## 1jpnea2022002 ## Source details **Canonical URL:** [1jpnea2022002](https://www.imf.org/-/media/files/publications/cr/2022/english/1jpnea2022002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1jpnea2022002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1jpnea2022002.pdf.json) --- ### Post‑pandemic fiscal policy: Buffer‑Stock Model findings and recommendations - Trade-off: support a strong, durable recovery vs. ensure debt sustainability; premature withdrawal risks derailing recovery while high public debt and rising age‑related spending require medium‑term consolidation. - Model setup and mechanics: - Government as buffer‑stock consumer; buffer = difference between current debt and debt limit; higher debt → higher probability of market stress. - Fiscal instrument: change in structural primary balance. - Key feedbacks: primary balance → output via fiscal multiplier; output → primary balance via automatic stabilizer; recessions can induce hysteresis; higher debt raises risk premium and constrains fiscal response; implementation lags matter. - Calibration highlights: - Sensitivity of interest rate to debt: 1 percentage point increase in gross‑debt‑to‑GDP → 1 basis point rise in JGB yields (Tokuoka, 2010); Mochida (2019) estimate 0.7; comparative: France (1.5), US (0.5). - Fiscal multiplier: Japan in “Medium‑multiplier” group; range expanded from 0.4~0.6 by 30 percent to 0.5~0.8; baseline multiplier = 0.65. - Growth‑adjusted interest rate (r‑minus‑g): baseline = zero; alternatives: +0.3 and −0.3. - Automatic stabilizer semi‑elasticity = 0.4. - Long‑run assumptions: potential growth = 0.3 percent, inflation = 1 percent, 10‑year JGB yield = 1.3 percent. - Main recommendations: - Near term: decisively roll out latest economic package and disburse contingent measures from November 2021 package to narrow output gap and minimize hysteresis. - Medium term: gradual fiscal consolidation after 2024 to place public debt on a downward path and rebuild buffers. - Fiscal design: prioritize targeted measures with higher multipliers and rely on automatic stabilizers for state‑contingent responses. ### Sensitivity analysis and scenario insights - Robustness: wider near‑term deficit recommendation holds across most parameter variants. - Notable sensitivities: - If no hysteresis → model does not recommend additional near‑term stimulus. - If fiscal multiplier is lower → model calls for a wider near‑term deficit (importance of targeting higher‑multiplier measures). - Eliminating multiplier sensitivity to shocks does not change recommended stance. - Sensitivities to elasticity of interest rate to debt and to adjustment cost are small. - Scenario outcomes: - Upside (quicker recovery): smaller temporary support phased out sooner; frontloaded consolidation. - Downside (Omicron/Ukraine hinder recovery): more near‑term stimulus advisable even if debt rises, followed by larger later adjustment. - Automatic stabilizers critical for adapting policy across scenarios. ### r‑minus‑g sensitivity and fiscal adjustment pace - Core finding: pace of consolidation depends largely on r‑minus‑g assumptions. - r‑g = −0.3 → more gradual consolidation; public debt can be reduced even with a negative structural primary balance. - r‑g = +0.3 → requires a higher structural primary balance and faster medium‑run debt reduction. - Institutional recommendation: strengthen a credible medium‑term fiscal framework (includes contingency plan) to pre‑empt risk premium rises and support investment/growth. ### Revenue mobilization: options, estimates, and priorities - Context: - Social security spending to grow with aging; non‑social security spending already low among G7. - Japan’s tax revenues (including social security contributions) = 31 percent of GDP in 2019. - Consumption tax: - Historical rates: 1989 = 3 percent; April 1997 = 5 percent; April 2014 = 8 percent; October 2019 = 10 percent. - IMF staff model (McGrattan et al., 2018): consumption tax rate needs to reach 15 percent by 2030 to finance rising aging costs; expected yield up to 2½ percent of GDP from 15 percent rate. - Reduced rate: 8 percent reduced rate for food, non‑alcoholic beverages, newspapers introduced in October 2019; top quintile spends twice as much on reduced‑rate goods as lowest quintile → large revenue foregone. - Option: replace reduced rate with targeted support or merge reduced rate with standard rate. - Property taxes: - Fixed Asset Tax statutory rate = 1.4 percent; effective tax rate for small residential land ≈ 0.2 percent due to heavy discounts for land <200m2. - Revenues from Fixed Asset Tax + City Planning Tax = 2.0 percent of GDP in 2020. - Policy: eliminate preferential treatment for small residential land → additional yield up to 0.5 percent of GDP. - Inheritance/gift/net wealth: - Inheritance and gift tax revenues ≈ 0.4 percent of GDP in 2020; top bracket raised from 50 to 55 percent in 2015. - Recurrent net wealth tax: high administrative costs and evasion risks; Japan repealed net worth tax in 1953. - Personal income tax (PIT): - Top statutory PIT rate ≈ 55 percent (highest in G7); revenues low due to generous deductions. - Employment Income Deduction (EID): starts at 0.55 million JPY, ceiling 1.95 million JPY after 2018 reform. - Lowering EID ceiling to 1.5 million JPY → revenue ≈ 0.2 percent of GDP. - Public Pension Income Deduction (PID): starts at 1.1 million JPY, ceiling 1.95 million JPY; aligning PID with post‑reform EID (floor 0.55 million JPY, ceiling 1.5 million JPY) → revenue ≈ 0.1 percent of GDP (mitigate burden on low‑income pensioners via targeted transfers). - Capital income tax: flat rate = 20 percent; raising to 25 percent → ≈ 0.1 percent of GDP. - Corporate income tax (CIT): - Statutory rate declined to ~30 percent; CIT revenues highest among G7 → limited scope. - SME reduced rate for taxable income below 8 million JPY → revenue loss ≈ 0.06 percent of GDP; eliminating reduced rate → additional 0.05–0.1 percent of GDP. - Allowance for Corporate Equity (ACE): could incentivize investment; negative revenue impact depends on design; consider for incremental equity only. - Environmental taxes: - Tax for Climate Change Mitigation (TCCM) ≈ 289 yen (~$3) per ton; revenues ≈ 0.05 percent of GDP. - Raising TCCM could yield additional ≈ 0.3 percent of GDP (net fiscal impact depends on revenue use and expenditure offsets). - Aggregate potential: - If every option implemented, additional revenues ≈ 4 percent of GDP over medium term (some gains, notably carbon tax, may be offset by increased expenditures). - Policy caveat: address distributional concerns (e.g., via targeted cash transfers). ### Distributional implications (Box 1) - Method: static micro‑simulation using KHPS January 2019, tax rules as of FY2021. - Reform package modeled: - Lower EID ceiling to 1.5 million JPY; lower PID floor to 0.55 million JPY and ceiling to 1.5 million JPY. - Raise VAT to 15 percent with no reduced rate. - Raise capital income tax to 25 percent. - Eliminate preferential treatment of residential land. - Introduce a VAT credit (modeled on Canada’s GST Credit). - Key findings: - Tax burden by income decile increases by 2 to 4 percentage points (ppt) after all six options. - Without a VAT credit, about half of the burden increase in every decile comes from higher consumption tax burden. - VAT credit provides large offsetting, redistributive effects. - By asset decile and age: older and wealthier households see larger average increases in tax burden. - Measurement: changes reported in percentage points (ppt). ### Banking sector, low rates, and consolidation implications - Empirical framework: panel threshold regressions on Japanese banks (annual data). - Sample examples: 120 banks, 2013–2020, observations 1,030/661/677 (various specs); 103 banks, 2000–2020, observations 721 (Table 2). - Estimated threshold ≈ −0.03 (text); Table 2 threshold estimators: Pre‑Abenomics 0.0643; Since Abenomics −0.0256. - Net interest margins (NIM): - Declines in short‑term rates have larger impact on NIM when rates are below threshold ≈ −0.03. - A 100‑basis‑points decline in short‑term rate → nearly double the impact on NIM when rates are below the threshold versus when more negative (illustrative shock size: 100 basis points). - Table 1 coefficients examples: Net interest margin (Lag) = 0.596***; 3‑mth short‑term rate = 0.011*** (col 1), 0.007** (col 2); Term spread = 0.003*** (col 1), 0.002** (col 2). - Table 2 highlights: NIM (Lag) = −0.352*** (Pre‑Abenomics), −0.467*** (Since Abenomics); short‑term rate coefficient if rate < rate^* = 0.017*** (Pre), 0.013*** (Since). - Provisions and loan growth: - Accommodative monetary conditions ↑ provisions and loan growth (mitigating profit impact), though not statistically different across thresholds. - No empirical evidence found for a reversal interest rate (no threshold at which cuts reduce loan growth). - Policy recommendations: - Maintain accommodative monetary stance to support recovery and inflation, accompanied by prudential measures. - Strengthen systemic risk assessment, broaden macroprudential toolkit, encourage bank risk management, support business model adjustment (diversify revenue, digitalization, IT investment), and facilitate orderly consolidation/market exit when appropriate. - Early Warning Mechanism for FSA monitoring welcomed. ### Carbon neutrality commitment, modeled policy package, and outcomes - Commitments: - Net‑zero by 2050 (pledge October 2020); FY2030 target: −46 percent vs FY2013 (April 2021). - Japan currently the world’s sixth‑largest CO2 emitter. - Current policies and fiscal support: - GoJ target: non‑fossil sources ≈ 60 percent of power generation by 2030 (replace current fossil share ≈ 80 percent). - TCCM: introduced 2012; increased to 289 yen (~$3) per ton CO2 in 2016; revenues ≈ 0.05 percent of GDP earmarked for green expenditures. - Public funds: 2 trillion yen (US$18 billion or 0.4 percent of GDP) fund over ten years for green investment; public investment on disaster‑resilient infrastructure ≈ 6 trillion yen (US$55 billion or 1 percent of GDP). - BoJ funds‑supplying operation: more than 2 trillion yen provided in first operation (Dec 2021). - Modeled policy package components: - (i) green energy supply policies with incentives/subsidies and a 10‑year green public investment program, - (ii) carbon pricing calibrated to achieve an 80 percent reduction by 2050 after green supply policies, - (iii) compensatory transfers to households (partly recycling carbon revenues), - (iv) supportive macro policies to facilitate debt