My Vision No.26
2016.10

Should Japan consider introducing
Reduced Tax Rates?
The Japanese government has announced a further postponement of its scheduled increase in
consumption tax. When it introduces the tax increase in October 2019, it will also introduce asystem of reduced tax rates. The purpose of introducing reduced tax rates is to ease regressivity.
Consumption tax is regressive in the sense that because the same tax rate is applied to allindividuals irrespective of their income or assets, the burden of the tax is higher on individuals
with lower incomes. However, experts in European nations which have already introduced
reduced tax rates advise against their introduction in other countries. Are reduced tax rates
actually effective in easing regressivity? Is it a system that suits conditions in Japan?
This issue of My Vision investigates these questions.

Expert Opinions
Should Japan consider introducing Reduced Tax Rates?
Japan’s government intends to introduce a system of reduced tax rates when it increases consumption
tax.
What lessons can we learn from mistakes made by western European nations?
Will reduced tax rates help to protect low-income earners?
We put these questions to experts in the field in this issue of My Vision.

Issues related to reduced tax rates in Europe

Learn from Europe’s mistakes to realize
economic and fiscal stability

Marco Fantini

Marie Pallot

Head of Sector D, VAT Unit, Directorate-Generalfor Taxation and Customs Union,
European Commission

Senior Policy Advisor,
Inland Revenue New Zealand

The case of Sweden: Value-added tax presents
a stable source of funding for the welfare state

Is increased consumption tax a loss for the
public? A behavioral economics approach

Bo Rothstein

Fumio Ohtake

Professor of Government and Public Policy,
Blavatnik School of Government,
Oxford University

Professor, Institute of Social and Economic
Research, Osaka University

Ease regressivity of consumption tax throughsimple benefits rather than complex reduced
tax rates
Takeo Hoshi
Chair of the Board, Tokyo Foundation
Interviewer: Miki Toyofuku, Academic Researcher,
Graduate School of Arts and Sciences, the University of Tokyo
Editor: Isao Arai
Period of Interviews: June – August, 2016
*Professors Fumio Ohtake and Takeo Hoshi submitted their own manuscripts.

] is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
This
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement

My Vision No.26
2016.10
Expert Opinions

Issues related to reduced tax rates in Europe
The value-added tax systems of almost all EU member states
employ reduced tax rates in areas such as foodstuffs andpharmaceuticals. There is a historical background to this. Europe has
a long tradition of general consumption taxes, and reduced tax rates
for some goods were already in use in the consumption tax systems inexistence before the VAT was introduced. The VAT was pioneered in
France in the 1950s, and when it was adopted by other countries, theyoften carried over the existing reduced tax rates to the VAT. Social
policy and redistributional concerns also played an important role in
Marco Fantini
the introduction of reduced rates. However, in the EU system, reduced
Head of Sector D,
rates are optional, and indeed some countries make limited, or even
VAT Unit,
almost no, use of them.
Directorate-General for
Taxation and Customs
There are problems associated with reduced tax rates. For one
Union,
thing, reduced VAT rates, together with exemptions, tend to push up
European Commission
the standard rate. In the EU, the cumulative effect of reduced rates
and exemptions eats up around one-third of VAT revenue. European governments have relied onincreasing the standard rate in order to compensate for this loss of tax revenue. This means that
reducing the rate on some items has the effect of increasing the rate on all other items.
Another problem is that reduced rates complicate the tax system, increasing the cost of levying andcomplying with taxes. This problem, and particularly the need to define precisely the nature of thegoods for tax purposes, is more serious than one may think at first sight. Multiple tax rates impose
more control costs on the tax administration, which are financed by tax money. In addition, when thescope of the tax reductions changes or expands, the burden of accounting procedures (employment of
VAT specialists, etc.) on companies and business owners increases, increasing compliance costs. It isdifficult to reduce these costs even if an invoice system is used.
In part because of this, the EU has never, generally speaking, encouraged member states tobroaden the application of reduced rates. The EU Directive on VAT stipulates that there should be no
more than two reduced tax rates, and that the rate should be no less than 5%. In some cases, theEuropean Commission has also recommended individual member states to limit the scope of reduced
rates and exemptions. Nevertheless, some countries apply four or even five reduced rates, and some
use rates of less than 5%. The EU has no choice but to allow these exceptions.
Once a reduced rate is granted, it is very difficult to take back. As a result, the scope of reduced tax
rates tends to grow over time. It is generally quite easy to find some justification for cutting taxes on aparticular product or sector, and the political pressure to broaden the application of reduced tax rates
is often fairly intense.
Mr. Fantini is involved in EU tax policy in the European Commission’s Directorate-General for Taxation and Customs
Union, specializing in VAT. After completing his studies at Bocconi University in Milan, where he also worked at theInstitute for Stock Exchange Studies, Mr. Fantini was recruited by Barclays Bank. In 1994, he joined the European
Commission’s Directorate-General for Economic and Financial Affairs, where he was responsible for the economic
analysis of countries including Germany and Russia. He joined the Directorate-General for Taxation and Customs
Union in 2005. Mr. Fantini has published a book studying the interplay of national strategies, alliances and interests
within the EU, and papers on the Russian economy, on EU-Russia relations, and on EU relations with neighboring
countries (the EU Neighborhood Policy). He was also editor of the annual report 'Taxation Trends in the European
Union' from 2005 to 2012. He has taught courses on EU policy at Moscow universities and as a visiting fellow at Yale
University.
This is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement

