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Tax reform: Nakasone's political hot potato. Plan could be most controversial move of premier's career

Tax reform is likely to prove the most sweeping and controversial measure of Prime Minister Yasuhiro Nakasone's term in office. After days of passionate dispute, the ruling Liberal Democratic Party (LDP) last week passed the first basic reform of tax law in 35 years.

Its three main features are:

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Changes in personal and corporate income taxes. Top rates on personal income will be reduced, but middle- and lower-income taxpayers may find their rates raised. Corporate rates will be reduced slightly.

A 5 percent value-added tax on most goods and services.

Abolition of tax-free savings, except for the elderly, and imposition of an across-the-board 20 percent tax on all interest income. At present, savings and government bonds of up to 3 million yen (approximately $18,500) are free of tax on interest.

Opposition parties have denounced the proposed changes as ``favoring the rich at the expense of the poor.''

Even among Liberal Democrats, there is great uneasiness as to how the public will view the reform measures, which are to be submitted to the Diet (Japan's parliament) in January.

Superficially, aspects of the proposed changes resemble the sweeping tax revisions adopted by the United States Congress this year.

The changes also appear to respond to American and European demands that the Japanese stop favoring savings and start encouraging consumption, thus increasing imports and reducing Japan's huge trade surpluses with the US and Western Europe.

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But observers who have followed Japan's history of attempted tax changes discern the hand of the powerful Finance Ministry in nearly every aspect of the proposed changes.

They also see a glaring discrepancy between the proposed tax reforms and Mr. Nakasone's categorical pledge during last summer's general election campaign not to introduce any ``large-scale indirect taxes.''

The LDP also pledged to reduce personal income taxes during that campaign.

As a result, the party won a landslide victory, securing an unprecedented 304 seats in the 512-seat House of Representatives. (They currently hold even more: 307 seats).

Finance Ministry bureaucrats are the cr'eme de la cr'eme of government officials. There have been Keynesians among them, but for the past decade the prevailing view within the ministry's cavernous precincts is the Confucian precept that there is something immoral and dangerous about living on borrowed money.

And indeed, Japan's accumulated deficits may reach $880 billion by next spring, a figure many economists find alarming.

These deficits were incurred after the oil shock of the 1970s, particularly after the Bonn summit of 1978, when Japan agreed with West Germany and the US to become ``a locomotive for economic growth.''

So for the past five years, the Finance Ministry has insisted on austerity budgets, with defense and overseas economic aid the only items permitted substantial annual increases. It has viewed the Reagan policies of tax cuts and whopping defense expenditures with scarcely concealed disdain.

Ministry officials say that they are not opposed to stimulating domestic demand, but that this can only be done within the context of reducing the deficit. With the strong support of the prime minister, at each budget season the Finance Ministry has waged spirited battles with officials from spending-prone ministries such as Construction (public works) and Welfare (social security).

So far, Finance has triumphed every time - in spite of the cohorts of outspoken Liberal Democratic politicians rival ministries have mobilized.

This is at least partly because the interests of Nakasone and of his three potential successors converge. Tax reform is one of Nakasone's three major domestic policy planks, the others being administrative and educational reform. Administrative reform - the two biggest chunks of which are privatization of telecommunications and the national railways - has been largely accomplished. Educational reform is still in an early stage of discussion.

But tax reform is urgent in this sense: The Finance Ministry must find new sources of revenue if it is going to reduce the deficit.

To raise personal income tax any further is politically impossible - hence the proposal to introduce indirect taxes, which have been proved revenue-producers in Europe.

But value-added taxes are also a political hot potato, because they are estimated to cost every taxpayer $125 a year.

Nakasone's three potential successors - Finance Minister Kiichi Miyazawa and party officials Shintaro Abe and Noboru Takeshita - would just as soon get tax reform out of the way before they come to power.

If things go wrong, Nakasone can take the blame. If they go right, Nakasone still will not be so powerful as to be able to remain in office beyond Oct. 31, l987, when his current term expires by agreement within the LDP.

What of the consumers, the taxpayers?

If there is a real reduction of personal taxes, they should be pleased.

But changes in personal income tax, according to Prof. Masaaki Homma of Osaka University, will benefit only those with incomes higher than 6.5 million yen a year ($40,620).

The others - 80 percent of Japan's salaried workers - will have their tax bite increased, he calculates. If this perception becomes general, the LDP and the government may find they have a real taxpayers revolt on their hands.

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