Markets laud Fukuda offer to untie taxes

Sensing the will for reform, financial markets have responded generally favorably to Prime Minister Yasuo Fukuda's proposal to free up road-related taxes for other purposes in fiscal 2009, but rural economies already suffering from cuts in public spending risk further damage, analysts say.

Attempting to avoid further political and market turmoil, Fukuda proposed Thursday that revenue from gasoline and other road-related taxes be used for general spending, including environmental protection and support for families with children, starting in April 2009.

This marks a significant move for Japan, where for decades road-related taxes have been set aside almost exclusively to build and repair roads.

"The change symbolizes a step forward for reform," said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance Co. in Tokyo. "His decision is favorable for the markets."

Finance Minister Fukushiro Nukaga told reporters Friday that he welcomes Fukuda's concession.

"It's highly beneficial to review the tax system across the board," he said.

However, Kodama also pointed out that reform has slowed since former Prime Minister Junichiro Koizumi left office, and it is unclear how far the government under Fukuda is willing to go.

"Fukuda's decision resulted from growing pressure from the Democratic Party of Japan. Uncertainties over reform still remain," Kodama said.

Fukuda made it clear Thursday that provisionally added rates on gasoline and other auto-related taxes will remain unchanged in fiscal 2008, but added that he is open to discussing the matter in and after fiscal 2009.

As long as the DPJ-led opposition camp, which controls the Upper House, remains against Fukuda's idea to keep the extra tax rates, they will expire on Monday. However, the Lower House is expected to reinstate them with a two-thirds overriding vote in late April, 60 days after it first approved them on Feb. 29.

Fukuda said the government needs to retain the higher rates to avoid a ¥2.6 trillion revenue shortfall. The DPJ contends that such taxes represent wasteful spending and have been a source of pork-barrel politics.

Some analysts say abolishing the higher rates altogether will have the same impact as a tax cut and help raise stagnant consumption.

The reduction will ease the annual tax burden on households by ¥1.6 trillion and on corporations by ¥1.1 trillion, said Toshihiro Nagahama, Dai-ichi Life Research Institute's senior economist.

While Fukuda's new proposal was generally welcomed by the markets, shifting tax revenues from road-related uses to other purposes further clouds the outlook for rural economies that rely on public works projects.

"It would cause a lot of confusion in (regional) economies," Kodama of Meiji Yasuda Life Insurance said. "They will have to freeze some plans."

Hokkaido, where the city of Yubari declared bankruptcy last March, would lose ¥40.7 billion in revenues from its ¥2.90 trillion 2008 budget if the provisional road-related taxes are abolished.

The political wrangling has already affected road construction, Seiya Sasaki of Hokkaido's road department said by telephone Thursday.

"We must continue to maintain and repair roads, but we have called off new orders for road construction for the time being. As we have not received any instructions from the central government, we just don't know what to do," Sasaki said.

"April and May is an important time for road and other construction to go smoothly as there is no snow, but the projects may be delayed if provisional taxes are abolished," he said.

A small Hokkaido-based construction company said the industry is already in trouble following the deep cuts in public works spending made under Koizumi.

"It might drive us out of business if (the situation) gets much worse," said its president, who asked not to be identified.

He said about 70 percent of the firm's revenue comes from public works projects, including road construction.

Analysts also said Japan's political stalemate could accelerate the withdrawal of money from financial markets.

The political deadlock has already left the Bank of Japan without a governor after the Upper House rejected two government nominees.

"While the U.S. and European central banks are working to fend off a credit crisis and calm the markets, Japan does not have a governor. Japan has sent a negative message and it could harm Japan's credibility," said Takahira Ogawa, director of sovereign ratings at Standard & Poor's in Singapore. "In terms of rating, it's not a good situation."

Takahiro Fukada contributed to this report