financing. - G‑cubed modeling specifics: - Carbon prices for Japan: US$16/ton CO2 by 2030; US$64/ton CO2 by 2050 (policy scenario calibrated to 80 percent emission reduction net of green investment). - Green public investment: start at 1 percent of GDP, linearly declining to zero over 10 years; 80 percent subsidy on renewables production in illustrative package. - Compensatory transfers: households receive compensation equal to 1/4 of carbon tax revenues. - Key modeled outcomes: - Business‑as‑usual: emissions rise to 2 Gigaton CO2 by 2050. - Green investment push + rising carbon prices can deliver emissions reductions toward net zero with reasonable output effects. - Green investment alone insufficient for net zero; carbon pricing critical to incentivize efficiency and reallocation. - Fiscal dynamics: initial budget weakening and debt finance required; carbon revenues grow over time and eventually broadly finance the package; private green investment would alleviate fiscal pressures and boost productivity. - Policy recommendations: - Make carbon pricing a central policy instrument (carbon tax or broad cap‑and‑trade); expand TCCM coverage and rates. - Consider relaunching and broadening cap‑and‑trade with auction price floor. - Use compensatory transfers to protect households; complement with energy‑sector reforms to ease renewable deployment and market competitiveness. ### Climate finance, disclosures, and financial‑sector climate risk management - Executive summary: - Regulatory initiatives underway; further action needed. - Green financial products growing but remain small; climate reporting and disclosure limited. - Progress on assessing financial risks associated with climate change. - BoJ actions and fund‑provisioning measure (since December 2021): - Zero interest loans to financial institutions for green loans/bonds and transition finance. - Financial institutions can add twice the amount of loans/investments under the scheme to the zero‑interest reserve remuneration tier. - First auction: slightly more than 2 trillion yen disbursed. - Green finance market figures (2020–2021): - Green bonds issuance = $12.7 bn in 2021. - Green loan origination = $1.5 bn in 2020; $0.3 bn in 2021. - Sustainability‑linked bonds and loans grew to $1.1 bn and $2.4 bn in 2021. - Disclosure and data gaps: - Only ≈ 14 percent of TOPIX firms report narrow scope 1 emissions; fewer report scope 3. - Environmental disclosures lag EU and US firms. - Private ESG data providers: methodologies opaque and inconsistent. - Policy recommendations: - Accelerate convergence to common global disclosure standards (TCFD, ISSB, NGFS). - Consider legally binding minimum disclosure requirements in addition to Corporate Governance Code. - Develop green taxonomy, strengthen external review/assurance, and code of conduct for ESG rating agencies. - Enhance supervisory guidance and scenario approaches for banks, insurers, asset managers; consider mandatory climate risk management and disclosure as methodologies mature. - Financial exposures and scenario analysis: - Japanese banks’ carbon intensity of loans relatively low; G‑SIBs’ loans to utilities/fossil fuel ≈ 6–7 percent of total loans. - G‑SIB climate scenario results: maximum annual credit costs from transition risks significantly below 0.1 percent of total loans; physical risk credit costs much smaller (high uncertainty acknowledged). ### Digitalization and productivity - Policy measures modeled: - Public ICT investment ↑ by 10 percent in 2021–2023 (third supplementary FY2020) → associated with 2 percent increase in private ICT investment in four years. - Business Adaptation Plan tax credit: 3–5 percent tax credit on ICT capital investment or 30 percent accelerated depreciation for qualifying firms (effective two years). - Calibration: 50 percent uptake assumed (θ = 2.5 percent) → ICT investment ↑ ≈ 3 percent medium term. - Combined effect → ICT investment ↑ ≈ 5 percent → labor productivity ↑ ≈ 0.8 percent. - Channels and elasticities: - Investment channel elasticity of labor productivity to ICT investment = 7 percent → labor productivity ↑ ≈ 0.35 percent. - TFP channel elasticity = 9 percent → labor productivity ↑ ≈ 0.45 percent. - Production function parameters: β ≈ 0.37, γ ≈ 0.07; TFP elasticity δ ≈ 9 percent. - Wider digital adoption effects: - E‑commerce: 1 percentage point increase in e‑sales → labor productivity growth ↑ by 0.3 percentage points (Falk and Hagsten, 2015); Asian e‑commerce firms have ≈ 30 percent higher TFP (Kinda, 2019). - Cash supply costs ≈ $15 billion per year (0.3 percent of GDP); ATM maintenance ≈ 700 billion yen ($6.6 billion) annually; branch cash handling ≈ 100 billion yen. - Digital payments and alternative data can reduce costs and expand credit access; about one‑third of Japanese SMEs face financing constraints. - Policy priorities: - Government‑led digital initiatives to boost private adoption while ensuring inclusion and competition. - Reorient spending toward digital skills and education; addressing IT engineer shortage (2015 shortage ≈ 170,000; projected increase to 790,000 by 2030). - Strengthen data privacy, consumer protection, cybersecurity; promote interoperability of payment systems. *Source: 1jpnea2022002 — IMF staff analysis.* ### References ____________________________________________________________________________________ 11 ### POST-PANDEMIC FISCAL POLICY: IMPLICATIONS FROM THE BUFFER-STOCK MODEL OF GOVERNMENT ### Introduction and Policy Trade-off - Post-pandemic fiscal policy faces a trade-off between supporting a strong, durable recovery and ensuring debt sustainability. - Premature withdrawal of fiscal support risks derailing the recovery; high public debt and rising age-related spending call for medium-term fiscal consolidation. - The analysis tailors a stochastic structural Buffer-Stock Model of the Government (Fournier, 2019a) to Japan to illustrate this trade-off and derive policy implications. ### Model Set-up and Mechanics - Model analogy: government = buffer-stock consumer (Deaton, 1991). The difference between current debt and a debt limit is a buffer; higher debt reduces the buffer and raises probability of market stress. - Government chooses fiscal stance (change in structural primary balance) to maximize household welfare subject to debt-sustainability concerns. - Key feedbacks: - Primary balance → output via fiscal multiplier. - Output → primary balance via automatic stabilizer. - Recessions can reduce potential output (hysteresis). - Higher debt raises risk premium and constrains fiscal response; implementation lags matter. ### Calibration and Key Parameter Values - Sensitivity of interest rate to debt: regression following Tokuoka (2010) implies an increase in the gross-debt-to-GDP ratio by one percentage point is associated with a rise in JGB yields by one basis point. - Comparable estimate: 0.7 in Mochida (2019). - Comparative calibrations: France (1.5), US (0.5) referenced. - Fiscal multiplier: - Japan categorized in “Medium-multiplier” group (multiplier of 0.4~0.6). - Lower and upper bounds increased by 30 percent due to prolonged near-effective lower bound of BoJ policy rate → range 0.5~0.8. - Baseline multiplier set at mid-point: 0.65. - Alternative multipliers used in sensitivity analysis. - Growth-adjusted interest rate (r-minus-g): - Baseline long-run assumption: zero. - Alternative scenarios considered: +0.3 and -0.3. - Automatic stabilizer: semi-elasticity of the primary balance to the output gap set at 0.4 (Price et al., 2015). - Data and long-run assumptions: - Projections to 2027 from 2022 Article IV Consultation Staff Report. - Beyond 2027, convergence over 2028~2030 to long-run values. - Long-run values: potential growth = 0.3 percent, inflation = 1 percent, 10-year JGB yield = 1.3 percent. - Note: DSA assumption for 10-year JGB yield was 2.0 percent but model uses 1.3 percent to match r-minus-g baseline. ### Model Recommendations and Main Findings - Near-term: roll out the latest economic package decisively to minimize hysteresis. - Model suggests a wider near-term deficit relative to current policy plans to narrow the output gap and minimize scarring. - This supports disbursing contingent measures included in the November 2021 economic package in response to Omicron and the Russia-Ukraine conflict. - Medium-term: gradual fiscal consolidation recommended after 2024 to anchor public debt on a downward path and rebuild buffers for future shocks. - Role of automatic stabilizers: automatic stabilizers that react quickly and accurately can help calibrate stimulus across scenarios. ### Sensitivity Analysis and Scenario Insights - Robustness: the argument for a wider near-term fiscal deficit broadly holds under most parameter alternatives. - Notable sensitivity observations: - If no hysteresis, the model does not recommend additional near-term stimulus—avoiding hysteresis is a main motivation for extra support. - If fiscal multiplier is lower, the model calls for a wider fiscal deficit in the near term (underscoring the importance of targeted support with higher multipliers). - Eliminating fiscal multiplier sensitivity to shocks does not change recommended stance. - Sensitivities to elasticity of interest rate to debt and to adjustment cost are small. - Scenario analyses for pace of recovery: - Upside scenario (quicker recovery, pent-up demand): smaller temporary support phased out sooner; frontloaded consolidation. - Downside scenario (Omicron and/or Ukraine conflict hinder recovery): more near-term stimulus advisable even if it increases debt, followed by larger fiscal adjustment later. - Automatic stabilizers play a key role in adapting policy across scenarios. ### Policy Implications (Summarized) - Near term: decisively implement contingent fiscal measures to close output gap and limit hysteresis. - Medium term: pursue gradual fiscal consolidation starting after 2024 to place public debt on a downward path and rebuild buffers. - Fiscal design: prioritize targeted measures with higher multipliers and rely on automatic stabilizers for timely, accurate response across uncertain epidemiological and geopolitical outcomes. *Prepared by Jean‑Marc Fournier (FAD), Anh Dinh Minh Nguyen (FAD), and Takuma Hisanaga (APD).