How do national and local governments raise money, and what do they spend it on? Public finance is an important system that supports people’s lives, and fair taxation is considered a foundation of democracy.
Basic Knowledge
Public finance refers to the activities of government revenue (income) and expenditure (spending). The three functions of public finance are ① resource allocation (providing public goods and services that markets have difficulty supplying), ② income redistribution (reducing inequality through progressive taxation and social security), and ③ economic stabilization (adjusting the economy through fiscal policy). Taxes are classified as direct taxes (such as income tax, corporate tax, and inheritance tax: the taxpayer and the person bearing the tax are the same) and indirect taxes (such as consumption tax and liquor tax: the taxpayer and the person bearing the tax are different). Income tax uses progressive taxation, in which the tax rate rises as income increases, and this performs an income-redistribution function. Expansionary fiscal policy increases public works and cuts taxes when the economy is weak, while austerity reduces public works and raises taxes when the economy is overheated. Budget deficits, in which expenditure exceeds revenue, are covered by issuing government bonds, and Japan’s outstanding government debt has exceeded 1000 trillion yen.
Direct tax (such as income tax and corporate tax. The taxpayer and the person bearing the tax are the same)
Indirect tax (such as consumption tax and liquor tax. The taxpayer and the person bearing the tax are different)
Progressive taxation (a taxation method in which the tax rate rises as income increases. Applied to income tax and inheritance tax)
Fiscal policy (a policy in which the government controls the economy by adjusting revenue and expenditure)
Social security (the four pillars of social insurance, public assistance, social welfare, and public health)
Built-in stabilizer (a fiscal function that automatically reduces economic fluctuations, such as progressive taxation and unemployment benefits)
Further Study (Background and Significance)
Japan’s social security system consists of four pillars: social insurance (health insurance, pensions, long-term care insurance, employment insurance, and workers’ accident compensation insurance), public assistance (livelihood protection), social welfare (welfare for people with disabilities, older people, and children), and public health (public health centers and vaccinations). As the birthrate declines and the population ages, social security costs are increasing and the burden on the working generation is growing. Consumption tax has the problem of regressivity, in which lower-income people feel a heavier burden, but it is used for social security as a stable source of revenue. Keynesian economics argues that the government should actively spend money, but some criticize the expansion of fiscal deficits as a burden on future generations.
- Three functions of public finance: resource allocation, income redistribution, and economic stabilization
- Progressive taxation applies to income tax and inheritance tax (consumption tax has a proportional tax rate)
- Four pillars of social security: social insurance, public assistance, social welfare, and public health
- Built-in stabilizer: a function in which tax revenue and benefits automatically change with economic conditions
- Japan’s expenditure: social security is the largest item (about one-third of the total)
- Regressivity of consumption tax: the share of income paid in taxes is larger for lower-income people
- Outstanding government debt exceeding 1000 trillion yen: the problem of fiscal burdens on future generations
Points to Note (Easily Confused Concepts)
① Definitions of direct taxes and indirect taxes: for a direct tax, the person bearing the tax = the taxpayer; for an indirect tax, the person bearing the tax ≠ the taxpayer (the consumer bears the tax and the business pays it). ② Progressive taxation applies to income tax and inheritance tax, while consumption tax has a uniform proportional tax rate. ③ Fiscal policy (the government’s control of revenue and expenditure) and monetary policy (the BOJ’s control of interest rates and the money supply) are different policy tools. ④ Social insurance (eligibility is obtained by paying premiums) and public assistance (livelihood protection: received free of charge when requirements are met) are different systems.
Practice
- What kind of system is “progressive taxation”? Explain its relationship with the income-redistribution function of public finance.
- Explain the difference between direct and indirect taxes using the terms “person bearing the tax” and “taxpayer,” and give a specific example of each.
- Name the four pillars of Japan’s social security system and briefly explain each one.