Rethink the Tax System Plan to Create a Strong Economy

On December 19, the ruling coalition of the Liberal Democratic Party (LDP) and the Nippon Ishin no Kai (Ishin) agreed to an outline plan for tax reform in FY2026. The emphasis of the plan is on combating inflation and creating a strong economy.

Among other things, the plan includes a commitment to raising the "annual income threshold" from which income tax starts to be levied. This move had been agreed upon the previous day by Prime Minister Sanae Takaichi (also LDP president) and Democratic Party for the People (DPP) leader Yuichiro Tamaki.

The Takaichi administration has adopted a clear stance of favoring "responsible and proactive fiscal policy." Moreover, has shown willingness to accommodate opposition-favored budget policies in order to stabilize administration operations. This will likely result in the same pattern as the FY2025 supplemental budget, in which expenditures ballooned.

As they struggle to cope with rising prices, many members of the public are hoping for a reduction in their tax burden. Therefore, it is important for legislators to respond by appropriately adjusting the tax system. Nonetheless, politicians must also responsibly weigh the policy effects and drain on financial resources that accompany tax cuts. The question remains as to whether sufficient discussions were held before these agreements were made.

Measures for Dealing with Rising Prices Are Critical

After reaching an agreement with Tamaki, Prime Minister Takaichi spoke to reporters. She said, "From the perspective of building a strong economy, we ultimately decided to increase income and improve consumer confidence. The intention is to create a virtuous cycle of increased business earnings."

Since the governing parties lack a majority in the Upper House, cooperation with the DPP is of the utmost significance. For the Takaichi administration, it lays the groundwork for ensuring the passage of a budget bill within this fiscal year. Nevertheless, the prime minister will also be severely questioned as to whether she can actually deliver the strong, sustainable economy she has promised.

*Prime Minister Sanae Takaichi and DPP Representative Yuichiro Tamaki exchange documents after signing the agreement, inside the Diet on December 18. (©Sankei by Ataru Haruna)*

The legislation also addresses the "annual income threshold" or income tax exemption limit. The basic deduction applicable to all taxpayers, and the employment income deduction for salaried workers, will be increased by ¥40,000 JPY ($255.84 USD) each. This is in line with inflation.

There is also a special exemption that allows for an additional deduction for two years. That would raise the annual income threshold for levying income tax from ¥1.6 million ($10,235) to ¥1.78 million (about $12,000).

Furthermore, the income bracket eligible for the largest deductions will be expanded from the current annual income level of ¥2 million ($12,800) or less to ¥6.65 million (about $43,000) or less.

In other words, 80% of taxpayers will benefit from the tax cuts. Meanwhile, it is estimated that approximately ¥650 billion ($4.157 billion) in tax revenue will be lost.

Strangely Skewed Benefits

The LDP agreed to include the middle-income class in response to a request from the DPP. But how well-thought-out was this move?

Increasing take-home pay for middle-class wage earners is certainly important for stimulating consumption. Nevertheless, the proper response to rising prices should be to provide generous support to the low-income earners who truly need it.

According to the Ministry of Finance, the tax benefits over eight years resulting from the raising of the income threshold will be less than ¥10,000 ($64) for those earning under ¥4 million ($25,584) a year.

Meanwhile, the benefits for the middle-income earners are quite generous. Those with an annual income of ¥5 million ($31,980) will keep ¥27,000 ($173) more than now. And those with an annual income of ¥6 million (about $39,000) will enjoy a ¥36,000 ($230.25) benefit.

Justification for this skewing of the tax cut benefits toward middle-income earners is clearly needed.

Automobile-related Taxes

Also, the revamped automobile-related tax system is inconsistent. The prefectural-level Environmental Performance Tax, which requires buyers to pay a fee that is based on their vehicle's environmental performance, will be abolished. Initially, the plan was to suspend it for two years, but the DPP demanded that it be eliminated entirely.

*TOYOTA's EV bZ4X is an electric vehicle using rare earth minerals in its engine parts. (©Toyota)*

Here, the aim is to stimulate domestic demand to mitigate the impact of the high tariffs imposed by the United States. However, the automobile industry is a key economic powerhouse in Japan. Eliminating the tax burden on cars with lower fuel performance than eco-vehicles, such as electric and hybrid cars, runs counter to the trend toward decarbonization.

In the past few years, rising gasoline prices have further increased consumer interest in eco-friendly cars. Normally, this would be the time to further stimulate demand for such vehicles. It would also increase the competitiveness of domestic manufacturers in this sector.

Ultimately, if the provisional gasoline tax rate and the environmental performance tax are both abolished, won't that actually increase gasoline consumption? It makes us wonder whether this tax cut will actually serve to create a strong economy.

Supporting Defense Capabilities

Another part of the discussion was an income tax increase intended to support a drastic expansion of the nation's defense capabilities. While the government decided to implement the income tax increase, its start date was subsequently postponed. It was finally decided that the increase would take effect a year later, in January 2027.

*Commanders of the Japan Ground Self-Defense Force and the US Marine Corps held a joint press conference at Ishigaki Garrison, Ishigaki Island, Okinawa, in September, 2025.*

Simultaneously, the special income tax implemented for reconstruction following the Great East Japan Earthquake will drop by 1%. Consequently, the net tax burden will remain unchanged for now. However, securing stable funding for defense spending is necessary to respond to the severe security environment surrounding Japan ー even in peacetime.

Families with Children

Due to the cautious stance of Ishin no Kai, the dependents deduction remains unchanged for households with 16-18-year-old high school-age children.

Inclusion of high school students in the scope of child allowances led to consideration of reductions in the amount of allowances. However, even previously agreed-upon tax reforms have been postponed. Therefore, the government needs to offer a convincing explanation for why the current allowances should be maintained.

As outlined, the plan clearly calls for the largest-ever tax cuts on capital investment. Meanwhile, it goes against the trend toward decarbonization by eliminating the provisional tax burden on vehicles with lower fuel efficiency than eco-cars, such as electric cars and hybrid cars. And, while decreasing the burden on families, the plan would increase spending to make elementary and high school education free.

Finding the Right Balance

To pay for these new initiatives, the plan taps ¥1.2 trillion ($7.675 billion) by abolishing the tax incentives designed to encourage large companies to increase wages.

Reimagining the kind of well-balanced tax system Japan needs should be continued without interruption.

Efforts to secure financial resources are an essential component of a "responsible and proactive fiscal policy." However, for this to work, there needs to be a thorough review of expenditures as well as the tax system itself.

(Read the editorial in Japanese.)

Author: Editorial Board, The Sankei Shimbun