Japan sales tax debate in final stage as deadline looms

TOKYO Dec 20 (Reuters) - Japan's government has entered the final stage of debate on doubling the 5 percent sales tax to pay for welfare costs, a welcome step towards fiscal consolidation that would still require further tax hikes and spending cuts to lower public debt.

Any delay in the sales tax proposal could draw the ire of ratings agencies, which earlier this year threatened Japan with downgrades.

The government has set itself a year-end deadline to flesh out a plan originally floated in June to reform welfare spending. Some of the details that have emerged so far, such as linking pension payments to Japan's falling consumer prices, would take some pressure off state coffers.

Lawmakers are still searching for consensus on which areas of welfare spending to expand, on the exact timing of sales tax hikes and on tax credits for low-income families.

"We have clear instructions to compile this proposal by year-end, so we'll proceed in cooperation with the tax panel," said Motohisa Furukawa, minister of economics and welfare reform.

"We will strengthen the areas of welfare that need to be strengthened and steamline what needs to be streamlined."

The ruling Democratic Party's initial proposal was to double the sales tax to 10 percent by mid-decade, on the assumption that the economy improves, and expand some spending on programmes for children and the elderly.

Japan's public debts are already twice the size of its $5 trillion economy, more dire than the countries at the heart of Europe's debt crisis.

Economists have said tackling welfare spending is unavoidable as it accounts for almost a third of the state budget and grows each year.

The government should set the approximate timing and amount of sales tax hikes in its final proposal, Hirohisa Fujii, chairman of the Democrat's tax panel, said last week. Still, the government needs to be flexible to appeal to opposition parties, he said, as their votes are needed in a divided parliament.

Prime Minister Yoshihiko Noda, a fiscal hawk, also needs to appeal to some members of his own party who oppose the plan.

Some Democrats argue that the economy won't be strong enough to withstand a higher sales tax. Others say that tax revenue won't rise much due to persistent deflation.

Noda's slumping public approval ratings are not helping his cause either.

The proposal still would not be ambitious enough to lower the ratio of gross debt to gross domestic product. It would only help keep that ratio stable, so further hikes would be needed.

Finance Minister Jun Azumi, as well as Fujii, have indicated they are willing to haggle into the final hours of the last day of the year to prevent the sales tax hike proposal from falling apart.

Standard & Poor's and Fitch have threatened Japan earlier this year with downgrades, and any delay in the sales tax proposal could hurt Japan's standing.

"The ratings agencies are not only looking for an agreement, they are also watching to make sure the proposal stands a chance of being enacted," said Shuji Tonouchi, senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities.

"From the government's perspective, that needs to make sure that the nerves surrounding Europe's debt crisis don't spill over to Japan."