threat of dispossession and sale of the taxpayer's property is worse than indirect taxation.
Our tax mission has debated these issues exhaustively during the past four months. Our field trips throughout the country, our interviews with taxpayers in all walks of life and with tax officials at all levels, have been made chiefly so that we might apply sound judgement in answering the question of the future of the personal income tax in Japan.
The conclusions we have reached are as follows:
The attempt to make the income tax the mainstay of the fiscal system should continue, but with the realization that the goal cannot be reached in one or two years. Even if progress is as rapid as we expect it can be, it will be five or ten years before Japan has at hand a smoothly working, adaptable fiscal instrument in the form of an income tax that will distribute the tax requirements equitably and induce a consciousness of citizenship without provoking blind irritation against government. This reservation, however, implies no reason for not moving forward steadily, year after year. Each year's achievement in income tax administration and income tax compliance should show a marked improvement over the preceding year. Lack of progress in any year would be an indication that the whole endeavor was in danger of failing.
We come now to the immediate prospects for the tax,in this and the forthcoming fiscal years.
At the present time the income tax is imperilled by evasion on the one hand and arbitrary reassessment on the other. Worse yet, the evasion and reassessment are much greater with respect to one group of taxpayers -- the small business man and the farmer -- than they are with respect to another -- wage and salary earners. A major source of injustice has thus developed.
A number of things must be done, to correct these defects. Accounting techniques must be developed, information from the food control administration must be more fully utilized, the methods of appeal by the taxpayer against reassessment must be altered. These and other changes are discussed later in this report. One more step that is essential if the income tax is to be given a fair chance to rid itself of evasion and harshness is a reduction in the tax rates and an increase in the personal and dependency deductions.
The present combination of high rates and high evasion has created a vicious circle. Tax administrators believe that it is a common practice for taxpayers, especially business men, to understate their incomes. Consequently, in view of the flood of returns that must be handled within a short time, many administrators routinely reassess the taxpayers for higher amounts, without inspection of their premises or books. Taxpayers, believing that just this is the practice of tax administrators, see no value in honesty; they anticipate being reassessed in any event. It is evident that this vicious circle must be broken if the income tax is to survive. A reduction in the tax rates and in increase in the exemption is an essential step in breaking it. It is, of course, not the only step: administration must at the same time be improved (see especially Chapter 14 on Compliance, Enforcement, and Appeal).
We are, therefore, recommending changes that reduce the average (weighted) rate of the income tax by more than one-fourth, in fact almost one-third. That is to say, if the rates and exemptions that we recommend are applied to the incomes of a particular year, say the incomes of 1949, the total amount of tax due on those incomes will be somewhere between three-fourths and two-thirds of the tax due on those same incomes if the present rates and exemptions are applied.
Even with so substantial a decrease in rates it is still possible to collect in 1950-51 only 7 per cent less, not one-third or one-fourth less, than the 310 billion yen budgeted for 1949-50. For one thing, if, as we assume, incomes maintain during the coming year and a quarter just the level they reached in mid-1949, they will average somewhat higher for 1950 than for 1949. Secondly, the estimate of 310 billion yen for 1949-50 is based on conservative anticipations concerning the increase in incomes from 1948 to 1949. It also assumes no improvement in the ratio of the income assessed to the actual income, and very little improvement in the ratio of taxes collected to taxes assessed. To be sure, even these modest assumptions about the ratios may be proved too optimistic when the figures for 1949-50 are in, but for our purposes, in planning a long-range program, it seems best to use these same ratios. Any deterioration this year should be followed by improvement next year, under the lighter pressure of the lower rates and higher exemptions.
Another reason why the revenue collections under the rates and exemptions recommended here should fall only 7 per cent, in 1950-51, below the budgeted revenues for 1949-50 is based on the amount of delinquency that can be cleared up, through payment of back taxes. The present fiscal year is drawing on a backlog of delinquent taxes that is smaller than the one that will be carried over into 1950-51 from the larger incomes and larger tax due of this year. This source of yearly increase in revenue will not recur to the same degree in 1951-52, if the lower rates and higher exemptions recommended for 1950 are adopted. Consequently, the yield of the new rates and exemptions could be expected to decline, by 1952, to a level somewhat more than 7 per cent below the 310 billion yen budgeted for the present year, unless, as may be hoped, a further increase occurred in the income-assessed ratio or the tax-collected ratio. Eventually, given a continuation of present prices and present business, and merely the present levels of achievement in assessment and collection, the income tax revenue und4er the rates and exemptions recommended in this report could be expected to level off at 278 billion yen.
This eventual point of leveling off will, however, be determined by a number of factors of which the quantitative effect cannot be estimated at this time. Some of them will be felt next year. The current progress being made in administration should improve the ratio of assessed income to actual income, and also the ration of collections to assessments. The tax administering personnel will become more experienced as the large number of quite inexperienced workers taken on during 1946-48 acquire competence. An independent investigatory tax service has been instituted at an intermediate level, as described in Chapter 14. The rationale of the tax should also improve as the price level becomes stabilized, and as the opportunities for black market and other illegal and unreported income decrease owing to the removal of controls. There should also be a notable improvement in compliance by taxpayers, under rates and exemptions that they may regard as more reasonable.
The revenue gains from these factors will be partly offset if our recommendations are adopted concerning the abolition of the requirement for combining the incomes of members of a co-living family, the liberalization of the definition of a dependent, and the special deductions for the physically handicapped (Section E of this chapter, below); the increase in depreciation for unincorporated concerns resulting from revaluation (Chapter 7, Section A), and the increase in the individual credit for dividends received, form 15 per cent to 25 per cent (Chapter 6, Section A).