* ### 10. The optimal path of fiscal adjustment depends on how economic growth rates and ### 10. The optimal path of fiscal adjustment depends on how economic growth rates and interest rates unfold in the long run ### Model findings on fiscal path and r-minus-g sensitivity - The model recommends supportive fiscal policy in the short run followed by medium-term gradual fiscal consolidation. - The pace of consolidation depends largely on assumptions about the interest rate-growth differential (r-g): - With a small downward change to the interest rate-growth differential (r-g=-0.3), the model suggests a more gradual fiscal consolidation; public debt can be reduced even with a negative structural primary balance. - With a positive interest rate-growth differential (r-g=0.3), the structural primary balance should be higher than in the baseline because: - A higher balance is required to achieve the same debt level target under this scenario. - Debt is costlier, so the model suggests the need to reduce the debt-to-GDP ratio faster in the medium run. - The model explicitly shows alternative scenarios (model advice, current policies, downside scenario, upside scenario) for: - Structural Primary Balance (General Government, percent of potential GDP) across 2019–2030 (chart axis values shown from -9.0 to 2.0). - General Government Gross Debt (Percent of GDP) across 2019–2030 (chart axis values shown from 210 to 280). ### Policy implications and recommendations - Short-run priority: - Give priority to narrowing the output gap to minimize hysteresis through roll-out of the latest economic package. - Near-term fiscal support should be state-contingent, reflecting health, economic and geopolitical developments. - Medium-run priority: - Gradually stabilize debt and rebuild fiscal buffers in the face of intensifying demographic pressures. - The recommended pace of adjustment is sensitive to r-minus-g assumptions, reaffirming the critical role of the interest rate-growth differential in debt dynamics for highly indebted countries like Japan. - Institutional recommendation: - Strengthen the case for a credible medium-term fiscal framework because: - Such a framework could affect the interest rate-growth differential favorably by pre-empting a rise in risk premium and retaining investor confidence in debt sustainability. - It could also reduce uncertainty and help prop up corporate investment and growth. - The framework could include a contingency plan that is readily implementable when, for example, there is a sustained decline in economic growth and/or a rise in interest rates. ### Model mechanics and calibration highlights - Government policy instrument: change in the structural primary balance pb_st to stabilize output fluctuations intertemporally under constraints including gross-government-debt-to-potential-GDP ratio d_t and output gap gap_t. - Household utility: constant relative risk aversion utility in consumption c_t and labor L_t with parameters σ (risk aversion) and η (inverse Frisch elasticity); ξ calibrated so utility peaks at potential output y_t*. - Market pressure and risk premium: - Interest rate increases with public debt and with the change in debt (risk premium calibrated per Fournier (2019)). - Probability to lose market access depends on debt level and change in debt: P(lose market) = [1 + yeexp(b1(1−b_t/b − b2(b_t − b_{t−1})))]^{-1}, where parameters determine debt-limit uncertainty and sensitivity to debt changes; b is the debt level at which probability to lose market access is 50 percent given no change in debt level. - Output dynamics: - Output subject to long-term exogenous potential growth and long-run hysteresis costs (skill decay when production is below perceived potential). - Fiscal multiplier m1 applies at equilibrium; multiplier magnified in downturns via coefficient m2 (empirical support cited). - Primary balance composition: eb_t = eb_t^st + n·gap_t (structural plus cyclical). - Aggregate resource constraint: c_t = y_t(1 − χ(Δeb_t^st)^2) where χ captures fiscal adjustment costs. - Calibration used for Japan reported in the accompanying table (see Section B in source). ### Revenue mobilization options (overview) - Revenue mobilization is indispensable for Japan’s medium-term fiscal adjustment given: - Social security spending will grow as population ages. - Non-social security spending is already low among G7 countries. - Japan’s tax revenues (including social security contributions) were 31 percent of GDP in 2019. - Tax composition and priorities: - Japan relies heavily on income taxes; social security contributions account for 41 percent of Japan’s tax revenues. - Share of goods and services taxes is 20 percent in Japan (lower than other G7 countries except the U.S.). - Consumption taxes and property taxes are promising tax handles for revenue mobilization because they are growth-friendly and can yield stable revenues amid demographic transition. - Consumption tax specifics and options: - Historical VAT/consumption tax rates: introduced in 1989 at 3 percent; increased to 5 percent in April 1997, 8 percent in April 2014, and 10 percent in October 2019. - IMF staff model-based study: consumption tax rate needs to reach 15 percent by 2030 if a rising cost of aging is to be financed by the consumption tax (McGrattan et al., 2018). - Expected yield from the rate increase to 15 percent would be up to 2½ percent of GDP. - Reduced rate issues: - A reduced rate of 8 percent (applicable to food, non-alcoholic beverages, and newspapers) was introduced in October 2019 to alleviate regressivity of the rate increase. - Household survey analysis shows the top income quintile spent twice as much on goods subject to the reduced rate as the lowest income quintile, illustrating large revenue foregone due to the reduced rate. - Policy option: replace the reduced rate with targeted support to vulnerable households or merge the reduced rate with the standard rate to improve efficiency and reduce administrative costs and distortions. - Targeted transfer schemes (administration considerations): - Example: Canada’s GST/HST Credit is a quarterly cash transfer targeted at low- and modest-income households; transfer is flat until household income reaches about 38 thousand CAD (figure shows 38,507). - Challenges for Japan in implementing a similar scheme: - Most employees in Japan do not file annual tax returns because labor income taxes and many investment incomes are withheld at source; National Tax Agency collects employers’ income information but coverage is partial; local governments hold resident income data not aggregated centrally. - Delivery of payments requires timely bank account linkage; municipal offices historically solicited bank account information causing implementation lags. - A recent legislative change enabled citizens to register bank account information linked to a unique identification number (My Number) for benefit delivery, facilitating implementation. *Italic: IMF staff calculations and analysis as presented in the chapter.* ### 6. In most G7 countries, property tax revenues are mainly comprised of recurrent taxes ### 1jpnea2022002 - 6. In most G7 countries, property tax revenues are mainly comprised of recurrent taxes ### Property taxes and recurrent taxes on immovable property - In Japan, municipal governments levy a recurrent tax at a standard rate of 1.4 percent on immovable properties (Fixed Asset Tax). - The City Planning Tax is imposed on buildings and land in urban areas. - Revenues from these two taxes are 2.0 percent of GDP in 2020. - Effective tax rate on Japan’s Fixed Asset Tax is low for small residential land (especially land smaller than 200m2): - Effective tax rate for small residential land is about 0.2 percent, versus the statutory rate of 1.4 percent. - Taxable values for residential land―especially land smaller than 200m2―are heavily discounted from assessed values. - Policy implication: - Eliminating the preferential treatment for small residential land could raise additional revenue yields from the Fixed Asset Tax and the City Planning Tax of up to 0.5 percent of GDP. - Rationale: taxing immovable property is growth-friendly because immobility limits distortionary effects on investment; raising holding costs could incentivize productive use and reduce unoccupied houses. ### Inheritance, gift, and net wealth taxes - Revenues from inheritance and gift taxes are about 0.4 percent of GDP in 2020; this is larger than other G7 countries except France. - Recent reforms: basic deduction narrowed and top bracket rate raised from 50 to 55 percent in 2015. - Net wealth tax considerations: - Recurrent net wealth taxes entail high administrative costs and difficulties in capturing and assessing asset values, and could discourage savings and lead to evasion. - Japan introduced a net worth tax in 1950, but repealed it in 1953 because of these issues. - Among OECD countries, Switzerland is the only country raising meaningful revenues from a recurrent net wealth tax. - Policy implication: - Focus on improving existing property tax system or reinforcing taxation on capital incomes rather than reintroducing a recurrent net wealth tax. ### Personal income taxes - Japan’s top statutory rate of personal income tax is about 55 percent; this is the highest among G7 countries. - Despite the high statutory rate, personal income tax revenues are the lowest among G7 countries due to generous deductions that erode the tax base. - Employment Income Deduction (EID): - EID starts at 0.55 million JPY and increases with employment income until a ceiling of 1.95 million JPY. - 2018 reform: EID amount reduced by 0.1 million JPY and ceiling lowered from 2.2 to 1.95 million JPY (except for households with children). - Staff estimate: lowering the EID ceiling to 1.5 million JPY (about three-quarters of the current level) could increase revenues by about 0.2 percent of GDP. - Public Pension Income Deduction (PID): - PID starts at 1.1 million JPY and rises until ceiling of 1.95 million JPY. - About three-fourth of pension benefits estimated to be exempt from taxable income largely thanks to PID. - Staff estimate: setting PID on par with the post-reform EID (from 0.55 million JPY with proposed ceiling of 1.5 million JPY) could yield about 0.1 percent of GDP. - Distributional note: extra burden on low-income pensioners could be mitigated by a targeted transfer scheme. - Capital income taxation: - Under the dual-income tax principle, capital gains, dividends of listed firms, and interest are subject to a flat rate of 20 percent with some exemptions (e.g., NISA). - Because the flat capital income tax is lower than top labor tax rates, tax burden declines after annual income exceeds about 100 million JPY. - Staff estimate: increasing the capital income tax rate from 20 to 25 percent could yield additional revenues of 0.1 percent of GDP. - Enforcement