Identifier
Created
Classification
Origin
06TOKYO6817
2006-12-03 22:59:00
CONFIDENTIAL
Embassy Tokyo
Cable title:  

THE ABE ADMINISTRATION,S PRO-GROWTH AGENDA: WHAT

Tags:  ECON EFIN 
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P 032259Z DEC 06
FM AMEMBASSY TOKYO
TO RHEHAAA/WHITE HOUSE WASHDC PRIORITY
RUEATRS/TREASURY DEPT WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC PRIORITY
RUEHC/SECSTATE WASHDC PRIORITY 8823
INFO RUEHFK/AMCONSUL FUKUOKA PRIORITY 9057
RUEHNH/AMCONSUL NAHA PRIORITY 1544
RUEHOK/AMCONSUL OSAKA KOBE PRIORITY 2487
RUEHKSO/AMCONSUL SAPPORO PRIORITY 0094
C O N F I D E N T I A L SECTION 01 OF 04 TOKYO 006817 

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STATE PLEASE PASS DEPARTMENT OF AGRICULTURE
WHITE HOUSE FOR NSC/MCCORMICK AND TONG AND USTR/BHATIA AND
BEEMAN, COMMERCE FOR LAVIN, BOHIGIAN AND MELCHER,
AGRICULTURE FOR TERPSTRA, TREASURY FOR ADAMS, DOHNER, AND
POGGI

E.O. 12958: DECL: 11/30/2016
TAGS: ECON EFIN
SUBJECT: THE ABE ADMINISTRATION,S PRO-GROWTH AGENDA: WHAT
DOES IT ENTAIL AND WHAT ARE THE IMPLICATIONS?


Classified By: CLASSIFIED BY: DCM JOSEPH R. DONOVAN FOR REASONS 1.4 (B)
AND (D)

C O N F I D E N T I A L SECTION 01 OF 04 TOKYO 006817

SIPDIS

SIPDIS

STATE PLEASE PASS DEPARTMENT OF AGRICULTURE
WHITE HOUSE FOR NSC/MCCORMICK AND TONG AND USTR/BHATIA AND
BEEMAN, COMMERCE FOR LAVIN, BOHIGIAN AND MELCHER,
AGRICULTURE FOR TERPSTRA, TREASURY FOR ADAMS, DOHNER, AND
POGGI

E.O. 12958: DECL: 11/30/2016
TAGS: ECON EFIN
SUBJECT: THE ABE ADMINISTRATION,S PRO-GROWTH AGENDA: WHAT
DOES IT ENTAIL AND WHAT ARE THE IMPLICATIONS?


Classified By: CLASSIFIED BY: DCM JOSEPH R. DONOVAN FOR REASONS 1.4 (B)
AND (D)


1. (C) Summary. Prime Minister Abe has defined a pro-growth
economic policy, calling for attaining more than 3% nominal
economic growth in the medium run. The agenda for achieving
this goal has not been fully fleshed out, though elements are
being developed in a number of areas, including tax policy,
the central government budget, and labor and deregulation
policies. While work is ongoing separately in each of these
areas under the direction of different LDP and government
councils and ministries, no one, including the Prime
Minister, appears to be driving the process of pulling the
various elements together into a unified whole. While LDP
Secretary General Nakagawa has the political power to pull

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all the players together to forge a comprehensive agenda and
way forward, so far he has not done so. End summary.


2. (C) With the slogan, "no fiscal reconstruction without
growth", Prime Minister Abe has defined a pro-growth economic
policy by emphasizing supply-side measures. PM Abe has
called for attaining more than 3% nominal economic growth in
the medium run, focused on an improvement in labor
productivity. Implicitly, the real economic growth target is
about 2%, with an inflation rate at 1%. As of yet, the
agenda for achieving this goal has not been fully fleshed
out, though elements are being developed in a number of
areas, including tax policy, the central government budget,
and labor and deregulation policies. While work is ongoing
separately in each of these areas under the direction of
different LDP and government councils and ministries, no one,
including the Prime Minister, appears to be driving the
process of pulling the various elements together into a
unified whole. While LDP Secretary General Nakagawa has the
political power to pull all the players together, so far he
has not done so in order to forge a comprehensive agenda and

way forward. Moreover, to date, the Prime Minister himself
has not availed himself of an opportunity to clearly
demonstrate his commitment to further reform. Two
opportunities to demonstrate his reform credentials will soon
present themselves to the Prime Minister, as the GOJ
determines its FY07 budget outline and as a key policy
committee decides its short term agenda.

Fiscal Policy


3. (U) In the fiscal area, the pro-growth agenda has
translated to impetus for further expenditure cuts, a delay
in consideration of tax increases, particularly for the
consumption tax, and proposals for corporate tax reform.


