The changes in the personal and corporate tax structure in Japan have helped the Nikkei index move to healthier terrain in the last several weeks, above 16,700 from lows of 13,000 last fall. The move coincided with several tax-rate reductions that have positive supply-side effects, especially a lowering of the top rate on personal income to 50% from 65% and a cut in the standard tax rate on corporate income to 40.87% from last year's 46.36%. At the same time, the Bank of Japan (BoJ) seriously began adding yen liquidity to the banking system, both to accommodate the increased demand invited by the lower tax rates and in an attempt to adjust the dollar/yen rate from its deflationary level. It reached an excruciating rate of 109 on January 11 and now hovers around 120. Note Wayne Angell's op-ed in The Wall Street Journal today, "Fix the Yen," which meanders all over the lot with dubious arguments but winds up at the right place, with the yen "fixed to the dollar" at a gold price of ¥40000 -- a roundabout way of fixing the dollar to gold at $285. To the degree that Angell, a former Fed governor, still has credibility with the BoJ and his former colleague, Chairman Greenspan, the op-ed is marginally helpful. If the BoJ targeted gold at ¥40,000, we would buy the Nikkei with both hands, as it would end the monetary deflation and put distressed yen debtors in a position to meet their obligations.
The monetary and fiscal moves taken thus far, though, are just baby steps in the right direction. They include several other smaller tax changes that have positive effects on long-term growth. Among those reduced is the tax that has caused most of Japan's problems for the past decade. The confiscatory tax on capital gains realized on the sale of real property will be reduced temporarily in the next two years to 26% on the first 60 million yen and 32.5% above that, from rates in excess of 50%. The rate still is excessive and will continue to deter most taxpayers from liquidating real property that had been swollen by inflation during the years when gold climbed to its present ¥34,000/oz. from ¥12,600 in 1971. Because most wealth in Japan is held in real property, there still are enormous caches of unrealized capital gain -- at least 100 trillion yen -- that represent pure inflation. The fact that the Ministry of Finance (MOF) opened that window a bit, to permit the desperate a chance to cash out at the lower rates, has liquified some capital. But it is not nearly what we would have seen if the rate were permanently dropped back to 17%, where it was when the Nikkei began its long goodbye from 38,000 on January 1, 1990.
Now for the bad news: The Keynesians at the MOF for years have had their eyes on a system that allows investors the option of paying a 1.05% transfer tax instead of capital gains on traded equities. They may have finally done it in, scheduling the transactions-tax alternative for elimination. "May have" because the new regime is not due to be in place until March 31, 2001. There is time between now and then to undo the potential damage. If it now were part of the package, the Nikkei probably would not have advanced at all. This was one of the principal engines of capital formation in Japan -- along with the tax-free Postal Savings system -- in the years when it looked like it was going to buy up the world. As long as Japan is in a monetary deflation, the equity markets don't require the protection of a zero capital-gains tax. But even if there would be a gold/dollar/yen fixed system by 2001, the loss of this option will hold back capital formation. It is something to bear in mind as we move closer to these cut-off dates. Meanwhile, the good news outweighs the bad.