Download Creating a new fiscal constitution in post-war Japan

CREATING A NEW FISCAL
CONSTITUTION IN POST-WAR
JAPAN
Martin Daunton
University of Cambridge
SIGNIFCANCE
• ‘the most dramatic tax reform program ever
launched in a modern industrial nation’
• Case study for the role of international experts
and transnational reform
Reshaping Japan: the context
• Japan was defeated militarily – how to ensure
that society was reshaped to remove the origins
of militarism and create a stable democracy?
• Tensions with Soviet Union and the victory of the
Communists in China, 1949: NSC-68 on “United
States Objectives and Programs for National
Security”, April 1950. Need to build up the
strength of the free world by agreements with
Japan, Western Germany, and Austria “which
would enlist the energies and resources of these
countries in support of the free world”.
Tokyo after the fire-bombing of March 1945
Japanese economy was devastated….
… and suffering from severe inflation
The Dodge Mission
• Joseph Dodge, a Detroit banker, was sent by President Truman
to reform the Japanese financial system and stop inflation.
Arrived in Feb 1949
• High money growth, large budget deficits and debts,
disruption of tax collection. Government issued bonds and
expanded money base – from average 34% p.a. range (19371944) to 212% p.a. by 1945. In 1946, Japan's price index rose
by 365% p.a.
• In tradition of ‘money doctors’ such as Edwin Kemmerer who
wanted to impose gold standard and taxes to pay creditors –
defaulting governments in Latin America and Cuba
• In the 1930s, criticised by New Dealers who wanted to
encourage development and reschedule debt
Who was Joseph Dodge (1890-1964}?
• Chairman of the Detroit Bank – not a member of the car
family
• Worked in government service in war, on contracts
• To Germany in August 1945 where he recommended policies
to stabilise the currency; then to Austria with George
Marshall; served on the advisory committee for the Marshall
Plan
• 1953, director of the Bureau of the Budget for Eisenhower –
aim to control inflation by controlling government
expenditure and balancing the budget
Resolving the yen exchange rate
• Initial task: fix the dollar/yen exchange rate
• Multiple exchange rates after the war: low rate for export and
high for imports, set by US officials. Aim – to solve the trade
deficit.
• 1948 US administration agreed on need for a single rate- but
what? Japanese business feared loss of markets
• Federal Reserve proposed 300Y to $; Supreme Command for
the Allied Powers, 330Y to $, with support of Dodge; but he
eventually agreed that inflation justified a rate of 360Y which
was introduced in April 1949.
• Rate was good for Japanese exports and offered some
protection from imports.
• This was only part of his policy – the so-called Dodge Line
The Dodge Line
• Reduce inflation – not clear if his policies the main reason
• Establish a single foreign exchange rate of 360Y to $
• Fiscal austerity: combine separate accounts, and require consolidated
budget to balance, a deflationary “super-balanced budget”. “The
Japanese people who lost the war while living in misery cannot
reconstruct without some suffering. What is most important for the
Japanese people now is ‘taibo seikatsu’, bear a hard life”.
• Refused tax cuts urged by Yoshida (prime minister) and Ikeda (finance
minister) as a sedative to absorb the shock. They had made election
promises and were critical of his rigidity; he feared political backsliding.
• Decrease government intervention in the economy, especially through
subsidies and price controls which went back to 1937 and continued in the
occupation.
• End zaibatsu busting and encourage creation of MITI
• Aim to stimulate exports – dampen domestic consumption, reduce social
spending, cut public employment
Japanese reactions
• Many SCAP and Japanese officials: Dodge led to deflationary
overkill, depression or euphemistically a ‘stabilization crisis’.
• Japanese politicians welcomed the end of New Deal meddling in
land reform [redistribution from landlords to tenants to make them
owner occupiers and hence more enterprising], labour rights [Trade
Union Law of 1945 giving right to organise, strike and bargain] and
they agreed on the need to balance the budget
• New Deal in retreat in US eg Taft-Hartley, with the rise of more
conservative voices
• Although Japanese politicians welcomed shift from New Deal
interventions, they still thought that Dodge went too far in austerity
and resistance to tax cuts
• Japanese politicians therefore welcomed a second, more limited
mission on tax reform: Carl Shoup was a balance to Dodge’s hard
line: hoped some tax reforms would make the austerity plan more
acceptable; able to work with Shoup who considered local social
conditions whereas Dodge was autocratic and insensitive
The Shoup Mission
• Carl Shoup was appointed by General MacArthur, Supreme
Commander for the Allied Powers to reform taxation
• Problem of divided authority: Dodge appointed by Truman
• Mission: strengthen the fiscal capacity of a democratic state
by increasing popular confidence in the tax system, and to
encourage capital investment and economic development
• Arrived in May 1949 and returned for a second visit in1950:
reports to SCAP were circulated in large numbers in Japanese
to sell comprehensive reforms
• Many, but not all, of his proposals were adopted in 1950 and
laid the basis of the Japanese tax system to the present
• Question is what survived and what was rejected, how
adapted by Japanese politicians? How hegemonic was the
US?
Who was Carl Shoup 1902-2000?