Considering those factors that can be given a quantitative expression at this time, we are led to the conclusion that the assessed taxable income on which tax is actually collected will average, in 1950, about 10 per cent higher than the incomes on which we would expect the 310 billion yen of income taxes to be paid in fiscal 1949-50, as estimated in the budget.
It is important that the program of rate reduction and exemption increase be put into effect as soon as possible, to lift compliance and enforcement to higher levels. But it is also essential to take no chances with the nation's financial stability.
We recommend, therefore, that only a part of the income tax revision program be put into effect for the fiscal year 1949-50, and be made applicable only to a part of the year. Specifically, we recommend that for wage and salary earners an increase in the personal exemption and allowance for dependents and a reduction in rates be initiated in January, 1950, thus decreasing the amount of withholding for that and subsequent months. We also recommend that farmers and self-assessed business and professional men be granted a 15 per cent earned income credit effective as of October 1, 1949, to be reflected in returns filed in January, 1950. On returns of 950 income and later years, however, this credit should be merged with the personal exemption, in order to keep the tax return form as simple as possible. That is, the personal exemption would be larger than it otherwise would be, by the amount of the earned income credit. Wage and salary workers would get the same enlarged exemption, plus a separate earned income credit of 10 per cent, in recognition of the greater earned income element in their type of income.
Let us suppose that the personal income tax, after the effects of rate reduction, exemption increases, improved administration, and improved compliance have had time to become fully effective, is yielding about 278 billion yen. How will the burden have been redistributed, compared with what it will be this year if the 310 billion yen estimate for 1949-50 is realized? We should expect the following changes:
1. The wage earners and salaried earners, as a group, will be paying less. Even under present conditions there does not appear to be much evasion of this portion of the income tax, thanks to collection at source. Under lower rates and better administration, therefore, the net result will be a lower tax for this group. The amount of tax relief will differ substantially, however, among types of taxpayers in this group. The single wage earner will get relatively little relief, while the married taxpayer with several children will get a great deal. This is because the combination we recommend, of greater personal exemption, greater credit for dependents, and lower tax rates, will work more to the advantage of the married person, especially with dependents, than the single person. But every taxpayer, single or married, will pay less tax (on a specified income) than under the present law.
2. Among the self-assessed taxpayers, the farmers would, as a whole, perhaps be taxed about as much as they are now. They will benefit by the tax reduction measures, but it is our impression that there is appreciable understatement of income at present, in farm returns, and much of this would be eliminated under the techniques of assessment and collection that we recommend. There would also be considerable redistribution of the burden as among farmers. Each farmer would be taxed more nearly on the basis of his own income, rather than on some area average.
3. The change would be greatest for this third group, the self-assessed business men and professional men. The group as a whole would, we expect, get no tax relief, but rather the reverse, even under the lower rates and exemptions. As a group, these taxpayers have been successfully evading their formal income tax obligations on a wide scale. The improved enforcement and compliance that can be expected with lower rates should, with this group, more than make up for the decline in their obligations. At the same time, there will doubtless be some individuals who will experience substantial tax relief. The taxpayer who has been making a true return, or an almost true return, of his income should benefit. He will be subject to lower rate, and will be freed from arbitrary reassessment. But it will be a different story with the taxpayer who has so understated his income that even with arbitrary reassessments he has been evading a substantial amount of tax. He will find himself compelled to pay much more, under the new program, than he pays at present, assuming, of course, still further, improvement in the Japanese tax administration.
B. Personal Exemptions and Allowances for Dependents.
The personal exemption of 15,000 yen in the present income tax law is too low; so is the credit against the tax that is allowed for each dependent, 1,800 yen.
However, there is no precise standard that can be followed in setting the basic exemption and the allowance for dependents. Some taxpayers' groups assert that the exemption should be high enough to cover the taxpayer's expenditures on the basic necessities of life - food, clothing, shelter, and medical care. Under this standard they suggest an exemption of 100,000 yen or more. But government is also a basic necessity of life. In a country with the limited resources of Japan, its capital equipment heavily damaged by war, it is not possible for the citizen of moderate income to get what he might think is a reasonable amount of the basic necessities of food, clothing, and so on, and also get a reasonable amount of government services. The production of the country is not large enough. This fact is reflected in the companion fact that, if personal exemptions were raised to 1000,000 yen, the income tax could not yield enough, under any workable system of tax rates, to avoid a heavy deficit. The lost revenue could, of course, be replaced by heavy indirect taxation, as through an increase in the transactions tax, but this would be taxing, not exempting, the necessities of life. The only other possibility is continued inflation, which is a hidden form of taxation that is apt to bear especially heavily on the low-income groups.
The adequacy of the personal exemption is sometimes tested by translating it into a foreign currency, the dollar, for instance, and then comparing the result with the exemptions in force in those countries. At the exchange rate of 360 to 1, the present personal exemption of 15,000 yen is only $41.67. Under the United States income tax, the personal exemption is $600. But such a comparison ignores both the cost of things the small income taxpayer buys, in his own currency, and the amount of time and effort it takes him to earn the amount in question. In Japan, for instance, a wage earner who gets about 10,000 yen a month is doing about the same grade of work as one who in the United States is earning about $250, or possibly $300, a month. The present personal exemption under the Japanese income tax is equal to one and a half month's earnings of this semi-skilled type of worker. The personal exemption in the United States is somewhat more than twice one month's earnings of the same type of worker in the United States. Measured in this manner, the personal exemptions of the two countries are not far apart. This is not the only measure that should be used, but it is relevant.
