Japan to sidestep funding in tax cut outline, keep fiscal concern alive

Japan's government plans to finalize an outline for a consumption tax cut and household payouts on Tuesday, without specifying how to finance the measures, potentially keeping alive worries about the country's already strained finances. The cabinet's approval of the tax cut plan is expected as global fiscal and inflation concerns pushed the benchmark 10-year Japanese government bond yield above the 3% threshold on Tuesday.

Prime Minister Sanae Takaichi's spending plans, combined with the tax cut, have already led to a bond sell-off and criticism from U.S. Treasury Secretary, Scott Bessent. Takaichi has pledged to limit new government bond issuance to around 40 trillion yen for the fiscal year 2027 budget, a target already facing scrutiny due to the already ballooning expenditure.

The total debt issuance for next year is difficult to predict, leaving markets jittery until the cabinet's approval of the draft budget at the end of the year. The tax cut plan aims to slash the 8% levy on food to 1% for two years from April 2027, with payouts compensating for the remaining 1% tax burden, essentially eradicating the tax on food purchases.

Japan will not resort to deficit-covering bonds to support the tax cut and will instead seek funding from non-tax revenues and reviews of existing subsidies and tax breaks. The tax cut, a key part of Takaichi's strategy to alleviate the impact of rising living costs on households, will create a revenue gap of approximately 5 trillion yen, and the outline will serve as a basis for legislation to lower the tax levy, which is set to be submitted to parliament, expected to convene next month.