My Vision No.26
2016.10
Expert Opinions

Learn from Europe’s mistakes to realize economic
and fiscal stability
New Zealand has had its goods and services tax (GST) system fornearly 30 years*1, and unlike western European nations, did not carryover multiple tax rates from its previous wholesale tax system when
the system was introduced. The GST was applied evenly to all
products, and there were minimal exemptions. Considering theexample of European nations, which introduced reduced tax rates as aresult of their specific political circumstances, but later found thatexemptions continued to multiply, it was considered wisest not to
introduce them from the beginning. The explicit policy in New
Marie Pallot
Zealand was to efficiently ensure tax revenue via the broadest
Senior Policy Advisor,
possible base and the lowest possible rate.
Inland Revenue
In New Zealand also, it was argued that reduced tax rates should
New Zealand
be applied to specific product groups such as foodstuffs. But reduced
tax rates are a very inefficient means of targeting regressivity. Is it
really lower income earners who buy the majority of these products? Newspapers, for example, might
be something that is purchased more by well-off classes. Reduced tax rates actually offer a benefit topeople who do not really need that benefit.
Rather than reduced tax rates, New Zealand’s approach has been to respond by offering tax
exemptions targeting low income earners, and providing social security benefits to support low income
earners in their daily lives. Singapore, which has adopted a system very similar to the New Zealandsystem, has established a voucher system for low income earners, enabling them to receive GST
refunds in relation to certain products.
Because New Zealand applies GST to almost all goods and services at the same rate, it is able to
make use of the innate strengths of the system and efficiently obtain revenue without excessive
administrative costs. The GST rate was maintained at 12.5% for 21 years following its introduction in
1989*2, and even today the level is far lower than the levels in effect in European nations, but New
Zealand has maintained fiscal soundness.
The lack of reduced tax rates also makes it easy to predict long-term tax revenues in New Zealand’s
system. When tax rates differ for different products, tax revenues fluctuate depending on which
industry grows and which industry shrinks in the future. By doing away with reduced tax rates, tax
revenue becomes stable, and that enables us to formulate policies with a view towards the future.
*1: 1 October, 2016 marked the 30th anniversary of the introduction of GST.
*2: Since 1 October 2010, New Zealand’s GST rate has been 15%.

Ms. Pallot is a lawyer, and Policy Manager with the Policy and Strategy Division of New Zealand’s Inland Revenue
Department. She is responsible for advising government ministers concerning tax policy in areas including GST,
employee benefits, and tax administration. Ms. Pallot was the Chair of the OECD’s Working Party 9 on consumption
taxes until April 2016.
This is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement

My Vision No.26
2016.10
Expert Opinions

The case of Sweden: Value-added tax presents astable source of funding for the welfare state
Sweden is known for its well-developed social welfare system, and,in addition to income tax, the government relies on value-added tax fora significant proportion of its revenue. Swedish citizens accept a high
25% rate of value-added tax because tax income and government
expenditure are directly linked, and they feel that they get good value
for the money in the form of the benefits of social welfare policies.
For example, I did not have to save any money to send my children
to university. If, hypothetically, the government reduced taxes, but
stopped paying for university tuition, reduced pensions, and changed toa system in which citizens were forced to purchase private health
Bo Rothsteininsurance, citizens would protest.
Professor of Government
Value-added tax applies the same tax rate to high-income earners
and Public Policy,
Blavatnik School ofand low-income earners. Because of this, some people argue that it isGovernment,
contrary to the principle of redistribution of income, and is not fair.
Oxford University
However, there is an entirely different understanding in Sweden.
Because the value-added tax is a fixed rate, the burden is higher for
wealthier people who spend more. Besides, because the revenue from value-added tax funds
expenditure on universal welfare measures, citizens can see that there is an effective redistributivefunction. The Swedes also have a prevalent ideology of fairness, and believe that even people who
cannot afford it should have access to reasonable medical care and education.
In Sweden the rate of value-added tax has been reduced in certain sectors, for example restaurant
services, and there has long been discussion of extending the reduction to food in general. However,this seems to be more the result of industry lobbying than consideration for low-income earners. Thereseems little good argument for encouraging people to eat more in an era in which food is abundant, orfor extending the reductions to such foods as caviar and foie gras.
Progressive taxes are not necessarily considered fair. There was a higher degree of progression inincome tax rates in Sweden in the past. High-income earners did not view the tax as legitimate, anddid all they could to avoid paying tax.
The Social Democratic Party which created the welfare state placed an emphasis on fiscal
soundness, and therefore used value-added tax as a source of revenue for the welfare system. Support
for the welfare state among Swedish citizens has not wavered as a result of globalization, but has
actually become stronger.

Professor Rothstein is an internationally acclaimed Swedish political scientist who is a frequent commentator onpolitical issues and academic freedom. He took his PhD in Political Science at Lund University. Before taking up a
professorship at Oxford in 2015, he was an associate professor at Uppsala University, following which he held theAugust Röhss Chair in Political Science at the University of Gothenburg. In 2004, Professor Rothstein co-founded the
Quality of Government (QoG) Institute at the University of Gothenburg with Professor Sören Holmberg, and was its
Head until 2015. He has been a member of the Royal Swedish Academy of Sciences since 2012. Professor Rothstein has
published several books in English, including The Quality of Government: Corruption, Inequality and Social Trust inInternational Perspective (University of Chicago Press, 2011).
This is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement

My Vision No.26
2016.10
Expert Opinions

Is increased consumption tax a loss for the public?
A behavioral economics approachIf asked whether they would prefer to receive 10,000 yen today or
10,100 yen in a week, most people will choose the former. However, if
asked whether they would prefer to receive 10,000 yen in a year, or
10,100 yen in a year and one week, most people will choose the latter.
Or again, many people will be quite sanguine regarding a choice thattakes effect a year in the future, but when a year has passed, will wish
to change the choice made by their selves of one year ago. In behavioral
economics, this is termed “present bias.”
Initially scheduled for October 2015, the increase in Japan’s
Fumio Ohtake
consumption tax rate was postponed for 18 months in November 2014,
Professor, Institute ofa year away from implementation. In June 2016, it was announced that
Social and Economic
the increase would be postponed for another 30 months, and would be
Research,
introduced together with reduced tax rates which will have a limited
Osaka University
redistribution effect and will distort consumption behavior. The
increase was supported when it was envisioned for the distant future,
but as the date for the introduction of the increase has grown nearer, it has now been postponed twice.
The Japanese public shares the awareness that a future increase in the consumption tax rate willbe essential if the nation is to avoid fiscal collapse. The public therefore approves of the government’s
commitment to increase the tax rate. However, as the scheduled date for the increase approaches, thepublic prioritizes present gain, and supports the government in backing down from its commitment.
This is because the public is caught up in present bias. But it is the public itself which will have cause
to regret these postponements.
“Loss aversion” is another concept supplied by behavioral economics which can help in explaining
the postponement of the increase in the consumption tax rate. This refers to the tendency, when facing
a loss, to choose a gamble involving the potential for an even greater loss rather than accepting theloss, if there is a possibility that the status quo might be maintained. In the context of theconsumption tax increase, in which the choice is between accepting an increase in the tax rate and aconsequent loss now, or a gamble in which the result is likely to be fiscal collapse and high inflation,
but in which fiscal soundness might be realized through economic growth, this means choosing thelatter.
In order to avoid postponement of the introduction of the increase in consumption tax due topresent bias, some commitment device which is binding on government action is necessary. However,the breaking of a public pledge twice has resulted in a loss of trust in that commitment. Preventing
the public from choosing a policy that represents a gamble due to loss aversion will necessitate
framing of the issue in such a way that the tax increase tends not to be seen as representing a loss.
Measures of this type based on behavioral economics must certainly have been put into effect incountries like New Zealand and Sweden, which have been successful in increasing taxes.