• Professor at Columbia University – home of fiscal economics
(Edwin Seligman, R M Haig) and historical/institutional
economics
• PhD on sales tax in France after the First World War: saw
political reasons why not adopt the income tax; but also
showed the political problems it created. Sensitive to local
conditions. Involved in a tax mission to France.
• Two tax missions to Cuba in 1931 and 1938/9; unlike the
money doctors, the tax doctors saw that equity and fiscal
capacity, more commitment to social justice could increase
public confidence in government, so strengthening fiscal
capacity and hence the borrowing capacity of governments
for social welfare and public works. Again, saw that income
tax not feasible whatever the theoretical superiority.
Shoup’s recommendations: debt
• Experience of debt default in Cuba: he feared the ‘aid curse’.
Foreign assistance reduced the need to collect tax revenues
• if a country were to borrow, it needed a strong tax base to
service the debt and hold down interest rates.
• Steady tax revenues would in any case reduce the need for
assistance, external and internal loans. Debt should be
minimised, it passed costs onto future generations and was
hidden
• preferred a balanced budget but less rigid than Dodge –
accepted counter-cyclical spending in some conditions,
though this was outside his remit.
Shoup’s recommendations: tax
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Structure of taxation reflected the level of economic development and legal
and administrative framework: historical or institutional approach
Not try to alter preferences for expenditure to encourage capital investment:
taxation should be fair between interests – ‘horizontal equity’ (Haig). Uniform
taxation on all forms of income to avoid distorting the allocation of resources:
neutrality in taxation would lead to growth
Remove tax breaks on income from savings in bank accounts, and introduce an
accessions tax
Bring more people into income tax by reducing exemptions, shift from
consumption taxes so more people were in direct contact with the state.
Income tax should be comprehensive, on all forms of income
More interest in government by broadening and democratizing the tax base
Reorganise local finance and reduce dependence on the centre: real estate tax
[localities] and enterprise tax which would become VAT for prefectures [he
played a role in introducing it in France]
Avoid need for deficit finance and produce revenue for public sector – gave a
role to public spending.
Increase tax on inheritance to break up large estates which were a threat to a
democratic society: same line taken by Jacob Viner in US in 1930s, and by
Shoup in Cuba, where he was defeated by Kemmerer
Dodge’s approach
• Would Shoup be defeated by Dodge?
• Not interested in horizontal equity: encouraged savings in
banks that could be invested in private business ie continued
the line taken since the Meiji restoration
• Corporatist approach of giving benefits to the large companies
– not integrate income and corporate tax
• Not interested in democratisation through the tax system
• Disagreement gave the Japanese government room for
manouevre
Outcomes: personal taxes
• Korean war meant that MacArthur was less interested in tax reform to
achieve democratisation and base-broadening.
• Gave room to Dodge who limited the Shoup reforms
• Local government reform not carried through, so more dependent on
central government
• taxation of interest income and capital gains blocked; failed to integrate
personal and corporate taxation. Hence privileged capital income and
departed from horizontal equity.
• Japanese had introduced withholding income tax in 1940 and expanded
personal income tax, so some continuity. But failure to create a
comprehensive income tax reduced sense of equity, and led to demands
to cut income tax
• Politicians less interested in broad-based support for taxes; more
interested in tax cuts
• Reduction in personal income tax meant that more reliant on corporate
taxation. Why?
Outcomes: corporate taxes
• Possible because of structure of corporations: limited use of equity meant
dividends were low, and intercorporate dividends were exempt from tax.
• Labour costs also low with use of outside contractors, could carry
corporate taxation
• Tax breaks to bank savings: gave the government cheap funds, used for
electoral purposes. Led to high levels of public debt – contrary to Shoup’s
wishes
• Firms could borrow from banks on favourable terms that led to sufficient
profit to pay the corporation tax. Dodge and government rescued the
capital formation strategy followed since the Meiji restoration – accelerate
private capital formation through incentives for savings in the banking
sector
• Not what either Shoup or Dodge wanted. Japanese tax regime
encouraged high personal savings through tax breaks – diverted to
business investment and high levels of public debt.
• American policy was to break up vertical zaibatsu but only led to
horizontal keiretsu
What survived of Shoup?
• Used by the Japanese government as a foil to
Dodge: they had space and the Americans were
not hegemonic
• Did create some limits to the privileging of capital
income: less than it would otherwise have been
• Did encourage income taxation and limited the
use of consumption taxes
• Some reform of administration which increased
capacity
Conclusions
• Debates in Japan reflected American political conflicts over the New Deal
• They were also being played out in international organisations –
International Bank of Recovery and Development led by bankers in the
same style as Dodge [John McCloy, Eugene Black], against advisers on the
ground (Lachlan Currie in Colombia)
• Coincided with debates at Havana on the International Trade Organisation
and ECOSOC on full employment: different visions of the governance of
the world economy
• Role of outside experts and constraints of domestic politics, used by local
elites
• Tax policy crucial to the shape of the post-war Japanese economy – for
good (initially) and ill (eventually). Led to a sclerotic economy and high
levels of public debt, with low personal consumption.
• Compare with other countries facing reconstruction : Korea and Germany