measures suggested: use My Number scheme, AEOI, and reporting requirements for large wealth abroad. ### Corporate income taxes - Japan’s statutory corporate income tax (CIT) rate declined from nearly 40 percent to about 30 percent over the past decade, but remains on the upper end among G7 countries. - Japan’s CIT revenues are the highest among G7 countries, indicating limited scope for additional revenue mobilization from CIT. - SMEs reduced rate: - A reduced CIT rate applies to annual taxable income below 8 million JPY for SMEs. - Annual revenue loss from the reduced rate is about 0.06 percent of GDP. - Eliminating the targeted reduced rate for SMEs could yield additional revenues of 0.05 to 0.1 percent of GDP. - Investment incentives: - Corporate sector’s net savings have been positive for most of the last two decades. - Introducing an Allowance for Corporate Equity (ACE) could incentivize investment by allowing a deduction for a notional return on equity; ACE has negative revenue implications but losses could be minimized if allowed only for incremental equity. ### Environmental taxes and carbon pricing - Japan’s environment-related tax revenues are on the lower side among G7 countries; revenues mainly from excise taxes on fuels and cars. - Tax for Climate Change Mitigation (TCCM): - TCCM has been imposed on fossil fuel consumption since 2012. - Current rate of TCCM remains low at approximately 3 USD per ton. - Revenues from TCCM are about 0.05 percent of GDP and are earmarked for green expenditures. - TCCM has broad coverage of greenhouse gas emissions relative to peers. - Staff estimate: raising the TCCM rate could yield additional revenues of about 0.3 percent of GDP, though the overall fiscal impact depends on how revenues are used and potential offsets to expenditures. - Policy considerations: - Strengthen carbon pricing while paying attention to impacts on vulnerable households and industrial competitiveness. ### Conclusions and aggregate revenue potential - Further revenue mobilization is warranted given Japan’s low tax revenues relative to G7 peers. - Key reform options and estimated revenue implications (staff estimates, as summarized in Table 1): - Consumption tax: raise the tax rate to 15 percent — additional revenue implication listed in Table 1. - Replace the reduced consumption tax rate with a targeted tax credit scheme. - Property tax: eliminate preferential treatment for residential land — 0.5 percent of GDP. - Personal income tax: streamline pension and employment income deductions — 0.3 percent of GDP. - Personal income tax: raise the tax rate for capital income to 25 percent — 0.1 percent of GDP. - Corporate income tax: merge the special rate for SMEs with the standard rate — 0.1 percent of GDP. - Corporate income tax: introduce an Allowance for Corporate Equity — revenue impact depends on design/impact on output. - Environmental tax: raise the rate of TCCM — 0.3 percent of GDP. - If every option is implemented, additional revenues of about 4 percent of GDP could be raised over the medium-term, though some gains (the carbon tax in particular) may be offset by increased expenditures. - Distributional concerns should be addressed, for example through a targeted cash transfer scheme. *Source: IMF staff estimates.* ### Box 1. Distributional Implications of Revenue Mobilization ### Box 1. Distributional Implications of Revenue Mobilization ### Methodology and data - Static micro-simulation broadly following the methodology of Kawade (2018). - Data: 16th wave of the Keio Household Panel Survey (KHPS), conducted in January 2019. - Tax codes and social security policies applied are as of FY2021. - Taxes and social security contributions included: Personal Income Tax (PIT) and Resident Tax, consumption tax, Fixed-Asset Tax, and pension, healthcare/long-term care, and employment insurance premiums. - Households divided into deciles based on households’ before-tax incomes adjusted for households’ sizes; tax burden measured as taxes and social security contributions as a share of total income. - Additional analysis: households divided into deciles based on equivalized net assets (Real assets + financial assets - debt) and further split by age-groups. Note: “There is zero sample for household below 35 years old in the tenth decile.” ### Reform options modeled - Lower the ceiling (maximum amount) of the Employment Income Deduction of the PIT to 1.5 million JPY. Resident Tax reformed accordingly. - Lower the floor (minimum amount) and the ceiling of the Pension Income Deduction of the PIT to 0.55 million JPY and 1.5 million JPY, respectively. Resident Tax reformed accordingly. - Raise the VAT standard to 15 percent, with no reduced rate. - Raise the capital income tax rate to 25 percent. - Eliminate the preferential treatment of residential land in Fixed Asset Tax. - Introduce a VAT credit (equivalent to the GST Credit in Canada). ### Key distributional findings (by income decile) - A tax burden for each income decile increases by 2 to 4 percentage points after all six options are implemented. - Without considering a VAT credit, roughly a half of the increase in tax burden in every decile is explained by a rise in the burden of the consumption tax. - The result highlights a large redistributive effect of a VAT credit scheme. ### Key distributional findings (by asset decile and age) - When households are grouped by equivalized net assets and split by age-groups, average tax burden of older and wealthier households tends to rise more than younger households with less assets after the reforms. - Decile is based on households' equivalized net assets (Real assets + financial assets - debt). ### Measurement and interpretation notes - Tax burden changes reported in percentage points (ppt). - The simulation applies current FY2021 tax and social security rules to KHPS household data from January 2019. - The VAT credit is modeled on the GST Credit in Canada and has large offsetting effects on the regressive incidence of a higher consumption tax. *Sources: KHPS, IMF Staff calculations* ### 8. This study further examines whether there is a certain level of interest rate that could ### 1jpnea2022002 - 8. This study further examines whether there is a certain level of interest rate that could ### Regression framework and data - Model specification (panel threshold regression as in Wang (2015)): - Y_it = β Y_{t−1,i} + δ y_{it} + γ X_{it} + θ Z_{it} + α_i + ε_{it} - δ = { δ_1 if y_{it} < y^* ; δ_2 if y_{it} ≥ y^* } - Dependent variables examined include: - Net interest margin (NIM) - Provisions-to-total assets ratio - Loan growth - Monetary policy indicators (y_{it}) include: - The three-month short-term interest rate - Term spread (10-year Japanese government bond yield minus short-term interest rate) - Controls: - X_{it}: bank-specific variables (e.g., Deposits/Liabilities (Lag), Cost-to-income ratio, Non-performing loan ratio, Tier 1 regulatory capital ratio) - Z_{it}: macroeconomic and financial variables (real GDP growth, inflation, volatility, unemployment, etc.) - Table 1 sample and estimation details: - Annual frequency, unbalanced sample of 120 Japanese banks, period 2013 to 2020 - Observations: 1,030 (columns 1–2), 661 (columns 3–4), 677 (column 5) - Estimation by ordinary least squares with heteroscedasticity-robust standard errors - Table 2 sample and estimation details: - Dependent variable: net interest margin - Annual frequency, unbalanced sample of 103 Japanese banks, period 2000 to 2020 - Observations: 721 - Threshold estimators reported ### Key empirical findings on interest rates, net interest margins, provisions, and loan growth - Threshold behavior: - Estimated threshold where monetary policy indicator potentially yields different impacts: about -0.03 (text). - Table 2 threshold estimator values: - Pre-Abenomics: 0.0643 - Since Abenomics: -0.0256 - Table 2 summary statistics: - Observations: 721 - Number of banks: 103 - R-squared: 0.171 (Pre-Abenomics), 0.254 (Since Abenomics) - F-stat: 39.181 (Pre-Abenomics), 0.21 (Since Abenomics) - p-value: 0.07330 (Pre-Abenomics), 0.0267 (Since Abenomics) - Impact of declines in short-term interest rates: - The impact of a decline in short-term interest rates on bank net interest margins appears larger when rates are lower than the estimated threshold of about -0.03. - The estimated impact on bank net interest margin corresponding to a 100-basis-points decline in the short-term rate is nearly double the impact when rates are more negative. - Mechanism suggested: lending rates react more strongly to changes in short-term interest rates than deposit rates; deposit costs can potentially bind at the zero-lower bound of retail deposit rates, leading to sharper declines in net interest margins when short-term rates are below the estimated threshold. - Provisions and loan growth: - Accommodative monetary conditions have positive effects on provisions and loan growth, which could help mitigate the impact on bank profits, although these impacts are not statistically different across interest rate thresholds. - Reversal interest rate: - The empirical analysis did not find a short-term interest rate threshold at which a cut in interest rates is associated with a decline in loan growth (i.e., no evidence that the reversal interest rate has been reached). ### International experience on bank consolidation (lessons for Japanese regional banks) - Cross-country consolidation patterns: - The number of commercial banks declined by about 30 percent in the U.S., Italy, and Spain during the last decade (figure reference). - Consolidation in Germany was limited among commercial banks and concentrated in credit unions and credit cooperatives. - Changes in commercial bank branches per population were moderate except in Spain. - Drivers and context: - Consolidation is primarily prompted by a difficult operating environment and in some cases encouraged by policy reforms or regulatory changes. - Europe: fallout from the Global Financial Crisis and prolonged downturn; reforms to legal and governance frameworks (Italy and Spain) encouraged consolidation mainly among cooperative and savings banks. - U.S.: relaxation of geographical restrictions since the early 1980s (including the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994) led to a sharp reduction in the number of banks. - Applicability to Japan: - Japanese regional banks are privately owned, commercially operated, and do not face geographic restrictions; therefore, international examples may not be directly applicable but provide