The fight to finance Japan’s historic defense splurge

Japanese Prime Minister Fumio Kishida’s administration dramatically increased Japan’s 2023 defense budget by 26.3% in 2022 to 6.82 trillion yen (US$52 billion). During former prime minister Shinzo Abe’s leadership, the defense budget steadily increased to 5.3 trillion yen ($39 billion) but stayed between 5-5.2% of the whole government budget. Kishida has now increased the defense budget to 5.9%. Future obligations concerning new contracts for the updated Defense Build-up Program amount to 7.06 trillion yen ($52 billion). As procurement takes several years, Japan is making as many contracts as possible in the first year of the program to deliver equipment to the Self-Defense Force (SDF) units swiftly. As of May 2023, a month from the start of the Japanese financial year, the government had already announced a 380 billion yen ($2.8 billion) contract with Mitsubishi Heavy Industries to upgrade and mass-produce Type-12 surface-to-ship missiles. The government also signed a 110.4 billion yen ($816 million) contract with the United States to purchase 400 Tomahawk cruise missiles. In the next five years, Japan plans to spend 43 trillion yen ($330 billion) on defense. In 2027, the defense budget will reach 9 trillion yen ($66 billion), equivalent to 2% of Japan’s gross domestic product (GDP) in 2023. Though this means that Japan might not achieve its 2% GDP goal in 2027, Japan is poised to become the third-largest military spender in the world. Internationally, US President Joe Biden’s administration welcomes such Japanese efforts, and there are already voices requesting more. But domestically Kishida is carefully balancing Japan’s wallet and bullets. To cover the new defense spending increases, the Kishida administration squeezed 4.8 trillion yen ($35 billion) out of the 2023 financial surplus, spending cuts and non-tax revenues in the 2023 financial year. Out of these 4.8 trillion yen, 1.4 trillion yen ($10.3 billion) were allocated to the 2023 budget and the other 3.4 trillion yen ($25 billion) are being saved for spending over the next four years. Japanese Prime Minister Fumio Kishida rides on a Japan Ground Self-Defense Force Type 10 tank during a review at JGSDF Camp Asaka in Tokyo on November 27, 2021. Photo: JiJi The Japanese government runs on a single fiscal year basis, which is incompatible with saving money for the future. Hence the government is trying to pass a “bill on special measures for securing financial resources for the substantial reinforcement of Japan’s defense capabilities.” With this legislation, the government is now able to establish a Defense Reinforcement Fund, which will pool non-tax revenues for future defense spending. While the Ministry of Finance does its best to fund the defense budget within its rights, it cannot be said that these revenue sources are reliable. The Public Finance Law requires that at least half of the budget surplus in each fiscal year be allocated for the redemption of government bonds and the remainder has traditionally been used to finance the following year’s supplementary budget. While the budgetary surplus has increased recently due to the unused emergency Covid-19 fund, there is no justification to appropriate unnecessary items to intentionally make a surplus. Spending cuts will get harder due to aging society and increasing social welfare spending. Kishida also promises to double the child-related budget. One of the government’s non-tax revenue sources, the Foreign Exchange Fund, recorded a surplus because of the depreciation of the yen last year and the increasing interest rates in foreign currencies. Still, as this account’s purpose is to buffer the damage of volatility in foreign exchange, it is not guaranteed to increase the defense budget. Other non-tax revenues, including the Fiscal Investment and Loan Program or capitalizing government properties, are also unsustainable. The funding of defense expenditures has caused an ongoing struggle between the tax hike faction and the debt financing faction within Kishida’s ruling Liberal Democratic Party (LDP). In December 2022, the Kishida administration announced that it mobilized one-quarter of the defense budget increases from newly raised taxes following the Ministry of Finance line. This announcement frustrated LDP politicians who have criticized tax hikes and instead called to issue additional national bonds. Chairman of the LDP Policy Research Council Koichi Hagiuda said that the government has to do its best to find non-tax means before discussing taxation. LDP politician Shigeharu Aoyama also argued that a tax hike for the defense budget is not justifiable, saying that national defense is the responsibility of the state, not a beneficiary liability. Aoyama also dismissed the government’s labeling of tax revenue as a stable source of income, saying that it is heavily affected by economic circumstances. The anti-tax hike faction

The fight to finance Japan’s historic defense splurge

Japanese Prime Minister Fumio Kishida’s administration dramatically increased Japan’s 2023 defense budget by 26.3% in 2022 to 6.82 trillion yen (US$52 billion).

During former prime minister Shinzo Abe’s leadership, the defense budget steadily increased to 5.3 trillion yen ($39 billion) but stayed between 5-5.2% of the whole government budget. Kishida has now increased the defense budget to 5.9%.

Future obligations concerning new contracts for the updated Defense Build-up Program amount to 7.06 trillion yen ($52 billion). As procurement takes several years, Japan is making as many contracts as possible in the first year of the program to deliver equipment to the Self-Defense Force (SDF) units swiftly.

