On a trip to Japan in early September, I had the pleasure of having breakfast with Nicholas Smith, the Japan equity strategist for Credit Lyonnais Securities Asia (CLSA). We discussed Japan’s tax policies, Prime Minister Abe’s popularity and the overall market environment. Here are the highlights of our conversation.
Question: One of the policy changes investors would like to see is the cut in the corporate tax rate. Please talk about the tax environment that has led to this change in policy.
Smith: Japan has one of the highest corporate tax rates in the world, second only to the United States. But one problem is that an ever increasing number of companies don’t pay any tax. Back in the early 1950s, only 16% of companies did not pay corporate taxes, but today it is 70% of companies—dominated by smaller companies. Generally speaking, corporate profits have increased over 60% cumulatively over the last 50 years, while corporate tax receipts are down 50% cumulatively over the same period. When I look at that, I have asked people at the Ministry of Finance: How did you mess this up so badly? The desire to lower rates and broaden the base of tax collected upon is much needed.
Question: What is the impact of reducing the tax rate?
Smith: I have calculated that if Japan reduces the corporate tax rate from the 39.3% effective tax rate currently to be in line with the effective tax rate in the United States of 27%, this would lead to a 20% increase in the earnings for the TOPIX 500 Index (after tax earnings).
Question: One part of the third-arrow growth strategies was reforming some of the public pension funds like the Government Pension Investment Fund (GPIF) to modernize asset allocations away from the low-yielding Japanese government bonds (JGBs). When do you expect this to take place?
Smith: There is a big question whether some of the flows to trust banks this year were caused by the GPIF purchases. I have looked at it, and we have talked to asset managers. My sense is the GPIF has not started increasing allocations to equities yet, but it will very soon. We could expect to see the purchases in September and October, if not already. The GPIF may very well be considering making purchases before fully announcing its new policy, as investors will try to buy ahead of the GPIF if they were fully clear on their intentions.
Question: There is some media focus on the declining support for Abe prior to his Cabinet reshuffle. What’s your take on how Abe is doing?
Smith: I believe Abe really has unprecedented support. Former Prime Minister Koizumi (some might call him “Elvis” for his popularity) was less popular than Abe at this stage of his run as prime minister. Usually there is an initial surge of popularity in the first few months in office, and then it trends downward. The historical average of popularity of Cabinet support ratios I have found as approximately one-third. I see Abe’s support over 50% at this stage. Thus far, he’s the most popular prime minister in three decades. This also shows in the execution of the bills that were passed that he submitted to parliament: 97.5% of the bills he has submitted were executed, a percentage only matched by Koizumi in 2003.