In recommending a new level of exemptions, we were guided by the following aims: (1) to continue the income tax as the chief source of government revenue in Japan, but (2) to decrease the rates and increase the exemptions enough to give a stimulus to enforcement and compliance and to take the burden off those at the bottom of the present taxpaying group. The exemptions that fit these aims best are: 24,000 yen as the basic personal exemption, and, in lieu of the present tax credit, a deduction of 12,000 per dependent (including wife).
Aside from the question of the general level of rates and the yield to be derived from the income tax, there are many technical changes which should be adopted in order to make the income tax a more equitable and effective fiscal instrument. Of these technical changes, two are particularly related to the level of rates and general distribution of burden. These two concern the methods of allowing for dependents, and the discrimination in favor of earned income.
Credit for Dependents.
At present the credit for dependents is in the form of a credit of 1800 yen against the tax. This operates to increase the level at which farm and business taxpayers become taxable by 9,000 yen for the first two dependents and slightly less for additional dependents. For wage earners, the 25 per cent earned income credit has the effect of increasing this exemption to 12,000 yen.
We recommend that there be substituted for this tax credit a deduction from income of 12,000 yen. This represents both an increase in the exemption and a slight change in its effects on various taxpayers. For wage earners, the proposed 10 per cent earned income credit will raise the effective exemption to 13,333 yen per dependent.
This recommended form of the dependency allowance has several advantages which together considerably outweigh any disadvantage there may be to changing from an established practice to one that is not so familiar to taxpayers.
In the first place, the basic personal exemption is already on a deduction-from-income basis. It will be simpler for the taxpayer to deal with only one form of personal allowance instead of two, in filling out his tax form.
Secondly, the deduction-from-income method allows the amount of income tax differential that is caused by dependents to increase, as the income increases. This results on the whole in a more equitable distribution of the tax burden, particularly as between large and small families at the higher income levels. For example: if 5400 yen is a suitable difference in tax between a single person and a married man with two children when both are at the 30,000 yen level, the difference should be greater than 5,400 yen when both are at the 100,000 yen level. This result is not achieved under the credit device: the difference in tax between the taxpayers remains at 5,400 yen all the way up the income scale. But if the dependency allowance is put in the form of a deduction from income, the difference in tax will be greater than 5,400 yen at the 100,000 yen level, and still greater at higher levels.
It is sometimes argued that the credit device produces a more progressive type of income tax than the deduction-from-income method, since the latter method does give the high-income taxpayer more yen in tax relief, per dependent, than it gives the low-income taxpayer of similar dependency status. But if, under these conditions, the income tax is not progressive enough to suit us, the difficulty is easily remedied by a slight change in the rate scale.
Changes in the rate schedule cannot adjust the relative tax burdens of families of different sizes, and it is this that should determine the selection of the type of credit to be allowed.
Thirdly, it is proposed elsewhere to permit the local governments to use the income in excess of personal allowances as reported for the national income tax as a base for assessment of part of the inhabitant's tax. This can be done much more simply if the deductions are all in terms of a deduction from income, so that the desired figure will already appear on the return filed for national tax purposes and will not have to be derived separately. If the allowance for dependents were in the form of a tax credit, additional computation would be required if the amount of such a local tax base were to be computed.
C. Rate Scale of Individual Income Tax.
I. Genreal Characteristics of the Rate Scale
In constructing a rate scale for the revised personal income tax, we have been subject to certain self-imposed limitation.
First, the total yield from the personal income tax for 1950-51 could not drop by more than about 7 per cent from the level estimated in the budget for 1949-50, owing to continued need for revenue. We have been able to meet this test, and yet present a scale of rates and exemptions that really represents more than a one-fourth cut in the personal income tax, as explained in Section A of this chapter.
Second, the rate scale had to meet certain technical tests described below, if no taxpayer was to pay more under that scale than he would under the present one.
Third, the top income tax rate had to be no more than 55 per cent, for reasons given in Section A of Chapter 5, which describes the net worth tax that we recommend for taxpayers with a net worth of more than 5 million yen.
The resulting scale contains marginal rates that may seem to be discouragingly high in the range of, say, 1000,000 yen to 200,000 yen. This impression would be heightened if the fallacious procedure were followed of converting the yen into dollars at the exchange rate (360 to 1), for purposes of comparing Japanese and American tax laws. On this point we refer back to our discussion of personal exemptions, in Section B of this chapter. But the fact is, we are here dealing with an economy in which the average level of real income is low, and where the individual incomes are probably fairly well concentrated about that average, instead of there being a poverty-stricken group at the bottom and a large number of well-to-do some distance above. Under these conditions, the rates must start at a substantial level and go up fairly sharply, if adequate revenue is to be gained.
Moreover, it must be recalled that the rate schedule is not as steep as it looks in the table; the personal exemption and the deduction for dependents (and the earned income credit, for wage earners) soften the rate of progression. A married wage earner with three children, for instance, does not reach the 40 per cent bracket rate until his annual net income exceeds 212,000 yen. The first 20,000 is exempt under the earned income credit; 24,000 more is exempt as personal exemption, and 48,000 more as deduction for four dependents. Of the remaining 120,000 yen, 50,000 is taxable at 20 per cent (10,000 yen tax), the next 30,000 at 25 per cent (7,500 yen tax) the next 20,000 at 30 per cent (6,000 tax), and the final 20,000 at 35 per cent (7,000 yen tax). If he earned another 1,000 yen that year, it would be taxed at 40 per cent. On his income of 212,000 yen he pays 30,500 yen income tax, under this recommended schedule.
The following is the recommended rate schedule, devised to yield a total of 288 billion yen for the year 1950 (fiscal year 1950-51):
Exemptions: 24,000 yen, plus 12,000 yen for each dependent.
