Impact of Local Corporate Income Taxes on the Effective Corporate Income Tax Rates: Excess Taxation and Tax Deductibility in Japan

This study explores local corporate income taxes in Japan, which are considered unique from an international perspective. Few countries impose local corporate income taxes. Although corporate income tax rates have decreased worldwide, countries with local corporate income taxes may show less flexibility in corporate income tax reform than countries without, as effective corporate income tax rates based on statutory tax rates remain higher than those without local corporate income taxes. Japan's local corporate income tax system allows for excess taxation and deductibility of corporate enterprise taxes. Countries such as Japan, where local corporate income tax revenues account for a significant share of total tax revenues, may need to reform their local corporate income tax systems. Germany's 2008 business tax reform, which abolished deductibility and lowered the tax rate, provides a helpful reference. This study incorporates the permanent effect of deductibility into the forward-looking effective tax rates by Klemm (2008, 2012) and analyzes the impact of excessive taxation and effective corporate tax rates of reforms of the deductibility of enterprise taxes, following the German business tax reform. First, the excessive taxation of the corporate inhabitant tax rate and the enterprise tax rate impacts 0.9 to 1.1% when converted to the real interest rate. Second, abolishing the deductibility of enterprise taxes and reducing the tax rate improves financing neutrality, possibly reducing the tax rate by approximately 1%. Third, a reform that changes the timing of deductibility in the current period has less impact than abolishing deductibility. Future reforms must be implemented in Japan's local corporate income taxes while considering the current impact on effective corporate income tax rates.