4. (U) The Abe Administration has been following the
medium-term fiscal consolidation plan laid out by former PM
Koizumi. In early July, the Koizumi Cabinet adopted a new
medium-term fiscal consolidation plan with two-stage targets:
(1) achieving a combined central/local government primary
surplus (excluding the social security fund and interest
payments on government debt) by FY2011, and (2) reducing
steadily the ratio of gross government debt to GDP through
the mid-2010s. Attaining the first objective is estimated to
require an adjustment of 16.5 trillion yen (3.3 percent of
GDP),or 3.3 trillion yen (0.65 percent of GDP) per year, on
average. While tax increases and economy-driven growth in
tax revenues are projected to cover 2.2 to 5.1 trillion yen
of the adjustment, spending cuts are projected to cover the
remaining 11.4 to 14.3 trillion yen, roughly 69 to 87
percent. The plan sets specific measures to restrain major
categories of government spending over the next five-years
(FY2007-11). The following is a brief description of the
planned spending restraint measures:
-- Public works spending by the central government will be
reduced by 3.9-5.6 trillion yen over the five-year period by
cut spending between 1 to 3 percent each year. A 3 percent
cut has been proposed for FY07.
-- Personnel costs of the central and local governments
will be lowered an accumulated 2.6 trillion yen over the next
five years by reducing the number of central and local
government employees by 5.7 percent each on a net basis,
largely through attrition or shifting employees to public

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corporations.
-- The central and local government,s contribution to
social security programs will be reduced by a combined 1.6
trillion yen over five years through tightening eligibility
conditions for the welfare public assistance program,
possibly cutting the central government,s contribution to
the employment insurance program, and reviewing the
reimbursement pricing system of medical fees.
-- An "other" category that includes: reducing local
government independently financed public work outlays by
between 1 and 3 percent each year; cutting spending on
official development assistance (ODA) by between 2 and 4
percent each year; and reducing national defense spending
below the previous year,s level over the next five years.


4. (U) As part of the yearly budget process, ministries have
made budget requests far outside the spending parameters
outlined above. The FY07 budget to be proposed at the end of
December by the LDP will provide the first indication of
whether the Cabinet,s expenditure-cutting measures are on
track.


5. (U) At the first meeting of the Government Tax Council
under Prime Minister Abe, the PM touched on four issues for
tax reform: improving international competitiveness to help
revitalize the economy, maintaining stable revenue sources to
meet the increased social security burden and declining
population, increasing child-rearing assistance packages and
giving autonomy to local governments. Prime Minister Abe has
put off discussion of tax increases, particularly in the
consumption tax, until at least next fall, after the Upper
House elections to be held in July 2007. In practice, this
means a tax increase could be implemented is FY09 at the
earliest, following proposals that would be made in the FY08
tax reform bills. Some market participants have speculated
that if tax revenues continue to outperform estimates as they
have this year, a consumption tax increase could be put off
until FY10 or FY11.


6. (U) In the corporate tax area, the immediate steps being
proposed are an acceleration of depreciation allowances for
corporations on buildings and equipment and allowing full
depreciation of assets, rather than the 95 percent currently
permitted. The press has indicated that these changes would
provide 500 billion yen in tax relief to corporations for
FY07.


7. (U) Another tax change being considered for 2007 is to
reduce the tax on internal reserves of companies to promote
dynamism of small and midsize companies. A tax of up to 20
percent is now levied on the internal reserves of small and
midsize companies, in which the majority of shares are owned
by the founding family. The measure was designed to prevent
managers of family-run businesses from evading taxes by
building up internal reserves. However, the business
community has complained that it hampers the growth of
start-up companies.


8. (U) Further, the temporary 10 percent tax rate on capital
gains and dividends is scheduled to expire in December 2007
and April 2008 respectively, and return to the previous level
of 20 percent. Financial services firms are lobbying to
extend the temporary cut, though MOF and the Government Tax
Council are in favor of the rate reverting to 20 percent.
LDP Tax Council Chair Tsushima has indicated that some
interim step might be considered to avoid an adverse impact
on financial markets.


9. (U) Over the medium term, Government Tax Council Chairman
Honma has suggested a cut in the effective corporate tax rate
from just over 40 percent now to 35 percent, more in line
with European corporate tax rates, while Keidanren Chairman
Mitarai has called for lowering the rate to 30 percent. Each
one-percentage point reduction in the corporate tax rate
represents a 400-500 billion yen decline in tax revenue. A
five percent reduction to 35 percent would drop tax revenues
by about 2 trillion yen or about 0.4 percent of GDP.
However, a decrease in the corporate tax rate might prove to
be controversial with the public, given that the remaining

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half of the 3.3 trillion yen special fixed-rate individual
income tax cuts will be eliminated completely starting in
January 2007. A few press articles already have complained
that corporations, which are achieving high profits, might be
given tax breaks at the expense of consumers. Current
indications are that consideration of changes in the
corporate tax rate may be postponed until next year. The
Government Tax Council is set to make its recommendations for
FY07 tax measures on December 1.