As of May 2023, a month from the start of the Japanese financial year, the government had already announced a 380 billion yen ($2.8 billion) contract with Mitsubishi Heavy Industries to upgrade and mass-produce Type-12 surface-to-ship missiles. The government also signed a 110.4 billion yen ($816 million) contract with the United States to purchase 400 Tomahawk cruise missiles.

In the next five years, Japan plans to spend 43 trillion yen ($330 billion) on defense. In 2027, the defense budget will reach 9 trillion yen ($66 billion), equivalent to 2% of Japan’s gross domestic product (GDP) in 2023.

Though this means that Japan might not achieve its 2% GDP goal in 2027, Japan is poised to become the third-largest military spender in the world.

Internationally, US President Joe Biden’s administration welcomes such Japanese efforts, and there are already voices requesting more. But domestically Kishida is carefully balancing Japan’s wallet and bullets.

To cover the new defense spending increases, the Kishida administration squeezed 4.8 trillion yen ($35 billion) out of the 2023 financial surplus, spending cuts and non-tax revenues in the 2023 financial year.

Out of these 4.8 trillion yen, 1.4 trillion yen ($10.3 billion) were allocated to the 2023 budget and the other 3.4 trillion yen ($25 billion) are being saved for spending over the next four years.

Japanese Prime Minister Fumio Kishida rides on a Japan Ground Self-Defense Force Type 10 tank during a review at JGSDF Camp Asaka in Tokyo on November 27, 2021. Photo: JiJi

The Japanese government runs on a single fiscal year basis, which is incompatible with saving money for the future. Hence the government is trying to pass a “bill on special measures for securing financial resources for the substantial reinforcement of Japan’s defense capabilities.”

With this legislation, the government is now able to establish a Defense Reinforcement Fund, which will pool non-tax revenues for future defense spending.

While the Ministry of Finance does its best to fund the defense budget within its rights, it cannot be said that these revenue sources are reliable.

The Public Finance Law requires that at least half of the budget surplus in each fiscal year be allocated for the redemption of government bonds and the remainder has traditionally been used to finance the following year’s supplementary budget.

While the budgetary surplus has increased recently due to the unused emergency Covid-19 fund, there is no justification to appropriate unnecessary items to intentionally make a surplus.

Spending cuts will get harder due to aging society and increasing social welfare spending. Kishida also promises to double the child-related budget. One of the government’s non-tax revenue sources, the Foreign Exchange Fund, recorded a surplus because of the depreciation of the yen last year and the increasing interest rates in foreign currencies.

Still, as this account’s purpose is to buffer the damage of volatility in foreign exchange, it is not guaranteed to increase the defense budget. Other non-tax revenues, including the Fiscal Investment and Loan Program or capitalizing government properties, are also unsustainable.

The funding of defense expenditures has caused an ongoing struggle between the tax hike faction and the debt financing faction within Kishida’s ruling Liberal Democratic Party (LDP). In December 2022, the Kishida administration announced that it mobilized one-quarter of the defense budget increases from newly raised taxes following the Ministry of Finance line.

This announcement frustrated LDP politicians who have criticized tax hikes and instead called to issue additional national bonds. Chairman of the LDP Policy Research Council Koichi Hagiuda said that the government has to do its best to find non-tax means before discussing taxation.

LDP politician Shigeharu Aoyama also argued that a tax hike for the defense budget is not justifiable, saying that national defense is the responsibility of the state, not a beneficiary liability. Aoyama also dismissed the government’s labeling of tax revenue as a stable source of income, saying that it is heavily affected by economic circumstances.

The anti-tax hike faction insists on using government bonds for defence build-up, including construction bonds, which have been used for Japan Coast Guard shipbuilding.

Japanese navy ship flying flag. Photo: iStock
A Japanese navy ship flying its flag. Photo: iStock

Answering these demands, the government has provisionally approved using construction bonds for defense, including 245.4 billion yen ($1.8 billion) for Ministry of Defense and SDF facilities and 188.8 billion yen ($1.4 billion) for shipbuilding.

But this is still only 1% of the 43 trillion yen ($330 billion). Other politicians have several ideas to source funds, such as accepting donations, removing the redemption period of the national debt and issuing defense bonds, which Abe suggested before his passing. Still, Minister for Finance Shunichi Suzuki is cautious of these measures, and the Ministry of Finance remains hesitant to rely on bonds.

The government may have to choose between raising taxes or debt financing, which includes expanding the coverage of construction bonds for more SDF facilities or issuing historic defense bonds for its defense build-up if it cannot mobilize the necessary capital as planned.

While the Japanese government has to make its economy resilient against higher inflation rates in the case of debt financing, it must also accomplish economic growth in the case of a tax hike. The monetary policies of the Bank of Japan, which already holds almost half of all government-issued bonds, may also be the key.

While the discussion on defense spending figures and SDF capabilities remains important, scholars must also continue to closely monitor the relationship between Japan’s economic situation and defense policies.

Ryosuke Hanada is PhD candidate in the Department of Security Studies and Criminology at Macquarie University.

This article was originally published by East Asia Forum and is republished under a Creative Commons license.