lessons. ### Policy implications and recommendations - Monetary policy stance: - Japan’s accommodative monetary policy stance remains appropriate given the priority to support recovery and inflation, but should be accompanied by prudential measures to safeguard financial stability. - Strengthen financial sector policies to mitigate risks from prolonged low rates: - Further broaden the scope of systemic risk assessment. - Enhance the macroprudential toolkits of Japan’s Financial Services Agency (FSA). - Encourage banks to strengthen their risk management. - Measures to support bank business model adjustment: - Continue encouraging regional banks to diversify revenue sources and adjust business models. - Recognize recent progress: regional banks have enhanced non-interest income through consulting services and reduced branch-related expenses. - Welcome measures: Bank of Japan’s special deposit facility and government subsidies to encourage overhead streamlining, mergers, and business integrations. - Note the November 2020 exemptions to the anti-monopoly law that lowered hurdles for some planned mergers among regional banks operating in the same region. - Recommend leveraging digitalization and investing in IT to improve efficiency and broaden client reach. - Pursue market exit when appropriate, through consolidation or orderly closure. - The Early Warning Mechanism (FSA monitoring and engagement on medium-term prospects) is a welcome step. ### Selected exact figures and regression coefficients (preserve reported numeric values) - Threshold and related numbers: - Estimated threshold (text): about -0.03 - Table 2 threshold estimator: 0.0643 (Pre-Abenomics), -0.0256 (Since Abenomics) - Shock size used in illustrative impacts: - 100-basis-points decline in the short-term rate - 100-basis-points decline in the term spread - Table 1 sample and estimates: - Unbalanced sample of 120 Japanese banks, period 2013 to 2020 - Observations: 1,030; 661; 677 (various specifications) - R-squared values reported: 0.802; 0.281; 0.026 (various columns) - Example coefficient highlights (Table 1): - Net interest margin (Lag): 0.596*** (columns 1–2) - 3-mth short-term interest rate: 0.011*** (column 1), 0.007** (column 2) - Term spread: 0.003*** (column 1), 0.002** (column 2) - Tier 1 regulatory capital ratio: 0.001*** (column 5) - Table 2 regression highlights: - Net interest margin (Lag): -0.352*** (Pre-Abenomics), -0.467*** (Since Abenomics) - Short-term interest rate if rate_{i,t} < rate^*: 0.017*** (Pre-Abenomics), 0.013*** (Since Abenomics) - Short-term interest rate if rate_{i,t} ≥ rate^*: 0.001*** (Pre-Abenomics), 0.007*** (Since Abenomics) - Observations: 721; Number of banks: 103; R-squared: 0.171 and 0.254 *Source: IMF staff estimates (chapter content provided).* ### 4. Japan has pledged to achieve carbon neutrality by 2050. Japan, currently the world’s ### 1jpnea2022002 - 4. Japan has pledged to achieve carbon neutrality by 2050. Japan, currently the world’s ### Overview and commitments - Japan committed in October 2020 to reducing net greenhouse gas emissions to zero by 2050. - In April 2021, Japan raised its medium-term target to reduce its greenhouse gas emissions by 46 percent in fiscal year 2030 from its fiscal year 2013 levels, up from its earlier goal of 26 percent. - Japan is currently the world’s sixth-largest emitter of carbon dioxide. ### Current policies and fiscal support - GoJ plans to increase the share of non-fossil sources including renewables and nuclear to about 60 percent of total power generation by 2030, replacing the current high share of fossil fuels of about 80 percent. - Tax for Climate Change Mitigation (TCCM): - Introduced in 2012 on fossil fuel in addition to the Petroleum and Coal Tax. - TCCM tax rate was gradually increased to 289 yen (about $3) per ton of CO2 emissions in 2016. - Revenues from TCCM of about 0.05 percent of GDP have been spent on measures to expand renewable energy and enhance energy efficiency. - Voluntary cap-and-trade emission trading mechanisms were implemented in Tokyo Metropolitan City and Saitama Prefecture during 2006 and 2012. - A Forest Environment Transfer Tax introduced in April 2019 aims to improve forest management and contribute to CO2 reduction. - Public funding and investment pledges: - 2 trillion-yen (US$18 billion or 0.4 percent of GDP) fund over ten years to promote green investment and innovation including renewables and hydrogen. - Public investment on disaster-resilient infrastructure of about 6 trillion yen (US$55 billion or 1 percent of GDP). - Bank of Japan announced a new funds-supplying operation to support climate-related investment and loan in June 2021 and provided more than 2 trillion yen under the new scheme in its first operation in December 2021. ### Adaptive capacity and international contributions - Annual average damages from weather-related natural disasters are negligible in terms of Japan’s GDP and significantly lower than that of G20 and Asian economy peers. - Japan ranks high on capacity to cope with weather-related natural disasters due to National Adaptation Planning and advanced adaptive technology. - Japan disseminates knowledge, experiences, and technology transfer for water-related disaster mitigation, particularly to developing economies. - Japan agreed to halt all new direct government support for unabated coal power generation abroad by the end of 2021. ### Modelled policy package and macroeconomic impacts - The study analyzes a comprehensive policy package including: - (i) green energy supply policies consisting incentives and subsidies on clean energy production and a 10-year green public investment program focused on low-carbon energy sectors, high energy-efficient building, and climate-resilient infrastructure, - (ii) carbon pricing calibrated to achieve an 80 percent reduction in carbon emissions by 2050 after accounting for emission reductions from the green supply policies, - (iii) compensatory transfers to households, recycling part of carbon tax revenues through targeted cash transfers, and - (iv) supportive macroeconomic policies to facilitate debt financing, with the debt increase to finance green spending partly offset by the additional carbon revenues. - Key modeled outcomes: - Business-as-usual scenario: Japan’s carbon emissions projected to continue rising and reach 2 Gigaton CO2 by 2050. - An initial green investment push combined with steadily rising carbon prices would deliver the needed emissions reductions toward carbon neutrality by 2050 at reasonable output effects. - Short-run positive effect from a green investment push supports COVID-19 recovery and conditions for transition to a low-carbon economy; but a green investment push alone is unlikely to reduce emissions to net zero. - Carbon pricing is critical to mitigation because it incentivizes energy efficiency gains and resource reallocation from high- to low-carbon activities. - Compensatory transfers to affected households help maintain purchasing power and consumption levels. - Fiscal dynamics: - Policy package would initially weaken the budget balance and require debt financing since carbon revenues are smaller than initial green spending. - As carbon prices rise, carbon revenues will eventually be broadly sufficient to finance the policy package. - If green private investment materializes, it could alleviate fiscal pressures and boost productivity due to relatively higher efficiency of private investment versus public investment. ### Carbon pricing options and considerations - Carbon pricing should be an integral component of the policy package. - Carbon tax: - A broad-based carbon tax would provide a robust price signal to reduce energy demand and redirect investment to cleaner technologies. - Japan’s existing TCCM tax rate remains very low; its rate and coverage could be expanded to other high-carbon sectors and activities. - Among advanced-economy peers, Japan’s effective fossil carbon rate is lower than in France, Germany, and the United Kingdom, but higher than in Canada and the United States. - Existing fuel tax scheme could be streamlined and further integrate carbon charges while extending them to carbon-intensive energy sources and economic activities. - Cap-and-trade: - With the same sectoral coverage, a cap-and-trade system is broadly equivalent to a carbon tax in achieving the same carbon prices and revenue. - A carbon tax provides more certainty about future prices; cap-and-trade provides more certainty about emissions reductions. - Cap-and-trade could be more costly to set up and administer. - Japanese Voluntary Emissions Trading System (JVETS) FY2006-12: - Covered industrial processes, offices, and waste management. - At its peak, JVETS covered only 0.01 percent of 2013 emissions with very few transactions. - Auctioned price was low at about JPY 810 or US$7.4 and highly volatile. - Recommendation: Relaunch and broaden the cap-and-trade scheme to full sectoral coverage and anchor a more stable carbon price path (e.g., auction price floor). - Other instruments: - Regulations can be used if carbon pricing is politically challenging but may be administratively costly and not generate financing for the transition. - Feebates (levies on generators with above-average emissions per kWh and rebates for below-average emitters) could foster energy-mix change; impact depends on market size and energy intensity. ### Energy sector reforms and market mechanisms - Significant progress: full liberalization of wholesale and retail energy markets; Legal Unbundling Act adopted in April 2020 to unbundle transmission and distribution from generation and retail. - Priority reforms to further enhance competition and promote non-fossil energy sources: - (i) administrative and regulatory reforms to ease regulations (e.g., Cropland Act, Act on Establishment of Agricultural Promotion Regions, and other red-tape bureaucracy restricting land use and renewable investment); - (ii) reforms to create a market to facilitate access to large hydro, nuclear, and other renewables, and a non-fossil certified market for small retailers; - (iii) introduction of an indirect auction system for usage of transmission lines across regions to promote price competitiveness; - (iv) establishment of a balancing market to procure and trade flexibly in accordance with a public offering of adjustment power. ### Co-benefits and international spillovers - Concerted global action to tackle climate change generates substantial positive externalities; all countries benefit according to model