Deregulation and Labor Market Policies


10. (U) Prime Minister Abe has stated that he wants the
Council on Economic and Fiscal Policy (CEFP) to continue as
the prime driver of the reform agenda in his administration.
The CEFP, established under former Prime Minister Mori in
January 2001, had played that role in the Koizumi
administration, particularly under the directorship of former
Minister Heizo Takenaka. Membership in the Council is
comprised of the Prime Minister, the Ministers of Economic
and Fiscal Policy; Finance; Economy, Trade and Industry;
Internal Affairs and Communications; the Chief Cabinet
Secretary; the Bank of Japan Governor and four private sector

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members. The private sector members have called for
completing a transitional phase to "a new growth economy"
over the next five years by setting the first two years as
the "takeoff period". They have proposed seven areas for
reform in the "takeoff period", and are now in the process of
fleshing out a specific agenda in these areas by the end of
the year. The areas are:


1. Innovation: Improving labor productivity through
technology and innovation. An Innovation Council has been
set up to prioritize sectors for investment through 2025.

2. "Labor Market Big Bang": This area of reform
encompasses ways to improve labor productivity and address
income inequalities. The Ministry of Labor has been
reviewing potential legislation that could affect labor
market flexibility in a number of existing advisory councils.


3. Open society and Asian gateway: Two aspects of this
element are expanding Japan,s network of FTAs and EPAs
(almost exclusively in Asia) and improving operations of
ports and airports to make Japan a more attractive hub for
Asian transshipment. Special Economic Advisor Nemoto also
has been charged with shepherding the Asian gateway project
and has set up his own advisory group.

4. Deregulation of agricultural and other markets to
expand domains in which private sector firms can participate.

5. Creating market-based medical and nursing care systems.

6. Effective management of government assets: Including
the sales of government stock holdings, assets such as
housing for government employees, privatization of
government-affiliated financial institutions such as Japan
Post, and sales of loan claims from the FILP program.

7. Decentralization: improving administrative services in
accordance with regional needs by giving more autonomy to
local governments.


11. (SBU) A number of these areas are likely to prove
controversial with other Cabinet officials and the
bureaucracy, particularly the deregulation of agriculture and
health systems. An important bellwether will be the specific
agenda devised by the private sector members of the CEFP by
the end of the year and how strongly it is backed by the
Prime Minister, particularly in the face of a likely backlash
from particular ministries and vested interests, such as
farmers and doctors.


12. (SBU) Another dimension of controversy in the CEFP is the
view of Bank of Japan (BOJ) Governor Fukui on the growth
targets implicit in the pro-growth agenda. The BOJ's general
stance is that the real growth rate should slow toward its
potential, which is estimated at 1.5-2.0 percent, while in
the medium term, inflation should remain in the 0-2 percent
range. BOJ is closely watching economic data to determine
the appropriate timing for its next rate hike, lest the
current low level of interest rates result in
"overinvestment" and increased inflation. This puts BOJ

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outside the mainstream in the CEFP, and sets the stage for
potential conflict between the GOJ and BOJ in the future.

Overall implications


13. (C) As noted above, work continues in a number of areas
to flesh out Prime Minister Abe,s pro-growth agenda.
However, aside from the slogan about growth being necessary
for the future and for fiscal reform, there is no overarching
plan tying the various parts of the agenda together and no
single actor with the Prime Minister,s backing to push
through the agenda once it is fleshed out. The Prime
Minister has also touted the "second chance agenda" as part
of his overall policy goals. Though that does not
specifically relate to the pro-growth agenda, it was devised
as an attempt to deal with income inequalities that have been
described by some as an outcome of the previous
Administration,s reform policies. Effectively relating
concrete measures to provide second chances, while moving
forward with pro-growth policies, might provide for more
public and political support for the overall agenda. Another
development that risks undermining the Abe Administration's
reform credentials is potential backsliding in allowing cross
border mergers and acquisitions through stock swaps
("triangular mergers"). Vested interests are pushing very
hard to introduce a technicality that would make the stock
swaps practically unworkable and political leadership will be
needed to resist these efforts and to support the Prime
Minister's stated goal of improving the climate for FDI.


14. (SBU) We will be watching developments over the next
several months to see if the agenda remains piecemeal under
various councils and ministries, or whether it can be pulled
together at the center, as well as the degree to which the
agenda remains intact as vested interests start to push back.

SCHIEFFER