Earned income credit: 10 per cent on the first 200,000 of salary and wage income.
| Rate Scahdule V: | 0 | to | 50,000 | yen | 20% |
| 50,000 | to | 80,000 | 25% | ||
| 80,000 | to | 100,000 | 30% | ||
| 100,000 | to | 120,000 | 35% | ||
| 120,000 | to | 150,000 | 40% | ||
| 150,000 | to | 200,000 | 45% | ||
| 200,000 | to | 300,000 | 50% | ||
| over | 300,000 | 55% |
Leveling the rates off at 45% would reduce the yield by about 12.3 billion yen; levelling [# leveling? ] off at 50% would reduce the yield by 4.6 billion yen. The yield estimate of 288 billion yen assumes:
1. A uniform increase in income assessed, for 1950, of 65 per cent over 1948.
2. Current collections to be same proportion of the total tax assessed as was obtained in 1948-49, namely 63.3 per cent for self-assessed taxpayers and 98.6 per cent for withholding on wage and salary incomes.
3. The collection of 36 billion yen in back taxes on 1949 incomes. Back taxes for the year 1948-49 were 15.8 billion yen, and those for 1949-50 are estimated at 20.8 billion yen, out of 42.8 billion yen and 57.2 billion yen total taxes, respectively, assessed but not collected for the preceding fiscal years. The rate is about 37% in both cases. If collections in 1949-50 on self-assessed taxpayers remain at 63.4 per cent of assessments, which would bring in 324.5 billion yen for the current fiscal year, there will remain 97.9 billion yen in delinquent taxes for next year, out of which the recovery of 36 billion yen or 37% would appear reasonable.
If a larger immediate collection ratio is obtained for the current year, this will cut down the amount of delinquent tax to be carried over, and hence cut down the amount of back tax to be collected in 1950-51. However, this improved collection ratio would then be expected to carry over into 1950-51, so that the collection of current taxes would be increased by more than enough to offset the reduction in back taxes.
| Amount of Tax | Percent of Income | |||||
|---|---|---|---|---|---|---|
| Net Income (yen) | Present (yen) | Proposed (yen) | Present (percent) | Proposed (percent) | ||
| Single Person | ||||||
| 30,000 | 1,500 | 600 | 5.00 | % | 2.00 | % |
| 40,000 | 3,000 | 2,400 | 7.50 | 6.00 | ||
| 50,000 | 4,625 | 4,200 | 9.25 | 8.40 | ||
| 70,000 | 8,375 | 7,800 | ?11.95 | 11.14 | ||
| 80,000 | 10,500 | 9,600 | 13.12 | 12.00 | ||
| 100,000 | 15,000 | 14,000 | 15.00 | 14.00 | ||
| 120,000 | 19,750 | 18,700 | 16.45 | 15.58 | ||
| 150,000 | ?27,075 | 27,350 | 18.41 | 18.23 | ||
| 200,000 | 47,500 | 45,200 | 23.75 | 22.60 | ||
| 300,000 | 94,750 | 93,000 | 31.58 | 31.00 | ||
| 500,000 | 212,000 | 200,800 | 42.40 | 40.16 | ||
| 1,000,000 | 546,750 | 475,800 | 54.07 | 47.58 | ||
| 2,000,000 | 1,294,125 | 1,025,800 | 64.70 | 51.29 | ||
| 5,000,000 | 3,691,500 | 2,675,800 | 73.83 | 53.52 | ||
| Married Couple with two children | ||||||
| 50,000 | - | - | - | - | ||
| 70,000 | 2,975 | 600 | 4.25 | 0.86 | ||
| 80,000 | 5,100 | 2,400 | 6.37 | 3.00 | ||
| 100,000 | 9,600 | 6,000 | 9.60 | 6.00 | ||
| 120,000 | 14,350 | 9,600 | 11.95 | 8.00 | ||
| 150,000 | 22,225 | 16,250 | 14.81 | 10.83 | ||
| 200,000 | 42,100 | 30,500 | 21.05 | 15.25 | ||
| 300,000 | 89,350 | 75,000 | 29.78 | 25.00 | ||
| 500,000 | 206,600 | 181,000 | 41.32 | 36.20 | ||
| 1,000,000 | 541,350 | 456,000 | 54.13 | 45.60 | ||
| 2,000,000 | 1,288,725 | 1,006,000 | 64.43 | 50.30 | ||
| 5,000,000 | 3,686,100 | 2,656,000 | ?73.27 | 53.12 | ||
[# The '?' mark in the table shows the different figures between English and Japanese edition.]
