PM may have abandoned pledge not to fund tax cut with deficit-financing bonds
During the current Diet session, the government aims to secure passage of a bill to reduce the consumption tax rate on food products and provide income-linked cash payments to ease the burden on working households. However, funding sources for these measures have yet to be specified. Key design details for the payments, including eligibility criteria and amounts, also remain undisclosed.
Every new policy entails a cost, and its merits should be debated by the public and the Diet in view of that cost. Since the source of funding determines who will ultimately pay the bill, it makes little sense to discuss legislation without providing this information.
The government and ruling coalition may be seeking to preserve flexibility so that they can incorporate opposition party views during the deliberations before ultimately deciding on policy details and funding. However, this approach is unlikely to win public support.
Against this backdrop, Prime Minister Sanae Takaichi took a step further in the discussion of how the consumption tax cut would be funded at the Upper House Budget Committee meeting on October 19.
Ms. Takaichi said the government would review revenues and expenditures under its budget-reform framework, assess the overall size of the budget, and appropriately manage JGB issuance over the course of the full year, including both the initial and supplementary budgets. She then said that additional JGB issuance "has not been ruled out."
As the prime minister had previously stated explicitly that the tax cut would not be funded with the issuance of special deficit-financing bonds, her latest remarks can be interpreted as a revision of that position. At a press conference, Chief Cabinet Secretary Minoru Kihara said that her comments “referred solely to the budget as a whole” and that "there has been no change in the government’s policy." However, Ms. Takaichi's precise intention remains unclear.
Funding the tax cut with construction bonds or bridge bonds would not violate the pledge to avoid relying on special deficit-financing bonds. However, the use of such instruments to fund a two-year consumption tax cut on food products would be difficult to justify and seems unlikely.
As such, I suspect the administration has reconsidered its pledge and now intends to fund the tax cut partly with JGB issuance. That could reflect a recognition that it would be difficult to secure ¥5tn annually through revenue and expenditure reforms. If so, the government may face criticism for having been overly optimistic in its initial funding assumptions. Indeed, securing ¥5tn each year through spending cuts and additional revenues rather than JGB issuance always seemed as though it would be a challenge.
At the same time, the government already issues large volumes of deficit-financing bonds every year. To the extent that this is unlikely to change in FY2027, I do not think a commitment to avoid using such bonds to fund the consumption tax cut would be enough to win the confidence of the market.
Every new policy entails a cost, and its merits should be debated by the public and the Diet in view of that cost. Since the source of funding determines who will ultimately pay the bill, it makes little sense to discuss legislation without providing this information.
The government and ruling coalition may be seeking to preserve flexibility so that they can incorporate opposition party views during the deliberations before ultimately deciding on policy details and funding. However, this approach is unlikely to win public support.
Against this backdrop, Prime Minister Sanae Takaichi took a step further in the discussion of how the consumption tax cut would be funded at the Upper House Budget Committee meeting on October 19.
Ms. Takaichi said the government would review revenues and expenditures under its budget-reform framework, assess the overall size of the budget, and appropriately manage JGB issuance over the course of the full year, including both the initial and supplementary budgets. She then said that additional JGB issuance "has not been ruled out."
As the prime minister had previously stated explicitly that the tax cut would not be funded with the issuance of special deficit-financing bonds, her latest remarks can be interpreted as a revision of that position. At a press conference, Chief Cabinet Secretary Minoru Kihara said that her comments “referred solely to the budget as a whole” and that "there has been no change in the government’s policy." However, Ms. Takaichi's precise intention remains unclear.
Funding the tax cut with construction bonds or bridge bonds would not violate the pledge to avoid relying on special deficit-financing bonds. However, the use of such instruments to fund a two-year consumption tax cut on food products would be difficult to justify and seems unlikely.
As such, I suspect the administration has reconsidered its pledge and now intends to fund the tax cut partly with JGB issuance. That could reflect a recognition that it would be difficult to secure ¥5tn annually through revenue and expenditure reforms. If so, the government may face criticism for having been overly optimistic in its initial funding assumptions. Indeed, securing ¥5tn each year through spending cuts and additional revenues rather than JGB issuance always seemed as though it would be a challenge.