simulations. - Further efforts to enhance carbon pricing in Japan and climate finance to less-developed economies will help global climate policy efforts. ### Conclusions and policy recommendations - Japan’s carbon neutrality pledge is an important step forward; reaching zero net emissions by 2050 will be especially challenging given heavy reliance on fossil fuels, small share of renewables, and constraints on building more renewable capacity. - Carbon pricing should be a central component of the policy mix. - A comprehensive policy package—including green energy investment combined with a gradual rise in carbon prices—would have net positive impacts on growth, employment, and investment. - Carbon pricing would: - Amplify incentives for green private investment, - Accelerate the shift from high- to low-carbon energy sources, - Underpin emissions reduction targets. - Compensatory transfers financed partly by carbon tax revenues could protect affected households’ purchasing power and consumption. - Complementary reforms to enhance competition in the energy sector and promote non-fossil energy sources are recommended. *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1jpnea2022002.pdf* ### References ### References ### Bibliographic citations - Environmental Defense Fund, 2015, “Japan: An Emissions Trading Case Study.” In The World’s Carbon Markets: A Case Study Guide to Emissions Trading. - Fuss, Sabine, William F Lamb, Max W Callaghan, Jérôme Hilaire, Felix Creutzig, Thorben Amann, Tim Beringer, et al., 2018, “Negative Emissions—Part 2: Costs, Potentials and Side Effects.” Environmental Research Letters 13 (6): 063002. - Government of Japan, 2018, “Climate Change in Japan and Its Impacts.” Synthesis Report on Observations, Projections and Impact Assessments of Climate Change, 2018, Ministry of Environment. - G20, 2021, “Reaching Net Zero Emissions,” Prepared by staff of the International Monetary Fund, June 2021. - International Monetary Fund, 2020a, “Regional Economic Outlook for Sub-Saharan Africa,” April, 2020. - International Monetary Fund, 2020b, “World Economic Outlook.” October, 2020. - International Monetary Fund, 2020c, “EU Climate Mitigation Policy.” IMF Departmental Paper No. 2020/13. - International Monetary Fund, 2021, “Fiscal Policies to Address Climate Change in Asia and the Pacific.” IMF Departmental Paper No. 2021/007. *JAPAN 50 INTERNATIONAL MONETARY FUND* --- ### Appendix I. G-Cubed Model ### Model description and purpose - Purpose: Gauge long-term dynamics of temperatures, carbon emissions, and effects of mitigation policies on carbon emissions and macroeconomic dynamics in the short, medium, and long term using the G-cubed global macro model as in IMF (2020b). - Model type: Multi-country, multi-sector intertemporal general equilibrium model. - Structure and coverage: - Regions: 10 regions. - Sectors: 20 economic sectors. - Agents: Heterogeneous households, firms, governments within each region and economic sector. - Features: Detailed energy sectors, forward-looking agents, real and nominal rigidities (wage rigidities, adjustment costs on firms), fiscal and monetary policies. - Emissions measurement: CO2 emissions measured through the burning of fossil fuels in energy generation. - Energy representation: Contains fossil fuels and clean energy sectors. - Carbon removal technology estimates drawn from Fuss et al (2018). - Source for model schematic: IMF World Economic Outlook, October 2020. ### Scenario design - Scenarios: - Baseline (business-as-usual): Reflects carbon emissions without policy adjustments. Based on initial dynamics from 2018 to 2019 and subsequent projections from 2019 onwards for sectoral productivity growth rates by sector and by country. Sectoral productivity growth driven by labor force growth and labor productivity growth. - Policy scenario: Strong policy adjustment to reduce net carbon emissions to zero by 2050 via a comprehensive global policy package. - Operationalization of net zero by 2050: - Reduction of gross emissions by 85 percent, with natural emissions sinks and some deployment of carbon capture and storage technologies to absorb remaining emissions. ### Policy package components (policy scenario) - Carbon pricing: - Calibrated to achieve the 80 percent reduction in emissions by 2050, after accounting for green investment. - Entails an annual growth rate of carbon prices of around 7 percent over the period of 2019-2050. - For Japan: carbon prices to reach US$16 a ton of CO2 by 2030 and US$64 a ton of CO2 by 2050. - Green supply policies: - An 80 percent subsidy rate on renewables production. - 10-year green public investment program starting at 1 percent of GDP and linearly declining to zero over 10 years. - Public investment assumed to target renewable and other low-carbon energy sectors, and climate-resilient and high energy-efficient infrastructure. - Note: Public investment assumption is illustrative; substitution by private investment could yield fiscal savings and investment efficiency gains. - Compensatory transfers: - Households receive compensation equal to 1/4 of carbon tax revenues to help poorer households maintain purchasing power via targeted cash transfers. - Supportive macro policies: - Policy package expected to require additional debt finance for the first decade and occur against a backdrop of low-for-long interest rates in a low inflation context to facilitate debt finance. - Additional model inclusions: - Estimates of the induced innovation response and the avoided damages from climate change are included. ### Simulation outcomes and mechanisms - Simulation results present net outcomes of policy adjustments on real GDP growth, investment, employment, and fiscal balances relative to the baseline. - Transmission channels: - Mitigation policies affect carbon emissions and the macroeconomy through prices of fossil fuel energy relative to clean energy and overall energy prices. - Simulations account for resource reallocation across sectors as some sectors contract and others expand. ### Model calibration and figures - Results of model calibration for Japan: 2010-19 average (source: IMF World Economic Outlook, October 2020). - Baseline simulations run using a G-Cubed model of McKibbin and Wilcoxen (1999, 2013) and Liu and others (2020). - Data labels: Use ISO country codes. EUW = European Union, Norway, Switzerland, United Kingdom; OEC = Australia, Canada, Iceland, Liechtenstein, and New Zealand; OPC = selected oil-exporting countries and other economies; ROW = rest of the world. *JAPAN 52 INTERNATIONAL MONETARY FUND* --- ### CLIMATE FINANCE IN JAPAN ### Executive summary points - The government emphasizes developing a financial system to support transition to a low carbon economy and manage financial stability implications of the transition and climate impacts. - Regulatory initiatives underway, but further action needed. - Green financial products and markets are developing but remain small. - Climate-related reporting and disclosure are still limited. - Progress is being made on assessing financial risks associated with climate change. *Prepared by Jochen M. Schmittmann (OAP). The author thanks Yun Gao (OAP) for excellent research assistance.* ### A. Introduction and regulatory approaches - Private sector investment required for mitigation and adaptation; Japan’s green growth strategy recognizes mobilizing private sector investment for decarbonization of energy, industrial processes, transport, and housing. - Carbon pricing and other fiscal measures are essential to achieve net zero carbon emissions by 2050 (see 2022 Selected Issues paper “Climate Change Policy Options”). - Climate risks to financial system: - Affect financial system directly (price impairment, reduced collateral values, underwriting losses) and indirectly (lower economic growth, tighter financial conditions). - Nonlinear and hard to estimate; depend on actions taken in next years. - Key government actors: - Bank of Japan (BoJ): integrating climate in monetary policy and financial stability functions. - Financial Services Agency (FSA): analyzing and monitoring financial implications, developing supervisory guidance, contributing to green market guidelines, working on climate scenario pilot with BoJ. - Ministry of the Environment (MoE): guidelines for green financial products and environmental disclosures, subsidy and pilot programs. - Ministry of Economy, Trade and Industry (METI): incentive programs for sustainable finance; jointly with MoE and FSA released guidelines for transition finance. ### BoJ actions and funding measure - BoJ climate strategy released July 2021; supports private sector climate action consistent with mandate for macroeconomic and price stability, with emphasis on market neutrality. - Financial stability actions: include climate risk considerations in micro-prudential surveillance, develop quantitative assessments with FSA, encourage enhanced climate disclosures. - BoJ to strengthen climate research, advance climate finance in international fora, purchase green government bonds in foreign currency reserve management, and incorporate climate considerations in operations and communication. - Fund-provisioning measure (since December 2021): - Zero interest loans to financial institutions for green loans/bonds, sustainability-linked loans/bonds, and transition finance. - Financial institutions allowed to add twice the amount of their loans/investments under the scheme to the reserve remuneration tier that carries zero interest (given part of banks’ reserves remunerated at -0.1 percent). - Loan duration: one year, rollover permitted (effectively long-term funding). - First auction: slightly more than 2 trillion yen disbursed; interest from financial institutions was strong. ### B. Green financial products and markets - Importance: Mainstreaming climate considerations in investment management and developing green products helps price climate risks and allocate capital to lower carbon activities. - Investment practices: Climate issues integrated within ESG approaches — engagement, exclusion, portfolio tilts, ESG integration, exercising shareholder voting rights. - Debt products: - Green bonds and loans: use of proceeds linked to green purposes per guidelines and standards. - Sustainability-linked bonds and loans: set overall sustainability targets for borrower. - Investor trends: - Many large asset owners and managers in Japan signed Principles for Responsible Investment (PRI). - Japan Sustainable Investment Forum survey: exercising shareholder voting rights