| Amount of Tax | Percent of Income | |||||
|---|---|---|---|---|---|---|
| Net Income (yen) | Present (yen) | Proposed (yen) | Present (percent) | Proposed (percent) | ||
| Single Person | ||||||
| 30,000 | 3,000 | 1,200 | 10.00 | % | 4.00 | % |
| 40,000 | 5,250 | 3,200 | 13.12 | 8.00 | ||
| 50,000 | 7,750 | 5,200 | 15.50 | 10.40 | ||
| 70,000 | 13,500 | 9,200 | ?19.25 | 13.14 | ||
| 80,000 | 16,500 | 11,500 | 20.62 | 14.75 | ||
| 100,000 | 23,250 | 16,500 | 23.25 | 16.50 | ||
| 120,000 | 30,500 | 22,300 | 25.41 | 18.58 | ||
| 150,000 | 42,500 | 32,900 | 28.33 | 21.93 | ||
| 200,000 | 64,250 | 54,200 | 32.12 | 27.10 | ||
| 300,000 | 115,250 | 103,000 | 38.41 | 34.33 | ||
| 500,000 | 234,500 | 211,800 | 46.90 | 42.36 | ||
| 1,000,000 | 573,000 | 486,800 | 57.30 | 48.68 | ||
| 2,000,000 | 1,322,250 | 1,036,800 | 66.11 | 51.84 | ||
| 5,000,000 | ?3,221,500 | 2,686,800 | 74.43 | 53.74 | ||
| Married Couple with two children | ||||||
| 50,000 | 2,350 | - | 4.70 | - | ||
| 70,000 | 8,150 | 2,000 | 11.57 | 2.86 | ||
| 80,000 | 11,100 | 4,000 | 13.87 | 5.00 | ||
| 100,000 | 17,850 | 8,000 | 17.85 | 8.00 | ||
| 120,000 | 25,100 | 12,500 | 20.91 | 10.43 | ||
| 150,000 | 37,100 | 20,500 | 24.03 | 13.67 | ||
| 200,000 | 58,850 | 38,500 | 29.42 | 19.25 | ||
| 300,000 | 109,850 | 85,000 | 36.61 | 28.33 | ||
| 500,000 | 229,100 | 192,000 | 45.82 | 38.40 | ||
| 1,000,000 | 567,600 | 467,000 | 56.76 | 46.70 | ||
| 2,000,000 | 1,316,852 | 1,017,000 | 65.84 | 50.85 | ||
| 5,000,000 | 3,716,100 | 2,667,000 | 74.32 | 53.34 | ||
[# The '?' mark in the table shows the different figures between English and Japanese edition.]
II. Method of Constructing the Estimate.
The general background for the present estimates of income tax yield is presented in the following table:
| Self-Assessed | With-holding | Total | ||||
|---|---|---|---|---|---|---|
| (Money figures in Billions of yen) | ||||||
| Fiascal Year 1947-48: | ||||||
| 1. Budget Estimate | 49.2 | 19.8 | 69.0 | |||
| 2. Amount Assessed | 92.1 | 28.4 | 120.5 | |||
| 3. Collected | 49.3 | 28.0 | 79.3 | |||
| 4. Delinquent (2)-(3) | 42.8 | .4 | 43.2 | |||
| 5. Collection ratio (3)/(2) | 53.5 | % | 98.6 | % | 65.8 | % |
| 1948-49: | ||||||
| 6. Budget Estimate | 122.2 | 61.3 | 183.5 | |||
| 7. Assessed Amount, new | 156.1 | 77.5 | 233.6 | |||
| 8. Collected: Current | 98.9 | 76.4 | 175.3 | |||
| 9. Back Taxes | 15.8 | - | 15.8 | |||
| 10. Total | 114.7 | 76.4 | 191.1 | |||
| 11. Current Collection Ratio (8)/(7) | 63.4 | % | 98.6 | % | 75.0 | % |
| 12. Back Collection Ratio (9)/(4) | 37.0 | % | - | 36.6 | % | |
| 13. Delinquest taxes (7)-(8) | 57.2 | 1.1 | 58.3 | |||
| 14. Assessment Estimated from bracket distribution, M/F | 158.2 | 81.0 | 239.2 | |||
| 15. Ratio, actual to computed | 98.6 | % | 95.8 | % | 97.6 | % |
| 1949-50: | ||||||
| Budget Estimate of Collections: | ||||||
| 16. Current | 169.2 | 120.2 | 289.4 | |||
| 17. Back Taxes | 20.8 | - | 20.8 | |||
| 18. Total | 190.0 | 120.2 | 310.2 | |||
| 19. Implied back collection Ratio: (17)/(13) | 36.4 | % | - | 35.7 | % | |
| 20. Calculated assessment, from M/F table for 1949-50 | 228.9 | 122.5 | 351.5 | |||
| 21. Implied collection ratio (16)/(20) | 74.0 | % | 98.1 | % | 82.3 | % |
| 22. Estimated assessment, from 1948 incomes increased 50% | 271.4 | 139.8 | 411.2 | |||
| 23. Est. Current Collections, at 1948 ratios (22)x(11)x(15) | ?169.6 | 132.1 | 301.7 | |||
| 24. Est. Delinquent Taxes (22)x(15)-(23) | 97.9 | 1.9 | 99.8 | |||
| 1950-51: | ||||||
| 25. Est. liability, Scheme Q,V, on incomes of 165% of 1948 | 199.3 | 134.2 | 323.5 | |||
| 26. Est. Current Collections, at 1948 ratios: (25)x(11)x(15) | 124.6 | 126.9 | 251.5 | |||
| 27. Back taxes: (24)x(12) | 36.2 | - | 36.2 | |||
| 28. Total collections, est. | 160.8 | 126.9 | 287.7 | |||
[# The '?' mark in the table shows the different figures between English and Japanese edition.]
In building up the estimates that have been used in the present study, the starting point was a table showing the cumulative bracket income distribution for the fiscal year 1948-49, provided by the Ministry of Finance. These figures were first validated by applying to them the rate schedule in effect for 1948. After deducting an estimated credit for dependents (for the withholding taxpayers, the credit was adjusted to cover the period March 1948 to February 1949, this being the wage period for which the revenue would be reported in fiscal 1948-49), the resulting calculated assessment is shown in line 14 of the table. This calculated assessment is only a few per cent above the actual total tax assessed, shown in line 7 of the above table.
Proceeding to estimate for the current fiscal year, 1949-50, a table of estimated bracket incomes was also submitted by the Ministry of Finance for this period. The total assessment calculated from this table is shown in line 20. If these figures were correct, then if the current yield estimated in the budget is to be obtained, the ratio of collection to assessment for the self assessed income tax will have to increase from 63.4 per cent in 1948-49 to 74 per cent in 1949-50, as shown in lines 11 and 21.