At the same time, the government already issues large volumes of deficit-financing bonds every year. To the extent that this is unlikely to change in FY2027, I do not think a commitment to avoid using such bonds to fund the consumption tax cut would be enough to win the confidence of the market.
Shifting focus to managing JGB issuance
The government appears to be shifting the focus of its efforts to maintain financial markets' trust in its management of fiscal affairs. Rather than emphasizing that the consumption tax cut will not be funded with special deficit-financing bonds, it now appears to be concentrating on managing JGB issuance.
However, it is unclear what Ms. Takaichi means by "appropriately managing JGB issuance over the course of the full year." Even without a supplementary budget, the fiscal deficit in FY2027 is likely to be substantially larger than the combined deficits for the initial and supplementary budgets in FY2025 due to new investments, higher debt-servicing costs, and increased defense spending.
If the government seeks to keep JGB issuance around the FY2025 level, the first option would be to exclude bridge bonds from the total amount. Investments in economic security are expected to be recorded in a special account and funded with bridge bonds backed by future redemption resources. Excluding those bonds would reduce reported issuance. However, unless the redemption resources are clearly specified, it is likely that the bridge bonds would ultimately be refinanced through the issuance of deficit-financing bonds, making them effectively the same thing.
A second possibility would be to curb long-term JGB issuance by sharply increasing short-term issuance. However, this would raise total annual JGB issuance, including short-term securities, and would effectively make the government even more reliant on continuous refinancing of its debt.
A third option would be to use funds already raised through front-loaded refunding bonds, which are issued to smooth out fluctuations in JGB issuance, to finance expenditures. However, this would merely change the timing of issuance and would not alter cumulative JGB issuance over multiple fiscal years.
As none of these options would materially improve the nation's fiscal position or JGB supply/demand dynamics, they are unlikely to increase the market’s confidence in the government.
However, it is unclear what Ms. Takaichi means by "appropriately managing JGB issuance over the course of the full year." Even without a supplementary budget, the fiscal deficit in FY2027 is likely to be substantially larger than the combined deficits for the initial and supplementary budgets in FY2025 due to new investments, higher debt-servicing costs, and increased defense spending.
If the government seeks to keep JGB issuance around the FY2025 level, the first option would be to exclude bridge bonds from the total amount. Investments in economic security are expected to be recorded in a special account and funded with bridge bonds backed by future redemption resources. Excluding those bonds would reduce reported issuance. However, unless the redemption resources are clearly specified, it is likely that the bridge bonds would ultimately be refinanced through the issuance of deficit-financing bonds, making them effectively the same thing.
A second possibility would be to curb long-term JGB issuance by sharply increasing short-term issuance. However, this would raise total annual JGB issuance, including short-term securities, and would effectively make the government even more reliant on continuous refinancing of its debt.
A third option would be to use funds already raised through front-loaded refunding bonds, which are issued to smooth out fluctuations in JGB issuance, to finance expenditures. However, this would merely change the timing of issuance and would not alter cumulative JGB issuance over multiple fiscal years.
As none of these options would materially improve the nation's fiscal position or JGB supply/demand dynamics, they are unlikely to increase the market’s confidence in the government.
Profile
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Takahide KiuchiPortraits of Takahide Kiuchi
Executive Economist
Takahide Kiuchi started his career as an economist in 1987, as he joined Nomura Research Institute. His first assignment was research and forecast of Japanese economy. In 1990, he joined Nomura Research Institute Deutschland as an economist of German and European economy. In 1996, he started covering US economy in New York Office. He transferred to Nomura Securities in 2004, and four years later, he was assigned to Head of Economic Research Department and Chief Economist in 2007. He was in charge of Japanese Economy in Global Research Team. In 2012, He was nominated by Cabinet and approved by Diet as Member of the Policy Board, the committee of the highest decision making in Bank of Japan. He implemented decisions on the Bank’s important policies and operations including monetary policy for five years.
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