common; deeper ESG integration gaining traction. - Market developments and figures: - Green bonds issuance: $12.7 bn issuance in 2021. - Green loan origination: $1.5 bn in 2020 to $0.3 bn in 2021 (plunged). - Sustainability-linked bonds and loans: grew in 2021 to $1.1 bn and $2.4 bn, respectively, from less than $0.3 mn for bonds and loans combined in prior year. - Issuance composition: ~50 percent of green bonds issued by financial institutions, 30 percent by other companies, 20 percent by government agencies. - Green loans mostly to non-financial corporates. - Despite growth, climate-related debt remains a small fraction of total debt. - Government support: - MoE published guidelines for green bonds, green loans, sustainability-linked loans; guidance on ESG finance, environmental reporting, responsible banking, and TCFD recommendations for climate scenario analysis. - FSA, METI and MoE jointly released guidance on transition finance. - MoE subsidy program for green bond issuance to defray external review and consulting fees. - Need for ecosystem to avoid greenwashing: - Strengthen monitoring, assurance, and review of green financial products. - Improve data and reporting on environmental impact, use of proceeds, and other aspects of greenness. - Taxonomies of green activities would help classification and investor/borrower decisions. ### C. Climate disclosures and reporting - Reliable and comparable climate-related data crucial to assess financial stability risks, price and manage climate risks, and mobilize opportunities from the transition (NGFS 2021). - Current data gaps hinder objectives: - Corporate emission reporting, locational data of assets, and impact reporting for green debt often insufficient. - Lack of forward-looking exposure analysis. - NGFS identified needed interventions around three broad themes: - Rapid convergence towards a common and consistent set of global disclosure standards. - Efforts towards a minimally accepted global taxonomy. - Development and transparent use of well-defined and decision-useful metrics, certification labels, and methodological standards. *JAPAN 56 INTERNATIONAL MONETARY FUND* ### 12. The government of Japan encourages climate reporting and disclosure. The MoE ### 12. The government of Japan encourages climate reporting and disclosure ### Climate reporting and disclosure framework - The MoE provides environmental reporting guidelines and the government encourages climate reporting based on guidance from the Task Force on Climate-Related Financial Disclosures (TCFD). - Major emitters of greenhouse gases (GHG) report emissions to MoE which is made public, however, matching this data with corporate financial data is challenging. - Revisions to Japan’s Corporate Governance Code (not legally binding) require companies to: - develop a basic sustainability policy and disclose initiatives on sustainability; - for prime market listed companies, enhance the quality and quantity of climate-related disclosures based on TCFD recommendations or equivalent international frameworks. - The Tokyo Stock Exchange is planning to require prime listed companies to make TCFD-consistent disclosures on a comply or explain basis. ### Status of corporate climate disclosures and data quality - Support for TCFD among Japanese companies and organizations is strong (Figure 2.1). - GHG emission disclosures among Japanese firms are limited: - about 14 percent of firms in the TOPIX stock index report narrow scope 1 emissions; - fewer firms report scope 3 emissions that include a company’s value chain (Figure 2.2). - Environmental disclosures by Japanese firms lag those of firms listed in the European Union (EU) and the United States (US), although the gap is narrowing (Bloomberg; Figure 2.3). - Private ESG data providers supply climate-related data but: - methodologies are often opaque; - there is a lack of consistency across providers, making it difficult for investors to rely on private ratings (Figure 2.4). - More than 65 Japanese financial institutions including the three Japanese global systemically important banks (G-SIBs) joined as supporters of TCFD. ### Policy recommendations and data improvements suggested - Continue working on disclosure standards and guidelines in Japan and through international fora including the TCFD, the Financial Stability Board (FSB), the International Sustainability Standards Board (ISSB), and the NGFS. - Broaden and deepen climate disclosures by corporates, financial institutions, and investors. - Consider legally binding minimum disclosure requirements in addition to the Corporate Governance Code. - Develop a green taxonomy in line with international developments or equivalent guidance on what constitutes a green activity. - Strengthen certification labels and external reviews and assurances. - Develop a code of conduct for ESG rating agencies and data providers to address transparency and reliability concerns. ### Climate risk exposures: physical and transition channels - Two broad channels by which climate change affects the financial system: - Physical risks: damage to property, infrastructure, and land (e.g., increased default risk of loan portfolios, lower asset values, higher insurance liabilities). - Transition risks: changes in climate policy, technology, and consumer/market sentiment during the adjustment to a lower-carbon economy. - Japan-specific exposures: - Japan has experienced stronger atmospheric warming and more surface temperature anomalies than the global average (MoE Japan, 2018). - Real estate in low-lying coastal areas (where the bulk of Japan’s population is concentrated) is at risk from flooding. - The frequency of natural disasters in Japan has been on the rise (Figure 4.1). - Japan’s 2050 carbon neutrality target will require radical changes in sectors such as automotive, energy, and cement; some assets may become stranded while other firms could thrive in low-carbon business models. - A World Bank study finds Japan less exposed in aggregate to transition risks than many other countries, particularly those with large fossil fuel sectors (Figure 4.2). - Japanese financial institutions have large direct exposures to climate risks across the world given Japan’s large stock of foreign direct and portfolio investment. ### Market pricing and equity evidence on climate risk - Stock market valuations in Japan do not appear to reflect firms’ emission intensities: - For TOPIX firms, little difference in price-earnings (P/E) ratios between high and low GHG emission firms (Figure 5.1). - No evidence that investors value firms that report emissions higher (Figure 5.2). - Stock return sensitivities to a climate risk factor (industry level worldwide): - Energy, basic materials, and utilities sectors are most sensitive to a climate risk factor after controlling for standard equity pricing factors (Figure 5.3). - Technology and industrials are not sensitive to the climate risk factor. - Japanese banks’ market signals: - Japanese banks along with most EU banks have negative sensitivity to the climate risk factor, implying markets view these banks as hedges against climate risks (Figure 5.4). - In contrast, banks in major oil and other commodity producers (Russia, Brazil, Mexico, Canada) show high sensitivity to climate risks. - Temperature sensitivity finding: - Japanese stocks with the highest sensitivity to temperature earn slightly lower returns than others, suggesting mispricing and lack of attention to temperature-related variables; result is economically small but statistically significant at the 10 percent level (Figure 5.5). ### Bank exposures and scenario analysis (G-SIBs and others) - Carbon intensity and fossil financing: - The carbon intensity of Japanese banks’ loan portfolios is relatively low in cross-country comparison (Figure 6.1). - Data on fossil financing for Japanese G-SIBs suggests these banks provide about 3 percent of their loan volume to fossil energy companies (Figure 6.2). - Sectoral loan exposures: - For G-SIBs, loans to utilities and fossil fuel companies account for around 6-7 percent of total loans (Figure 6.4). - For smaller Japanese banks including regional banks, exposure to these sectors tends to be much lower. - Real estate is viewed by many banks as the sector most at risk from physical risks, especially flooding. - Climate scenario analysis by G-SIBs: - G-SIBs’ climate scenarios suggest maximum annual credit costs from transition risks are significantly below 0.1 percent of total loans. - Credit costs related to physical risks are estimated to be much smaller. - Scenarios acknowledge high uncertainty (policies, time horizon) and are preliminary; they focus on direct impact on default in exposed sectors and do not consider wider macroeconomic implications. - Scenario analyses support banks’ engagement with clients on managing and mitigating climate-related risks. - Specific illustrative self-reported G-SIB scenario figures (banks’ TCFD reports; Billions of Yen; scenarios follow TCFD recommendations but are not fully comparable due to different assumptions and scope; sectors in transition risk analysis are energy and utilities; physical risk scenarios focus on natural disasters especially flooding): - Mitsubishi UFJ Financial Group, Inc: "10 to 90 each fiscal year 38 cumulative by 2050 110,856" - Mizuho Financial Group: "120 (dynamic scenario) to 310 (static scenario) cumulative by 2050 52 cumulative by 2050 85,513" - Sumitomo Mitsui Financial Group: "2 to 10 per year through 2050 30-40 cumulative by 2050 84,581" ### Definitions and methodological notes - Scope definitions: - Scope 1 emissions cover direct emissions from owned or controlled sources. - Scope 2 covers indirect emissions from the generation of purchased electricity, steam, heating, and cooling consumed by the reporting company. - Scope 3 includes all other indirect emissions that occur in a company’s value chain. - Lower reporting share in 2021 compared to 2020 is due to data submission lags. - The IMF developed the carbon footprint adjusted loans to total loans (CFALTL) indicator: obtained by multiplying domestic loans to a specific industry by their corresponding carbon emission factors, summing over all industries and dividing the final result by total domestic loans. - Stock return regressions include the Fama-French factors and a momentum factor; methodological details referenced to the CARIMA project. *Source: 1jpnea2022002 — Chapter 12 (IMF).