However, the bracket distribution table for 1949-50 is derived from estimates prepared early in 1949 as part of the budget for 1949-50, and before the actual data for 1948 income were available. Accordingly, these figures are based on data for 1947, with incomes multiplied by about 2.9 to allow for the increase in incomes between 1947 and 1949. This implied an estimated income for 1949 about 35 per cent above 1948. However, the trend since the beginning of the year points to a 1949 income of at least 150 per cent of 1948, so that the income assumptions on which the Ministry of Finance income distribution for 1949 was based now appear too low.
Accordingly, alternative estimates were prepared, using the 1949 distribution of income, increased by 50 per cent to allow for the increase in income from 1948 to 1949. These figures are shown in line 22. If the assessment so calculated is multiplied by the collection ratios for 1948, and also by the ratio of actual to calculated assessment for 1948, the result is an estimated yield for fiscal1949-50 of some 12 billion yen above the budget estimate. Thus the budget estimate for the income tax for 1949-50 would seem to be at least 4 per cent too low, even if no improvement in assessment or collection takes place.
For 1950, it seems reasonable to assume a level of income of 165 per cent of that for 1948. Accordingly, a bracket income distribution table was prepared for 1950 on the assumption of an increase in income of 65 per cent over 1948, with further allowance for a proposed change in the earned income credit from the present 25 per cent on earnings up to 150,000 yen to 10 per cent on earnings up to 200,000 yen, proposed change in the personal exemption from 15,000 to 24,000, and a proposed change in the dependency credit from 1,800 yen against the tax to 12,000 against income.
To do this, the bracket distribution for 1948 was first adjusted to what it would have been had there been no earned income credit, the income and income levels increased by 65 per cent, and the result readjusted to allow for the proposed earned income credit of 10 per cent.
An average exemption per return was then estimated separately for withholding taxpayers at 49,200 yen, assuming 2.1 dependents per return, and at 67,200 yen for the self-assessed, assuming 3.6 dependents per return. The cumulative bracket income distribution was then obtained for levels of 49,200 yen, 59,200 yen, etc. for the withholding taxpayers and similarly for the self-assessed taxpayers, to give estimated amounts subject to the various rates to be proposed. The resulting bracket distribution was designated rate base Q.
In setting up the rate schedule designated V, three objectives had to be reconciled. The most definite objective was to avoid imposing any nominal burden under the new rate schedule that actually exceeded that under the old. While exemptions were increased, the earned income credit is to be reduced. If the rates of the present law were then applied, some wage earners would find that the reduction in earned income credit outweighed the increase in exemption, so that the tax would actually be increased. Since this would result in considerable criticism of a supposed tax reduction program, it is necessary to reduce rates at least enough to prevent this from occurring. As the proposed dependent credit of 12,000 yen is considerably greater in its effect than the present tax credit at 1,800 yen, the problem is greatest for the single wage earner. Accordingly, Schedule V is designed so as to avoid increasing the burden on the single wage earner at any point. Actually, in order to produce a schedule increasing by 5 per cent jumps and having a reasonable pattern of progression, a considerable margin of tax reduction is afforded even the single wage earner; it is generally true however, that this margin of reduction is less for the single wage earner than it is for taxpayers with dependents, and less for the wage earners subject to the earned income credit than for the self-assessed.
The second objective, of course, is to raise the required amount of revenue. It is found that this can just about be done with the Schedule V. Thus between the requirement of raising a given amount of revenue, that of providing at least some tax reduction for every-one, and that of also reducing the differential between earned and unearned income of 10 per cent, there is very little margin for shifting the tax rates.
The third objective is to keep the rates on the top incomes down to levels where a reasonable degree of enforcement can be obtained. Here we have limited the top rate to a maximum of 55 per cent. It is worthwhile to note that even if the progression of the rates had been kept up to 85 per cent as in the present law, the additional revenue received would have been less than 9 billion yen, even assuming that such drastic rates did not increase the amount of evasion. The reduction in top rate from 85 per cent to 55 per cent is quite likely to increase the level of compliance, assessment, and collection, so that the reduction in revenue will certainly be much smaller than the 9 billion indicated by the distribution of bracket income. The following table and the accompanying chart may help to give a better understanding of the revenue limitations of steeply progressive rates, at least under the present limitations to effective discovery of high incomes. This table shows the distribution of taxable income by brackets, not by classes. A wage earner with 60,000 yen of income does not have his entire income entered in the fifth line from the bottom, for instance. Instead, 6,000 yen of it is entered in the lowest line (earned income credit, 10 per cent of wage), 24,000 yen more is entered in the second line, forming part of the 938 billion total (personal exemption, assuming ht has no dependents), 20,000 yen more is entered in the third line from the bottom, in the category "0 to 20,000", and the remaining 10,000 yen falls in the fourth line from the bottom (20,000 to 50,000 yen), forming part of the 295 billion total.
