Japan’s latest stimulus package takes new focus: Boosting tax-free income

TOKYO-Japan’s new, minority government has just launched a now nearly annual attempt at stimulating its economy—this time toying with the controversial idea of keeping more of consumers’ income tax-free.

Japan’s annual income-tax threshold, the level above which the government can start taking tax, is 1.03 million yen, equivalent to $6,727. That hasn’t changed in the last 30 years.

It was designed to protect a chunk of income from tax so that more money can be spent on basic necessities. After three decades of stagnant prices and deflation, prices in Japan are now starting to rise, spurring calls for an increase in the taxable income threshold.

The idea is that a permanent boost to income will help trigger consumption more strongly than the cash handouts and subsidies of past stimulus packages. A succession of prime ministers since the pandemic have tried a series of such measures, with limited success.

Analysts say that consumers’ response to temporary measures are often to save money rather than spend it.

“The level of consumption doesn’t respond much to temporary increases in income,” said BNP Paribas economist Ryutaro Kono. “On the other hand, the marginal propensity to consume tends to be relatively high if income increases are perceived to be permanent.”

Last week, the government of Prime Minister Shigeru Ishiba unveiled the new 21.9 trillion yen package as an antidote to the increase in prices. That comes after the defeat of Ishiba’s long-governing party in elections earlier this fall. Ishiba hung on to the premiership, but in a minority government now needing to form new alliances if it wants a strong mandate for policymaking.

The latest plan is roughly the same size as a stimulus package in 2023, but nearly half the amount approved in 2022, when Japan was reeling with a pandemic-induced economic slowdown and growing inflation.

This year’s package includes temporary measures like energy subsidies and one-off financial aid for low-income households. But its bigger focus—which has yet to be finalized—is on boosting the take-home pay of Japanese workers. Raising the tax threshold is one of the things the government said it would consider.

The opposition Democratic Party for the People has become one of the biggest advocates for raising the threshold. The party is looking to raise the allowance to 1.78 million yen. The DPFP says the move could encourage part-time workers to increase their working hours without fear of increasing their tax burden.

According to estimates by the Daiwa Institute of Research, a private think tank, about 610,000 students currently cut back on working hours to avoid hitting the threshold and having to pay tax. An increase in the threshold to 1.78 million yen would boost the annual labor supply by about 330 million hours, the analysis found. It would also lift workers’ compensation by 456 billion yen a year and increase private consumption by 319 billion yen, according to the estimates.

The move would be pricey. The government expects that a threshold lift to 1.78 million yen would cost central and local governments up to 8 trillion yen in tax revenue. Some local government leaders have voiced concerns over the impact on their tax revenue, which could affect local services and public spending.

“As prices continue to rise, the idea of ​​increasing disposable income and easing the economic burden by raising the basic deduction amount is understandable,” Tomikazu Fukuda, the governor of Tochigi prefecture, north of Tokyo, said at a recent news conference. But “if this is going to become a permanent measure, it will cause significant disruptions on the stable management of local government finances,” he said.

Former Bank of Japan official Tsutomu Watanabe, a professor at the University of Tokyo’s Graduate School of Economics, says the fiscal burden might be more muted thanks to rising prices. Inflation benefits borrowers by reducing the real value of their debt.

“In Japan, the government is the biggest debtor,” Watanabe said in a recent briefing. “If the country makes a shift to an inflationary economy, it is possible to provide the funding for what the Democratic Party for the People is demanding.”

Write to Megumi Fujikawa at megumi.fujikawa@wsj.com