* ### 24. Climate risks are important for other financial institutions including insurers, pension ### 24. Climate risks are important for other financial institutions including insurers, pension funds, and asset managers ### Climate vulnerabilities and current practices among nonbank FIs - Insurers and pension funds are vulnerable to climate risks in their investment portfolios given the long-term nature of their assets. - On the liability side, insurers are exposed to physical risks including from more frequent and severe natural disasters. - Major Japanese insurers support TCFD and publish TCFD reports. - Several insurers publish climate stress scenario analysis. - Pension funds and asset managers are improving their climate disclosures. - Example: The Government Pension Investment Fund (GPIF) publishes an analysis of climate-related risks and opportunities in its portfolio including value at risk measures under different temperature scenarios. ### Banks’ portfolio exposure to climate risks (Figure 6 — key findings) - 1. The overall emission intensity of bank loans in Japan is relatively low compared to other countries. - 2. Large Japanese banks provide less fossil fuel related funding than US banks, but more than European banks. - 3. Banks have begun to evaluate the climate risk exposures of their portfolios. Utilities and fossil fuel are typically seen as most exposed to transition risk. - 4. Loan exposures to utilities and energy are highest among the Japanese G-SIBs. Smaller banks tend to be less exposed. ### Ongoing regulatory and industry efforts; need for further improvements - Ongoing efforts by Japanese regulators include: - Development of climate scenario analysis and supervisory guidance on climate risk management. - Research on the effects of climate change on the financial system. - Engagement at the international level at the FSB and NGFS to advance methodologies and guidelines. - Many Japanese financial institutions have made progress in analyzing their exposure to climate risks and putting in place strategies to address risks. - Recommendation: As guidelines and methodologies advance, consideration should be given to mandatory climate risk management and disclosure practices. ### Conclusion — priorities to strengthen Japan’s capacity to manage climate financial risks (paragraphs 26–27) - Priority areas to build on climate finance initiatives underway: - Improving data and disclosures. - Building expertise among financial institutions and regulators. - Developing risk measurement and management approaches including scenarios. - On data and disclosure: - Consider minimum compulsory disclosure requirements in addition to the legally non-binding requirements in the Corporate Governance Code. - Consider extending the scope of corporates and financial firms subject to reporting. - On risk management and supervision: - Climate risk management guidelines for banks, insurers, and asset managers would support mainstreaming climate risk assessments and promote common standards. - Plans to issue supervisory guidance for banks and insurers are welcome. - Role of central banks and regulators: - The BoJ’s and FSA’s efforts on advancing climate finance research including through international cooperation in the context of the NGFS are commendable and will help mainstream climate finance. - The publication of the BOJ’s climate strategy is welcome. - The BoJ could study the merits of incorporating climate-related risks in its asset purchase and collateral policies. - Green finance market development: - The burgeoning market for green financial products will need an ecosystem that includes investor and issuer expertise, and data, ratings, and assurance providers to ensure the integrity of green finance instruments. - Authorities can support the private sector through guidelines (for example MOE’s green bond standards and recently released transition finance guidelines), support schemes, and supervision. - Data and disclosure improvements will be needed to develop green financial markets. - Consider labeling of financial products including investment funds to make green investments more accessible and provide quality assurances to end investors. - Green taxonomies or equivalent approaches would support the private sector in classifying activities and reduce greenwashing and reputational risks. *Source: IMF staff analysis in 1jpnea2022002 - 24. Climate risks are important for other financial institutions including insurers, pension funds, and asset managers* ### 8. Digitalization can boost labor productivity through ICT capital investment and total ### 8. Digitalization can boost labor productivity through ICT capital investment and total factor productivity gains ### Quantified impact of two specific digitalization policies - Planned increase of public ICT investment: the government plans to increase public ICT investment by 10 percent in 2021-2023 (third supplementary budget of FY2020). - Estimated spillover: a 10 percent increase in public ICT investment is associated with a 2 percent increase in private-sector ICT investment in four years (estimated from a panel regression using 20 countries in the EU KLEMS database, 1995–2017). - New tax credit (Business Adaptation Plan, third supplementary FY2020 budget): - Firms that satisfy Digital requirements and Business transformation requirements can receive a tax credit of 3-5 percent of their ICT capital investment or apply a 30 percent accelerated depreciation. - Tax measures are effective for two years. - Calibration in a Ramsey-Cass-Koopmans model with ICT capital: assuming a 50 percent uptake of the tax measures (θ calibrated at 2.5 percent assuming 50 percent of firms utilize the 5 percent tax credit), ICT investment could increase by about 3 percent over the medium term. - Combined effect: - The two policies together could increase Japan’s ICT investment by about 5 percent. - This increase in ICT investment could raise labor productivity by about 0.8 percent. ### Channels through which ICT investment raises labor productivity (and estimated magnitudes) - Channel 1 — Investment (capital accumulation) channel: - ICT capital enters production directly and boosts the marginal product of labor. - The elasticity of labor productivity with respect to ICT investment is estimated at 7 percent. - Applying this elasticity, labor productivity could increase by about 0.35 percent through the investment channel. - Channel 2 — Total factor productivity (TFP) channel: - ICT investment improves TFP via IT-induced externalities and IT-leveraged innovations. - The elasticity of TFP with respect to ICT investment is estimated at 9 percent. - The boost to labor productivity through the TFP channel is about 0.45 percent. - Model and estimation notes: - The tax-credit effect on ICT capital is derived from a calibrated neoclassical growth model (Box 1). - Production function parameter estimates from industry-level data in Japan: β ≈ 0.37 and γ ≈ 0.07. - The TFP elasticity (δ in the Box 1 regression) is estimated at 9 percent using industry-level data in Japan. ### Wider digital adoption: e-commerce and digital financial services - E-commerce: - Evidence from firm-level data for 14 European economies (2002–10): an increase in e-sales by 1 percentage point raises labor productivity growth by 0.3 percentage points (Falk and Hagsten, 2015). - Asian firms engaged in e-commerce have on average 30 percent higher total factor productivity than other firms (Kinda, 2019). - In Japan, a 2018 business survey by Japan Fair Trade Commission: "94 of percent businesses confirmed that they benefitted from online sales through expansion into new business areas and customer bases, and 77 percent indicated that competition intensified in terms of lower prices and higher product diversity, thus also benefitting consumers." - Further expansion of e-commerce could create new demand beyond substitution from offline to online and boost consumption over the medium term. - Digital financial services and alternative data: - Supplying cash to society is estimated to cost around $15 billion per year (0.3 percent of GDP) in Japan (Nomura Research Institute estimate). - Maintaining ATMs alone costs about 700 billion yen ($6.6 billion) annually, and another 100 billion yen is spent handling cash at branch counters. - Wider adoption of digital payments can reduce costly labor-intensive cash processing, speed payments, and provide data on payment behaviors. - Alternative data from e-commerce and digital payments platforms can help lenders identify creditworthy clients and expand tailored services; big-tech companies (e.g., Rakuten and Amazon) have offered financial products using alternative data since 2013. - A third of Japanese SMEs face financing constraints due to high information costs, high collateral requirements, and high credit costs (2017 Financial System Stability Analysis); start-ups lack credit history in Japan’s credit risk database. ### Policy implications and priorities - Government-led initiatives: - Government-led initiatives are essential to boost private-sector digital adoption while ensuring inclusion, competition, and innovation. - The government’s digital reform agenda focuses on improving public digital services; public-sector modernization can compel private firms to upgrade legacy systems. - Labor market and education responses: - To mitigate displacement of unskilled workers, increase labor market mobility and reorient government spending toward digital-related education and labor skills, including digital financial literacy. - Japan’s shortage of IT engineers was about 170,000 in 2015 and is estimated to increase to 790,000 in 2030 (Ministry of Economy, Trade and Industry survey and projections). - Japan’s respondents scored an average of 7 percentage points lower on comparable questions in the 2019 financial literacy survey than respondents in the United States, Germany, and the United Kingdom. - Implement programs to ensure senior citizens learn basic digital skills (example cited: "Seniors Go Digital" program in Singapore). - Regulation, trust, and interoperability: - Strengthen data privacy, consumer protection, and cybersecurity regulations to address growing cyberattack threats (a 2019 survey of Japan’s financial institutions: more than 70 percent recognized that the threat of cyberattacks is growing). - Promote interoperability and reduce fragmentation of payment platforms to improve network effects and user convenience. *Source: 1jpnea2022002 - 8. Digitalization can boost labor productivity through ICT capital investment and total* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1jpnea2022002.pdf_