As the most indebted country in the Organization for Economic Cooperation and Development (OECD), Japan’s dire fiscal situation is no secret. Yet despite its financial woes, in March 2008 the Japanese government failed to renew a relatively minor tax on gasoline that had been in force for thirty-four years. The government introduced a bill that would renew the so-called “provisional” gas tax. Although it passed the House of Representatives at the end of February, the Democratic Party of Japan (DPJ) blocked the bill in the opposition-controlled House of Councilors in March, causing the provisional tax to expire. With more than a two-thirds majority in the House of Representatives, the ruling Liberal Democratic Party (LDP)-led coalition overrode the House of Councilors at the end of April, and passed the extension of the provisional tax. What can one make of this episode and what does it say about the government’s ability to rebuild its precarious finances?

Prime Minister Yasuo Fukuda’s stance on the gasoline tax is an attempt to take the high ground, sticking to the position that the government must take painful but necessary steps to address Japan’s public debt crisis. After being selected as the head of the LDP and prime minister, Fukuda appeared set to prioritize fiscal reconstruction. He appointed well-known fiscal hawks to key party posts and cabinet positions and indicated a need to raise taxes. Fukuda soon backed away from a general tax increase, but on the provisional gasoline tax issue he stood his ground, arguing that its abolition would worsen Japan’s deficit and also run counter to the government’s effort to reduce greenhouse emissions.

The Fukuda administration’s stance on the provisional gasoline tax proved to be a disaster for both his cabinet and the LDP. The largest opposition party, the DPJ, skillfully turned the gasoline tax into an issue that it used to attack the LDP. During a recent by-election in Yamaguchi prefecture, historically a LDP stronghold, the DPJ candidate, Hiraoka Hideo, soundly defeated the LDP candidate, taking 70 percent of the vote. Hiraoka and the DPJ touted their success in abolishing the gasoline tax, while denouncing the government’s move to deduct health insurance premiums from seniors seventy-five years and older.

The DPJ successfully turned the provisional gasoline tax into a winning issue in large part because the tax has been viewed as a funding source that feeds the LDP-run pork barrel machine. The heart of the matter is not the tax, but how tax revenues are spent. Funds from the gasoline tax have been earmarked for road construction projects that are widely viewed as inefficient, corrupt, and driven above all by political considerations. Although the DPJ could only temporarily block the government’s bill to renew the gasoline tax, the action signaled the DPJ’s commitment to cutting wasteful government spending. The DPJ also advocates further constraints on road spending by abolishing the earmarking of funds from the basic, nonprovisional gasoline tax. Prime Minister Fukuda has now agreed to consider this proposal, indicating the extent to which public opinion has turned against such earmarking.

While the DPJ scored a political victory with its symbolic attack on road spending, it is less clear if it or the LDP will be able to take the much harder step of increasing taxes in the future. One proposal that has emerged is to earmark revenues from an increase of the national value-added tax (VAT) for social security spending. This proposal is intended to dampen resistance to the move by ensuring that the revenues will not be diverted to wasteful projects but rather used for popular welfare programs. Some within the LDP support such a plan. The DPJ has publicly endorsed turning the VAT into a “social security” tax, but it remains vague on the details. However, a poll from the Nikkei Shimbun revealed that only 34 percent of the population supports an increase in the VAT, even if the revenues are used for social security.

It has always been politically perilous to raise taxes. This fact is not lost on the LDP, which suffered declining support after it introduced the VAT in the 1980s and then raised it under Prime Minister Ryutaro Hashimoto (1996–98). This realization largely explains why LDP-led administrations have attempted to pursue fiscal reconstruction through cuts on the expenditure side while avoiding measures to increase revenue. From “fiscal reconstruction without tax increases” during the 1980s to Junichiro Koizumi’s structural
reforms without raising taxes, this formula has proved durable.

If Japan is to get serious about restoring its public finances, it cannot indefinitely postpone the issue of increasing revenue. The fundamental problem, however, is the public’s widespread belief that the government is wasteful, corrupt, and inefficient. Ultimately, if Japan is to succeed in raising taxes and rebuilding the nation’s finances, the LDP, DPJ, or any new party that may emerge will have to address this deep-seated public perception.