JPRI Critique Vol. VII No. 5 (May 2000)
Ishihara Taxes the Banks
by Andrew DeWit

Shintaro Ishihara, best known overseas as the noisily nationalist author of "The Japan That Can Say No," has also become the taxing Governor of Tokyo. He remains staunchly right-wing, but in the confusion of contemporary Japanese politics he is winning acclaim from much of the Left and the enmity of most conservatives. This is because being in charge of Tokyo, in the midst of a full-blown fiscal crisis and widespread disdain for the central government, Ishihara has been able to play a masterful game of populist politics. His most brazen move yet is a new tax, enacted on April 1, 2000, to be levied on Japan's biggest banks with the enthusiastic approval of Tokyo residents.

On February 7 of this year, Ishihara told a news conference that he was making his most important announcement since taking office as governor of Tokyo the previous spring. He was not exaggerating. With characteristic aplomb, he declared that he would introduce legislation to levy an extraordinary tax on banks operating within the metropolitan area. Ishihara's scheme exploits a provision in Japan's intergovernmental tax law that allows prefectural governments such as Tokyo to impose a local corporate tax based on criteria other than profits, which is the normal practice at present. His new tax, with a rate of 3 percent, will be levied on the banks' gross operating income rather than their net income. Gross operating income is equal to profits from core operations minus such expenses as personnel costs but not the banks' write-offs for nonperforming loans. Effective for five years beginning with fiscal year 2000, the tax is expected to reap about 110 billion yen (about US$1 billion) annually. Those paying it will be the thirty or so banks, with headquarters or branches in Tokyo, that have had at least five trillion yen ($46 billion) in deposits and equivalent assets over the past five years.

Since last summer, Ishihara planned the tax reform with a few selected officials in great secrecy, so the announcement took just about everyone by surprise. Even public finance academics participating in an ad hoc tax research group, held under the auspices of the Tokyo Tax Bureau, claim that they were unaware of what was up. And tax officials in the Ministry of Home Affairs, normally well informed about all fiscal moves among subnational governments, were said to have been stunned. In a conspicuous snub, Ishihara notified them of his intentions through one of his assistants, who delivered a one-page summary of the proposal after Ishihara had made it public.

Ishihara as Hitler

Also taken aback, to put it mildly, were the banks. They had grown used to being pampered by the central government, and were very flustered when Ishihara suddenly pulled the blankets from the bed. They quickly jumped up and began lobbying hard against the tax, complaining that it is unfair for them to be singled out and that it even violates Japan's constitutional guarantees of equality. They are now determined to take Tokyo to court in May, a measure that Ishihara has openly derided as being about as useful as "spitting on themselves." Such disdain drives the banks to distraction: one of Japan's weeklies, the Shukan Post, reports that the bankers' national association got so furious that it sent around a memo referring to Ishihara as "Hitler."

Many national-level Liberal Democratic Party (LDP) politicians are also angry with Ishihara. They have recently pumped about US$70 billion worth of taxpayers' money into the banks in order to shore up the country's financial system. Now they confront the maddening likelihood that a significant portion of this money will be effectively siphoned off by Tokyo. Worse yet, current tax laws will allow the banks to deduct Ishihara's levy from the taxes they pay to the central government. Politicians are careful to avoid seeming to support the banks, which is why their counterparts in the Tokyo legislature voted in favor of the tax, but many grumble privately that Ishihara is just a cynical opportunist.

That is, to say the least, somewhat hypocritical coming from LDP politicians. Over the past few years they have clawed their way back into power via some of the most cynical coalitions of convenience imaginable in Japanese politics. These include a stint with their erstwhile enemies, the Socialists, and a continuing fling with the deeply distrusted religious sectarians in the New Komeito. Moreover, about two weeks after Ishihara's announcement, the LDP's Michio Ochi, head of the Financial Reconstruction Agency, was forced to resign his post, having been caught on tape promising to give the "utmost consideration" to financial institutions that felt unduly pressured by auditors. This scandal came on top of previous charges that banks receiving public funds were illegally making donations to the LDP. These are a few of the many reasons why the establishment's sniping at Ishihara has done nothing to erode his high levels of public support.

Soak the Poor

In fact, Ishihara is a hard-nosed political entrepreneur who has made a very smart move. It can even be viewed as progressive, given the current "soak the poor" trend in Japanese tax politics. Tokyo is running a deficit this year of about 620 billion yen ($6 billion), and carries a debt of around ten times that amount. As a result Ishihara has already been compelled to slash spending in a number of politically sensitive areas, including a 4 percent cut of city employees' salaries and a 10 percent reduction of their bonuses. But there are limits to how deeply personnel costs can be reduced given Japan's already quite lean bureaucracies. Ishihara evidently reached those limits and decided to eliminate part of the deficit by squeezing additional revenues from the most politically acceptable source.

Although the Japanese corporate world claims that its tax burden is inordinately high, polls suggest that the public is unmoved. Moreover, one frequently quoted statistic shows that the Tokyo Metropolitan Government's revenues from financial institutions have dropped precipitously over the last 10 years, from a 1989 peak of 213 billion yen ($2 billion) to just a little over 3 billion yen ($28 million) in 1999. Indeed, in 1999 only one bank-- the Bank of Tokyo-Mitsubishi-- paid any taxes at all to Tokyo. And while banks in any country are always among the least popular of institutions, recently in Japan they have gained a particularly bad image. Not only do their salary levels seem suspiciously high to many people, but even as they received huge amounts of public money their tight-fisted lending has sent hordes of small and medium-sized firms into bankruptcy. Making the banks pony up for their share of public services is thus good populist politics.

