Greater effect of Japan's nominal GDP growth on tax revenue

Ahead of the government's announcement of a mid-term plan on fiscal policy by end-June, the focus of discussion is the tax revenue elasticity, i.e. the ratio of how much tax revenues rise or fall against a change in nominal economic growth. In the current economic cycle, the tax revenue (excluding consumption tax) elasticity (10-year rolling) is about 4.0, but the average over the long term (during the last few decades) is widely considered to be around 1.0. 

Tax revenue for FY2014 is likely to jump, underpinned by strong corporate earnings. The government's projection in the initial budget plan was about 50 tn yen. 

"But the figure for the general account budget is expected to jump to about 54.5 tn yen, the highest since FY1993. Excluding the consumption tax hike, tax revenue is expected to increase by around 8% of FY 2014 nominal GDP (+1.6%), implying a tax revenue elasticity of around 4.0", says Societe Generale.

A higher elasticity means a higher tax revenues is expected for a growth in nominal GDP, with the result that fewer spending cuts will be needed for the government to meet its commitment of achieving a primary surplus in FY2020. The problem with this reasoning is that only the rate (flow) of tax revenue growth and nominal GDP growth are being compared; the levels of tax revenue and nominal GDP are not considered.

In FY1990, i.e. during the bubble economy (excluding consumption tax), tax revenue as a ratio of nominal GDP was around 12%. However, the ratio continued to fall rapidly thereafter. Since Japan fell into deflation in the latter half of the 1990s, it has remained at around 7%. Currently, with the elasticity largely exceeding 1.0, the ratio of tax revenue to nominal GDP is on a rising trend and if Japan is exiting deflation it should continue to risesteadily, suggests SocGen.