Japan Mulls Income Tax Hike From 2027 To Help Fund Defense

Japanese Prime Minister Sanae Takaichi’s ruling coalition is discussing raising income taxes from 2027 to help pay for higher defense spending, breaking a three-year stalemate on the issue as mounting geopolitical risks make it more urgent to secure funding sources.

The Liberal Democratic Party is proposing raising the income tax rate by 1 percentage point across all income brackets from January 2027 to help finance defense spending, according to a recent draft of its tax reform plans. The effective income tax rate would remain unchanged for now, as a reconstruction surtax introduced after the 2011 earthquake would be cut by the same amount, the proposal said.

Last week the LDP’s coalition partner Japan’s Innovation Party was still considering whether to support the idea, according to local media.

The ruling parties are in the final stages of compiling their tax reform package for the next fiscal year. Once signed later this week, it will be sent to the cabinet for approval, and then taken up for parliamentary debate early next year.

The decision would allow the government to lock in its long-delayed blueprint for funding expanded defense outlays. Under former Prime Minister Fumio Kishida, Japan agreed in 2022 to lift defense spending to 2% of gross domestic product by fiscal 2027, resulting in total outlays of ¥43 trillion ($277 billion) over the following five years. Japan initially planned to allocate about 1.8% of GDP this year, using 2022 as a base figure.

Takaichi announced earlier this year she would move the goal forward by two years to the current fiscal year, using ¥1.1 trillion from an extra budget to close the gap in budgeted funding. This fiscal year Japan is set to spend more than ¥10 trillion on defense, including the extra budget outlays.

Last year, the government decided to start raising tobacco and corporate taxes from April 2026 while shelving a decision on when to begin raising the income tax due to public opposition.

The move comes as some in Japan have begun to question the extent to which the nation can rely on the US for its security needs, an arrangement that stretches back to the end of World War II. Earlier this year, President Donald Trump urged allies to spend 5% of GDP on defense, although Trump welcomed Takaichi’s pledge to fast-track the increase in defense spending to 2% when he visited Japan in October.

Japan may soon face calls to revisit its defense spending target. Separately, Trump has also pressed Japan to shoulder more of the costs related to its hosting of US military bases, calling the current arrangement unfair. The two sides are expected to begin talks next year over the host nation support treaty, which expires in March 2027. Japan currently pays an average of ¥211 billion a year.

Japan’s focus on GDP as a measure for defense spending implies higher nominal outlays, as the economy has expanded to a record ¥609 trillion in nominal terms last year. That marks nearly a 9% increase from fiscal 2022, the reference year for the current goal.

Discussions over defense spending come as geopolitical tensions escalated since Takaichi said in parliament last month that a Taiwan crisis might constitute a “survival-threatening situation” for Japan, a description that could provide a legal justification for Tokyo to deploy its military alongside other countries if they chose to respond. Strains rose further this month after Japan said at least one Chinese fighter jet locked its fire-control radar onto Japanese aircraft. Beijing countered that Japanese jets interfered with its military exercises.

Japan’s annual tax reform process, a central fixture of domestic politics, typically begins with a draft prepared by the ruling parties. In addition to income tax changes, the coming overhaul may expand the scope of an additional income tax on the super rich by halving the tax-exempt threshold to ¥165 million, while raising the rate to 30% from the current 22.5%. The measure, slated for fiscal 2027, is expected to help offset roughly ¥1.5 trillion in lost revenue stemming from lower gasoline taxes.

The super rich in Japan often benefit from the comparatively lower 20% tax rate for asset sales.

Expected tax system reform measures for next fiscal year:

• Extending mortgage tax breaks by five years

• Allowing those under 18 to invest through the tax-free NISA or “Nippon Individual Savings Account” accounts

• Doubling the tax-free cap on company meal subsidies to ¥7,500 a month

• Introducing incentives for large-scale corporate investment, including immediate expensing and tax credits of up to 7% of investment value

• Excluding large companies from wage-growth related tax breaks

• Raising the departure tax to ¥3,000 from ¥1,000 from July 2026

Ruling parties often use the reform process to secure opposition backing for budgets by incorporating some of their policy demands. Reflecting a prior agreement with the Democratic Party for the People, the LDP is also weighing an increase in the tax-free income ceiling to ¥1.78 million from ¥1.6 million, according to Nikkei newspaper.

Takaichi’s coalition holds a razor-thin majority in the lower house after adding three independent lawmakers last month, but it still lacks control of the upper chamber. The weak position in parliament has made the ruling party more open to incorporating opposition demands to ensure the budget’s smooth passage. Takaichi’s cabinet still has solid public support, but her party hasn’t fared so well in surveys, limiting its room to sideline opposition voices.

Some of the proposed measures would reduce tax revenue, likely adding strain on public finances and stoking concerns over fiscal sustainability. Benchmark government bond yields have been hovering near multi-decade highs.

After rolling out the largest extra budget since pandemic restrictions were lifted, Takaichi and Finance Minister Satsuki Katayama said total bond issuance this fiscal year would stay below last year’s level, in an apparent attempt to reassure investors concerned about the nation’s debt levels.