The Japanese Fiscal Policy and Tax System during the Lost Two Decades

After the global recession prompted by US financial crisis in 2008, the perceptions of economists and policy makers of the fiscal policy's effectiveness has drastically changed. Extreme austerity has lost popularity. The effectiveness of fiscal stimulus, especially at the time of economic crisis, now receives more positive evaluation. In this article, we reconsider the evolution of Japanese tax system and fiscal policy in the lost two decades since the 1990s based on such a post-Lehman view on the fiscal policy. First, the examination of contents of the government spending and government investment in recent years suggests that the Japanese government used them as means of income redistribution across regions, downplaying economic efficiency. Existing empirical studies suggest that this is the major reasons that the efficacy of fiscal stimulus package has declined. Second, there was a major structural changes in Japanese tax system during the 1990s, namely flattening of the income tax schedule and an increase of the indirect tax share in total tax revenue. Because of these changes, the Japanese government's tax revenue became less variable and its correlation with business cycle declined. This paper provides empirical evidence for these claims and shows that the function of the built-in stabilizer declined during the 1990s. In evaluating the effectiveness of Japan's fiscal policy in the lost two decades, it is important to take these considerations into account.