Japan to Approve Tax Cut Outline Without Funding Details, Stirring Fiscal Worries

Japan's government is poised to approve an outline for a consumption tax cut and household payouts on Tuesday, but the plan is set to leave unanswered how the measures will be financed, according to a draft seen by reporters. The omission is likely to sustain market unease over the country's already stretched public finances.

The cabinet's approval comes as global fiscal and inflation worries pushed the benchmark 10-year Japanese government bond yield above the closely watched 3% mark on Tuesday.

The tax cut would add to Prime Minister Sanae Takaichi's ambitious spending plans, which have already triggered a bond sell-off and drawn criticism from U.S. Treasury Secretary Scott Bessent. Takaichi's pledge to cap new government bond issuance at around 40 trillion yen ($258.7 billion) for the fiscal 2027 budget is under scrutiny, with expenditure expected to rise from budget requests that have already swelled to pandemic-era levels.

"It's hard to pre-empt the total size of next year's debt issuance, so markets will remain jittery until cabinet approval of the draft budget expected at the end of this year," said Keisuke Tsuruta, senior bond strategist at Mitsubishi UFJ Morgan Stanley Securities.

Japan currently levies a 10% consumption tax on most goods and services, with food items charged a reduced 8% rate. The outline will detail a plan to cut the 8% levy on food to 1% for two years from April 2027, supplemented by payouts equivalent to the remaining 1%, effectively eliminating the tax burden on food purchases, according to a draft approved at a ruling party panel last week.

The government will not rely on deficit-covering bonds to fund the tax cut, instead seeking funding from non-tax revenues and reviews of existing subsidies and tax breaks, the draft said. The tax cut, a centrepiece of Takaichi's efforts to ease the impact of rising living costs on households, creates a revenue shortfall of roughly 5 trillion yen.

The outline will serve as a basis for legislation to lower the tax levy, which will be submitted to parliament, expected to convene next month.