| Taxable Income Bracket (Thousands of yen) | Proposed Rate V | Estimated Amount of Income Taxable in given bracket (billions of yen) | Cumulative amounts in brackets above income level (billions of yen) | |||
|---|---|---|---|---|---|---|
| over | 5,000 | 55 | % | 2.5 | 2.5 | |
| 2,000 | to | 5,000 | 55 | % | 7.0 | 9.5 |
| 1,000 | to | 2,000 | 55 | % | 10.8 | 20.3 |
| 500 | to | 1,000 | 55 | % | 30.1 | 50.4 |
| 300 | to | 500 | 55 | % | 41.3 | 91.7 |
| 250 | to | 300 | 50 | % | 24.3 | 116.0 |
| 200 | to | 250 | 50 | % | 38.0 | 154.0 |
| 150 | to | 200 | 45 | % | 64.0 | 218.0 |
| 120 | to | 150 | 40 | % | 42.0 | 260.0 |
| 100 | to | 120 | 35 | % | 63.0 | 323.0 |
| 80 | to | 100 | 30 | % | 67.0 | 390.0 |
| 50 | to | 80 | 25 | % | 174.0 | 564.0 |
| 20 | to | 50 | 20 | % | 295.0 | 859.0 |
| 0 | to | 20 | 20 | % | 303.0 | 1162.0 |
| Persona exemption and deduction for dependents | 0 | % | 938. | 2100.0 | ||
| Earned income credit | 0 | % | 100.0 | 2200.0 | ||
| 2200.0 | ||||||
That is, of the 2,200 billion yen expected to be reported by taxable individuals under the proposed provisions, almost half will be covered by the personal exemptions (including the deduction for dependents) and the earned income credit. Of the remaining 1162 billion that is actually subject to tax, over half is found in the taxable brackets below 50,000 yen. Less than one-tenth is found in the brackets above 300,000 yen, and we propose that this be taxed at 55 per cent in any case. It is clearly not possible to raise any substantial amount of revenue merely by further increasing the rates in the top brackets. Indeed, if the reduction in the rates from 85 per cent to 55 per cent were to result in an increase in the assessed income of taxpayers above the 500,000 yen level by as little as 20 per cent, the tax on this increased assessment would more than offset the loss from the reduction in rates, so that the net result would be an increase in revenue and an increase in the real progression of the income tax.
Our objections to rates of more than 50 per cent on income are explained in detail in Section A of Chapter 5, where a net worth tax on well-to-do individuals is proposed in lieu of high income tax rates.
We recommend a top rate of 55 per cent for the time being, but it is our expectation that once the net worth tax is a familiar and dependable part of the tax system, it will be possible to use a personal income tax that does not exceed 50 per cent, or perhaps 45 per cent.
D. Earned Income Credit
The present Japanese law provides for an earned income credit of 25 per cent of earned income up to 150,000 yen. Earned income consists of all compensation for employment, but not including income from agriculture, profession, or business. Several reasons have been give for this earned income credit:
1. that it represents a sort of depreciation allowance for the exhaustion of the working life of the individual;
2. that it represents a recognition of the effort and sacrifice of leisure involved in "earning";
3. that it is a rough allowance for additional expenses incurred because of the work which nevertheless cannot for administrative reasons be allowed as specific deductions, since they are often almost indistinguishable from normal living expenses;
4. that it operates to offset the relatively more adequate assessment of wages and salaries as compared with other forms of income.
Of these reasons, the last must be strictly excluded as a basis for drawing up a tax law. Once it is admitted that the tax on A is deliberately made lighter than the nominal tax on B because it is expected that B will evade part of his tax, the B's will feel justified in their evasion, since then it becomes necessary for them to evade in order to be on equal footing with A. Also, the tax officials will tend to condone the evasion, and the evasion will grow until the entire structure of the tax is undermined. The remedy for such inequalities must be sought in better administration and assessment, not in arbitrary adjustments of the rates.
Items 1 and 2 apply just as well to farm income and to income from small business, to the extent that the bulk of the income is attributable to personal effort rather than to the ownership of property. To what extent item 3 is applicable to business and farming depends largely on how other items of imputed income and deductions are treated. As long as income in kind of farmers is, at least in the law, fairly completely includible in income, as it is under the present Japanese law, they have an equally good claim to an earned income credit on this basis as to wage earners. In any event the amount of the credit justifiable on ground (3) would be smaller than the present earned income credit.
The present earned income credit has several substantial disadvantages.
1. It involves extra computation in the determination of the tax, especially where earned incomes are combined with unearned.
2. It produces a jump in the scale of graduation of the rates at the point where the credit is cut off. Thus below earnings of 150,000 yen, the rate of tax on additional earnings is only 30 percent (40 per cent on three-fourths of the income), but the rate jumps to 40 per cent on income over 150,000 yen and to 45 per cent on income over 165,000 yen.
3. It produces a disparity in the effective exemptions and increases the relative number of taxpayers that are difficult to assess correctly as compared to those that are easy to assess correctly. Thus under the present law wage-earners with two dependents are not taxable until an income of 44,000 yen is reached, whereas farmers and businessmen with two dependents become taxable at 33,000 yen. This means a relatively large number of farm and business incomes are subject to tax, and relatively few wage and salary incomes, as compared to what the situation would be if the exemption were, say, 38,000 yen in both cases. As the farm and business returns are relatively difficult to administer, whereas the tax of employees involves relatively little work on the part of the tax office, this means that the earned income credit causes an undesirable increase in the work load of the tax offices.
The main obstacle to abolishing the earned income credit entirely is that it would not be possible, within the revenue requirements of the immediate future, to reduce the rate schedule to the extent that would be required if no net additional burden were to be imposed upon wage earners.
On balance, we conclude that the earned income credit should not be abolished, but should be reduced to 10 per cent of the first 200,000 yen of earned income. At the same time, as will be recommended elsewhere in this report, rates will be reduced and exemptions raised to an extent to insure that all income taxpayers, including all wage earners, will pay less tax than at present. In effect, the net result may be considered an extension of 15 per cent out of the 25 per cent of the present earned income credit to all taxpayers, but, instead of this 15 per cent credit being expressed as a separate item, it is absorbed in the rates and exemptions.
