Japan's tax-cut fantasy does not add up

JAPAN'S government has just approved a dramatic cut to the consumption tax on food, one of the most expensive populist measures a country with the world's highest public-debt ratio could devise. The plan would lower the rate from 8% to 1% for two years from April 2027, supplemented by a cash benefit that brings the effective rate to zero. That costs roughly ¥5tn a year in lost revenue, or about 4% of the entire national budget.

The fiscal arithmetic is not encouraging. Prime Minister Sanae Takaichi has pledged not to fund the measure with deficit-covering bonds, a category of Japanese government debt that explicitly signals fiscal deterioration and has long been a market red flag. Instead, the government has promised a "comprehensive review of both expenditures and revenues", a formulation that says everything and nothing. In the absence of concrete alternatives, speculation has turned to the Bank of Japan's enormous portfolio of exchange-traded funds as a possible revenue source. The suggestion has been floated by analysts and, according to reports, by the opposition Democratic Party for the People.

The trouble is that the numbers do not add up. The BoJ's ETF portfolio, accumulated over more than a decade of unconventional monetary easing, is worth roughly ¥70tn-80tn at market value and ¥37tn at book value. It is indeed one of the largest single holdings of Japanese equities in existence. But the BoJ has committed to selling them at a pace of around ¥330bn a year at book value - a rate deliberately chosen to avoid disturbing stock prices. At that speed, the bank's own governor, Mr Kazuo Ueda, told lawmakers in December that the full sell-down would take "a little over 100 years". Even if all proceeds from ETF sales were remitted to the treasury, they would cover about 6% of the annual shortfall. It is not a funding plan; it is a rounding error.

The arithmetic reveals something about the politics. The LDP won a landslide victory in February's lower-house election partly by promising relief from Japan's cost-of-living crisis. Rice prices surged by nearly 100% year-on-year in mid-2025 before easing to around 30%. Cutting the tax on food is the most visible way to demonstrate that the government is acting. But the party is also terrified of the political history of consumption-tax increases. The LDP lost the Upper House in 1998 after raising the rate to 5% in 1997; the now-defunct Democratic Party of Japan lost power in 2012 after passing legislation to raise it to 10%. The LDP therefore wants a tax cut that can be reversed without looking like a betrayal. A two-year temporary measure achieves exactly that - if the government can find the money to pay for it.

That is where the BoJ's balance sheet becomes an attractive fiction. To a politician, ¥80tn of market value sounds like a war chest. The fact that these assets were bought with printed money, that selling them faster would violate the BoJ's own mandate to avoid market disruption, and that the annual proceeds would be a fraction of what is needed - these are technicalities. The BoJ has already resisted pressure to accelerate sales. In January an opposition lawmaker from the Democratic Party for the People called for a faster sell-down, arguing it would fund a 3-percentage-point food-tax reduction. The BoJ rejected the call.

Even the more imaginative proposals do not close the gap. An op-ed in Nikkei Asia, published by the Centre for European Policy, suggested that ETF holdings could be moved to a public-interest vehicle in exchange for perpetual bonds, with interim capital gains and dividends funding public investments. That is institutionally creative but fiscally modest. The BoJ's equity income is unlikely to generate anywhere near ¥5tn a year. And transferring central-bank assets to a government-controlled entity raises questions about monetary independence that markets in Japan, where yields are already rising, would not welcome.

To be sure, the tax cut is not without economic merit. Lowering the cost of food would reduce inflation, which has stayed above the BoJ's 2% target since April 2022. ING, a Dutch financial group, estimates the measure could trim inflation by approximately one percentage point. Households, particularly lower-income ones who spend a larger share of their income on food, would benefit directly. And Takaichi's broader agenda includes a ¥370tn public-private investment drive through to fiscal 2040, designed to lift productivity and expand the tax base. If it works, growth could make Japan's debt burden more manageable over time.

Yet the danger is not immediate collapse but slower erosion. The IMF projected Japan's government debt at roughly 204% of GDP in 2026, and its 2026 country report urged Tokyo not to reduce the consumption tax, calling it "an untargeted measure that would erode fiscal space and add to fiscal risks". Debt-servicing costs already account for about a quarter of the fiscal 2026 budget and are projected to rise from ¥13tn to ¥21.6tn by fiscal 2029 under the finance ministry's own scenario. The 10-year government bond yield touched 2.87% this week, near multi-decade highs. Daiwa Institute of Research estimates the tax cut would boost GDP by only about ¥0.3tn against the ¥4.4tn in lost revenue - a return of less than 7 cents on every yen forgone.

The deeper problem is institutional. When a government faces an unfunded commitment, the honest answer is one of three things: raise other taxes, cut spending elsewhere to compensate, or borrow and accept the market's verdict. Punting to the central bank's balance sheet is a fourth option that disguises the choice. It does not eliminate the fiscal hole; it merely makes it harder to see. And in a country where the public debt is already more than double GDP, visibility matters. Markets may tolerate high debt when they understand how it is managed. They are less patient when the accounting grows opaque.

Takaichi has inherited a political system in which fiscal discipline has been nominally sacrosanct while actual discipline has been episodic at best. The LDP's own general council approved the tax cut unanimously on Wednesday, August 5th, yet some members skipped the meeting in protest at the absence of a clear funding source. The party's Tax System Research Commission heard warnings from its own fiscal hawks. Upper House member Shoji Nishida, himself a supporter of aggressive spending, objected that moving the consumption tax rate up and down "will disrupt society".

The better answer would be to target relief more precisely. A means-tested cash transfer to households most affected by food-price inflation would cost less than a blanket tax cut and would not require ¥5tn in annual resources. It would also avoid the problem of subsidising everyone, including the wealthy, for the benefit of the poor - the classic fiscal policy equivalent of using a sledgehammer to crack a nut. If the LDP is unwilling to accept the political optics of means-testing, then it should at least acknowledge the cost honestly and explain to markets and voters which other spending is being cut to compensate.

The Bank of Japan's ETF portfolio is not a slush fund. It is the residue of an extraordinary monetary experiment, and its unwinding is a technical exercise designed to avoid destabilising the markets it once propped up. Politicians should be tempted to look at a balance sheet of that size and imagine possibilities. But the arithmetic is unforgiving. The BoJ's sales will trickle in over a century. The tax cut's bill comes due every year. That mismatch is not a problem of imagination; it is a problem of accounting. And in Japan, where the margin for fiscal error is thinner than almost anywhere else, pretending otherwise is a luxury the country can no longer afford.