Japan Institute for National Fundamentals

Speaking out

Etsuro Honda

【#1095】Sound Public Finances Do Not Mean Balanced Budget

Etsuro Honda / 2023.11.29 (Wed)

November 27, 2023

Article 4 (1) of Japan’s Public Finance Act, the basic law on national finances, provides for the balanced budget principle that denies dependence on government bonds, while exceptionally allowing the issuance of government bonds for such purposes as public works within an amount of money approved by the National Diet. The exceptional allowance is called the “principle of construction bonds.” In fact, however, Japan has almost annually enacted a special law to issue special deficit-financing bonds to cover some of ordinary expenditure. In recent years, laws have been enacted to provide the legal basis for issuing special deficit-financing bonds over multiple fiscal years.

In addition to the above-mentioned Public Finance Act, Article 3 (1) of the Act on Establishment of the Ministry of Finance stipulates that the ministry is responsible for “ensuring sound public finances.” However, there has been no definition of sound public finances, leading to a widespread misconception that sound public finances mean a balanced budget.

Public Finance Act reflecting non-war mentality

There is a consensus that public finances should perform the following three functions: (1) to provide public goods and services (resource allocation function), (2) to correct income disparities among people through a graduated tax system, etc. (income redistribution function), and (3) to smooth economic fluctuations (economic stabilization function). A recent trend is to understand that securing sound public finances means that the three functions are fully exercised. It is called a functional finance theory. In this case, whether a budget is balanced is not important.

The balanced budget principle has a surprising origin. The Public Finance Act was enacted along with Japan’s constitution under the rule of the General Headquarters of the Allied Powers (GHQ) just after the World War II. Heiji Hirai, former head of the Legal Division of the MOF Budget Bureau, who was involved in the drafting of the Public Finance Act, in his commentaries on the act said: “Article 4 of the Public Finance Act aims to prevent the risk of war through public finances as well as maintaining sound public finances. There is no war where there is no public debt. The article intends to endorse the renunciation of war in Article 9 of the constitution.”

“Budget and Public Finance Act” (by Takeshi Komura, former Vice Finance Minister), which can be called the bible of current MOF officials, also says, “[Article 4 of the Public Finance Act] stipulated the principle of sound public finances, but one of the triggers was the reflection on the massive issuance of public bonds for military spending before and during the war.” The description reflects a non-war atmosphere at the time of the act’s enactment.

Sustainable fiscal management is a must

If the issuance of special government bonds is denied, it is impossible to wage a war, for sure. However, as is clear from the current international situation, a war can occur even if Japan is denied the ability to fight back. No one says that a balanced budget is more important than the survival of a nation. If someone says so, it is like putting the cart before the horse.

Fiscal management must maintain first and foremost the sustainability of public finances. It is the minimum requirement for sound public finances. In order to meet the condition of sustainability, it is necessary to completely break away from deflation and maintain a nominal economic growth rate that exceeds the interest rate on government bonds. There is no problem with leaving a balanced budget as a long-term goal.

Etsuro Honda is a member of the Planning Committee of the Japan Institute for National Fundamentals and a former special adviser to the cabinet. He is also a former ambassador to Switzerland. He advised then Prime Minister Shinzo Abe for the success of Abenomics.