Indeed, this reduction of the present undue discrimination against farm and other self-assessed incomes is so desirable that we recommend it be put into effect as of October 1, 1949. It is primarily in the realm of farm and self-assessed incomes that there is the greatest room for improving the efficiency of tax assessment and collection through the reduction of rates to levels that taxpayers and administrators consider reasonable. As long as the earned income credit remains at its present unduly high level, there may remain some tendency for taxpayers and tax officials to regard a certain amount of understatement of income on the self-assessed returns as justified, to avoid overburdening these taxpayers, as compared with the withholding taxpayer. The longer this state of affairs is allowed to continue the greater will be the difficulty of reestablishing the income tax on a sound basis of full reporting and fair assessment.
Specifically, provided that the surplus planed for 1949-50 is not impaired, it is recommended that this reduction take the form of extending an earned income credit of 15 per cent of earned income up to a maximum credit of 37,500 yen to all income taxpayers other than those now eligible for the 25 per cent credit. For the purpose of this credit, it would on the whole be simplest and not seriously inequitable to consider all income up to 250,000 yen as earned, regardless of the source; however, if it is desired to assume the burden of denying the credit with respect to income from dividends, interest, and other property or business which does not involve the personal effort of the taxpayer, we see no serious objection, although this would seem an unnecessary complication in what is intended as a purely temporary adjustment. It is contemplated that in any case this credit plus 15 per cent of the credit on wages and salaries will for calendar year 1950 be absorbed in a general reduction of rates, and increase of exemptions, leaving only a 10 per cent earned income credit for wages and salaries.
It should be again emphasized here that we do not by this step intend that the relative amount of tax revenue collected from the self-assessed should be reduced in comparison to the withholding tax by anything like the extent to which the nominal tax is reduced. To a considerable extent we expect this reduction in the nominal tax to offset by better compliance and improved administration, if not immediately, than over the course of the next two or three years. Primarily, we expect to see the burden on the conscientious taxpayer lightened, and lax and delinquent taxpayers brought to the point of paying more nearly their fair share of the cost of their government. If our hopes in this direction can be realized, Japan will be on the road to the eventual development of a sound, equitable, and efficient tax system.
E. The Treatment of the Family as a Unit
Under the present Japanese income tax law, the income of all of the members of the "co-living" family are required to be aggregated for purposes of applying the graduated rates. This treatment in form follows the traditional Japanese unity of the family. In practice, however, it has several undesirable effects:
1. The aggregation of incomes pushes the combined income into brackets taxed at higher rates than are otherwise applied to taxpayers on the same general level of welfare and taxable capacity. It is widely felt that this is an unfair distribution of the tax burden. Taxpayers feel aggrieved, and taxpayer morale suffers.
2. The increase in tax creates an artificial incentive for the breaking up of large families into smaller units. Actual changes will be induced by the tax in relatively few cases, but there seems to be no good reason for applying such a pressure by means of a tax differential. Indeed, while there is an acute shortage of housing, this pressure is especially undesirable, as it encourages some families to occupy more dwelling units than the might otherwise, imposing increased crowding on the others.
3. The determination of whether two or more taxpayers actually belong to the same co-living family is often difficult, and the application of the criteria are not uniform. This results in discrimination, complicates the administration, and creates dissatisfaction.
4. The process of determining the tax and apportioning it among the various members of the family is complicated and time consuming. Especially where one or more of the members of the family are subject to withholding on wages, special trips to the tax office have often been found necessary to work out the details
Accordingly, it is recommended that the aggregation of the income of the "co-living family" be abandoned, and that each taxpayer be permitted to file a return and pay a tax on his income separately, without aggregation with other incomes. However, it is appropriate to provide that the income of any person claimed as a dependent must be included in the income of the taxpayer if the dependent credit is to be allowed.
If this separate reporting of income is allowed without further restriction, however, a certain amount of dispute is likely to arise from attempts bye well-to-do taxpayers to reduce the tax burden by transfers of property and income thereon to the spouse or to children. Likewise, they might go through the form of paying wages to members of the family employed in a family enterprise. This kind of dispute may be avoided without too great sacrifice of the principle individual returns by requiring that property income of the spouse or of minor children living with the taxpayer must be included in all cases in his return and the tax computed on the aggregate. Likewise earnings of a spouse or minor children in an enterprise carried on by the taxpayer should be required to be included in his income.
Under the present law, dependents eligible for the dependent credit are limited somewhat narrowly to the husband or wife of the taxpayer, and other members of his family who are either over 60 years of age and disabled, or under 19. This has worked a considerable hardship in cases where adult members of the family live with the taxpayer and receive their maintenance from him, possibly contributing their labor to his farm or business. In effect no personal allowance at all is provided for such members of the family.
It is proposed that the dependent credit be allowed with respect to any person who receives more than half of his maintenance from the taxpayer, provided that the taxpayer be required to include with his taxable income any income received by a person for whom he claims the dependent credit. This would be a simple rule that can be applied easily, and the requirement that the income of the dependent be included will adequately protect the revenue. As an administrative device, any adult for whom credit is claimed should be required to sign and affix his seal to the return by way of certifying to the fact that his income has been included in the return, and that he is not claimed as a dependent in any other return.
There will still be some tax incentive for a taxpayer to go through the motions of paying a wage to adult members of his family who work for him, so that they can file a separate return and thus secure the full 24,000 exemption. There is indeed no objection in principle to allowing them to do this, provided the wage payment becomes genuinely the property of the recipient. This is not at present apparently the general custom, and the liberalization, of the dependent credit will reduce the discrimination against those who adhere to the older custom to a somewhat more tolerable level. To go further than this and provide a larger credit for such adult dependents would involves additional administrative problems and would also, in many cases, provide a greater total exemption than the circumstances warrant, particularly where the dependent does not actually have effective command over as much as 24,000 yen of the resources of the family.
[# end of chapter 4]