Professor Ohtake took his PhD in Economics from Osaka University, and took up his present position in 2001, following
a period teaching at Osaka Prefecture University and as an assistant professor at Osaka University’s Institute of Socialand Economic Research. He specializes in labor economics and behavioral economics. From 2013 to 2015, Professor
Ohtake served as Executive Vice President of Osaka University. He has also been a member of numerous government
committees, including an Extraordinary Member of the Tax Commission of the Cabinet Office, and an Expert Memberof the Ministry of Education, Culture, Sports, Science and Technology’s Central Council for Education.
This is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement

My Vision No.26
2016.10
Expert Opinions

Ease regressivity of consumption tax throughsimple benefits rather than complex reduced tax
rates
The stated purpose for the introduction of reduced tax rates forJapan’s consumption tax (value added tax) is to ease the regressivity,
but, it actually has the effect of exacerbating the sense of income
inequality because it is equivalent with a policy to distribute moremoney to high income earners. A simpler and more effective method isavailable to ease regressivity.
A numerical example will help. Let us consider a low income earnerwith a salary of 200,000 yen per month, and a high income earner witha salary of one million yen per month. The low income earner spends
150,000 yen per month, of which 50,000 yen represents expenditure on
Takeo Hoshi
food; the high income earner spends 440,000 yen per month, of which
Chair of the Board,
100,000 yen represents expenditure on food.
Tokyo Foundation
If a tax rate of 10% is applied to all consumption, the low income
earner and the high income earner will pay 15,000 yen and 44,000 yen in tax respectively. In terms of
the proportion of their respective incomes, the low income earner pays 7.5%, and the high income
earner pays 4.4%. In this sense, consumption tax is regressive.
Let us now assume that a reduced tax rate of 8% is applied to food. The tax burden on the low
income earner is now 14,000 yen (100,000 yen × 10% + 50,000 yen × 8%), and the tax burden on thehigh income earner is 42,000 yen (340,000 yen × 10% + 100,000 yen × 8%). The low income earner now
pays 7.0% of their income, and the high income earner pays 4.2%. Thus, the reduced tax rate on foodproduces a slight easing of regressivity.
However, if we compare the absolute value of the reduction in tax, the reduced tax rate reduces thetax burden on the low income earner by 1,000 yen, while the tax burden on the high income earner isreduced by 2,000 yen. Of the 3,000 yen “saving” by the reduced tax rate, the low income earnerreceives one-third, and the high income earner receives two-thirds. While it is technically correct to
say the regressivity of consumption tax has been eased, no-one would claim that the economic
disparity has been reduced.
It is simple to achieve a greater easing of regressivity using the same 3,000 yen. This would involve
distributing the 3,000 yen equally to each individual. This 1,500 yen return would make the tax
burden on the low income earner 13,500 yen, and the tax burden on the high income earner 42,500
yen. Relative to their incomes, this represents 6.75% and 4.25% respectively.
Compared to the introduction of reduced tax rates, which are complex, involve high administrative
costs, and produce a considerable distortion of economic activity, the equal distribution among thegeneral public of an amount equivalent to the reduction in tax revenue resulting from the reduction in
the tax rate would be both simpler and have a greater effect in easing regressivity.
Based for more than 30 years in the US, Professor Hoshi is one of that country’s leading researchers in the field of theJapanese economy, and has been instrumental in advancing the Japanese research program at Stanford University.
Professor Hoshi’s major fields of specialization are financial theory, macroeconomics, and the Japanese economy. After
receiving a PhD in economics from the Massachusetts Institute of Technology, he was a professor at the University ofCalifornia San Diego, before taking up a professorship at Stanford in 2012. Since 2016, he has also served as the Chairof the Board of the Tokyo Foundation.

This is a translation of a paper originally published in Japanese.NIRA bears full responsibility for the translation presented here.
Translated by Michael Faul.
Copyright Ⓒ 2016 by National Institute for Research Advancement