Watch Japan. Pressures are mounting on the Japanese government to put the economy back on the growth track. Everybody knows how to do this: cut marginal tax rates. Cut taxes on extra income. That decreases the punishment government inflicts on enterprise whenever it tries to expand. This is true supply-side policy: increase supply by cutting unnecessary costs. The ultimate supply-side policy is a zero marginal-tax rate: no taxes on any extra income, which means taxation within any year is a fixed cost, with zero taxes on productive activity. That implies no sales or income taxes, and a tax (or charge or assessment) only on fixed resources and on bad activities such as pollution. Clearly, the major and key fixed resource is land and its rent.
The Japanese government, like any government chosen by mass democracy, is geared to the political market for legislation, rather than benevolently choosing the best public policy. That implies that Japan will not go to the logical conclusion of supply- side policy to tax only land rent and pollution. But it is prepared to cut marginal tax rates to at least reduce the tax punishment of investment and growth. Even this partial measure will be effective. If the Japanese government enacts significant tax cuts, wait and watch: the Japanese economy will take off. The stock market will take off and perhaps the real-estate market, in decline for several years since the land bubble burst, will turn around. The Japanese growth machine will come roaring back.
A summit of 25 Asian and European leaders convened on Friday, April 3 in London to discuss the crisis in East Asia. The Japanese economy has suffered not only from the crash of its real-estate market but also from the East Asian depression. Steel production, for example, is down because the currency devaluations in East Asia has made Japanese steel more expensive. Bankruptcies in Japan have risen, especially in retailing, services, and construction, due to low consumer demand and because of difficulties in obtaining loans from banks. Many banks in Japan are trying to reduce, not increase, their loans. Thus, low interest rates and a low value of the Japanese currency, the yen, relative to the dollar, have not been sufficient to get the Japanese economy off its doldrums.
Moody's Investor Service indicated it may downgrade Japanese government debt from the top "Aaa" class. The Japanese stock market has fallen due to both bad economic news and political problems in the finance ministry. Japanese Prime Minister Hashimoto has put together a $124 billion economic stimulus program, but this did not include a tax cut. Sony corporation Chairman Ohga, warning that Japan's economy faces a collapse, has urged the government to cut taxes. At the conference, Hashimoto agreed that confidence in the Japanese and East Asian economies must be restored. He stated that "concrete measures will follow."
Often, the news is worst just before a turnaround. When you are in the bottom of a pit, the only way out is up. At the South Pole, all paths lead north. The Japanese government needs more than demand-side stimulus. A supply-side push is needed, and that is a tax cut, plain and simple. That's why a big tax cut is quite likely for Japan, and this will signal the recovery of the Japanese economy, and when Japan recovers, the rest of East Asia will follow.
That's the good news, but there is also bad news. Tax cuts alone will make an economy recover and grow, but the growth itself will not be sustainable because real-estate prices and interest rates will choke the growth. When East Asia recovers, the global economy boom will most likely go into overdrive, which will then make the world ripe for the biggest crash in global history. The recent economic history of Japan and East Asia confirms this, but sadly, people don't learn the right lessons from history, not unless they first get some basic lessons in real economics. If you haven't gotten this education, think about getting it.