For the central government, however, it is additionally galling that Ishihara has in large measure simply repackaged a tax reform that they have had in the pipeline for years. Over half of all Japanese firms regularly avoid paying corporate taxes at the national and subnational levels. This is because the basis of their taxation is income and the majority of firms manage to place themselves technically in the red. The problem has become especially serious over the last decade, opening an immense hole in subnational governments' revenues and prompting the center to recalculate the political costs of reforming the system.

The Ministry of Finance's Government Tax Advisory Council has in fact studied various alternatives for shifting away from taxing firms on the basis of income and towards such "external standards" as payrolls, sales, and the like. In its report of July 1999, for example, the council outlined four different options for doing this. In its plan for fiscal 2000, the LDP's tax commission stated that the central government would introduce some such new tax in the near future. But Ishihara scoffs, with good reason, that another decade might have been lost had he waited for the center to act. A week after Ishihara's news conference the LDP's tax commission announced that it planned to propose that the new tax be considered-- but only so long as the economy is clearly on the way to recovery.

You Say You Want Devolution?

Another of Ishihara's brilliant tactics has been to link his tax to governmental decentralization. This is ostensibly a goal of the LDP as well, which in the summer of 1995 enacted a Law for the Promotion of Decentralization. Over the following five years, a special committee created by the law delivered five major reports on the issue. Given this background, Ishihara scored heavily with the public by pointing to the official commitment to decentralize and wondering aloud why it should be problematic for Tokyo to exercise a little fiscal autonomy.

This debate is rich in deliberate irony. Most analysts argue that only limited progress on decentralization has been made since the LDP regained power in 1994. Indeed, former Prime Minister Ryutaro Hashimoto asked the decentralization committee's chair to provide him with "realistic" recommendations, with the result that all were vetted by the bureaucrats and the most important reform proposals were removed from the agenda. Thus, even though a large number of decentralization measures also became law on April 1, alongside Ishihara's tax, they were a good deal less than revolutionary and justly received few headlines.

Ishihara's tax has renewed discussion about a glaring deficiency of the decentralization laws: the very limited transfer of taxation powers from the central to the subnational governments. Japan has an unusually centralized fiscal regime, and the central government is naturally loath to see it reformed. Fiscal decentralization was therefore swiftly put to the sword when it dared raise its head back in early 1996. The center has since then put subnational administrations through an aborted round of fiscal austerity followed by a prolonged force-feeding of public works. Like goose-livers fattened for foie gras, local debts are now swollen to gargantuan proportions.

A growing chorus of observers argues that it is high time for fiscal decentralization to be brought back onto the policymaking agenda. The last Tokyo-led effort to this end was Governor Ryokichi Minobe's "fiscal war" against the central government in the 1970s. In 1977, Minobe's campaign to expand the welfare state and create a new Japan fizzled because he lacked sufficient numbers in the Tokyo Metropolitan Assembly. But Minobe was a leftist, which Ishihara assuredly is not. Just as only Nixon could go to China, in Japan it seems that only Ishihara has the right stuff to drag the LDP, the ministries, and many subnational colleagues towards fiscal decentralization.

In spite of his right-wing credentials, Ishihara's tax is a source of some consternation in business circles. The big lobbies, such as Keidanren, are long on rhetorical support for decentralization because they assume that devolution means lower taxes. Their thinking-- heavily influenced by the American model-- is that local voters will bear most of the costs and thus be less inclined to support public spending. Local governments in general are not in the business of redistributing income, and in any case, Japan has never had Anglo-American style class-based tax politics. Business has therefore long believed that its worst enemy was not labor and the political left, but rather MOF's commitment to a robust regime of corporate taxation. The tax reforms of the late 1990s effectively sidelined MOF and cut the burden on corporate income by a fifth. But Ishihara's levy on Tokyo's banks is an unpleasant reminder for big business that nothing in this world is certain-- except, of course, death and taxes.

The central government is of course worried that other subnational jurisdictions in Japan will follow Ishihara's lead. Such fretting is well-founded. A recent survey revealed that, spurred by Tokyo's activism, over 40 percent of local governments were interested in adopting special-purpose local taxes. Ishihara's example makes it almost certain that other large subnational administrations, such as the virtually bankrupt city of Osaka, will become more activist. Decentralization could thus become a juggernaut that breaks through the porkbarrel cliques of politicians, bureaucrats, and business that have wasted trillions of yen over the last several years.

At the very least, Ishihara has deftly outflanked his former LDP colleagues in the spendthrift national government and exposed a deep fault line in Japanese fiscal politics. The opposition parties, especially the Democrats, would do well to wake up and ponder Ishihara's example as they prepare their platforms for the next general election.

ANDREW DEWIT is Associate Professor of Economic Policymaking at Shimonoseki City University and author of "The New Politics of the Income Tax in Japan," JPRI Working Paper No. 63

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