Hosokawa to Push $49-Billion Tax Cut to Spur Japan Economy : Asia: Prime minister also announces hike in consumption tax to 7%, which threatens to cause domestic political chaos.

Japanese Prime Minister Morihiro Hosokawa early today announced a $49-billion income tax cut to kick-start Japan’s foundering economy, but a new welfare levy to finance it could irreparably shatter his fragile ruling coalition.

The tax reduction has long been urged by Japan’s industrial and trading partners to combat Japan’s worst recession in two decades. The United States has made a Japanese tax cut one of the key points in its campaign to open up Japan’s markets to American products. The tax cut measure is the centerpiece of an estimated $140-billion stimulus package that will be announced later today and will require approval by Parliament.

But a new, 7% “people’s welfare tax” on goods and services, to replace the 3% consumption tax in April, 1997, drew sharp opposition from the Socialists. It may lead to political chaos just days before Hosokawa’s Feb. 11 summit with President Clinton.

Tomiichi Murayama, Socialist Party chairman, hinted that all six Socialist ministers would resign from the Cabinet in protest and that the party may leave the coalition. He also said it would be “very difficult” to win support from Socialists for next year’s budget.

The Socialists wanted to finance the tax reduction with deficit-financing bonds, an idea adamantly opposed by the conservative Finance Ministry. The idea to basically rename the consumption tax and increase it from 3% to 7% was reportedly pushed by Ichiro Ozawa, leader of the Japan Renewal Party.

The sudden manner in which it was announced--in the wee hours of the morning--was criticized not only by the Socialists but also members of Hosokawa’s Japan New Party and New Party Harbinger members. Critics also said the government should have first looked for ways to cut expenses before seeking a tax increase.

Japanese stocks gave up early gains in today’s trading on concern that the government coalition may fall apart. The benchmark Nikkei index lost 124.72 points to 20,125.31 during midday trading.

In Washington, Treasury Secretary Lloyd Bentsen welcomed the move, while awaiting its details. “I am pleased that Japan has come forward with a program to stimulate the economy, including a reduction in the income tax,” he said in a statement. “This is a step in the right direction.”

Clinton Administration officials have long pushed Japan to cut taxes to stimulate consumer spending and help shave Japan’s politically nettlesome $50-billion trade surplus.

But how much the tax cut will stimulate the economy is in question. Japanese consumers may decide to save the tax windfall instead of spend it, analysts said.

Nobuya Nemoto, an economist with Nomura Research Institute, called the tax cut “a little disappointing.” He said most economists had expected a larger cut of $65 billion. Because the present tax reduction will be offset three years later by a consumption tax increase, the net effect will be a $28-billion tax increase, he said.

But he estimated the total stimulus package would boost the gross national product by 1.4%, with an effect on par with earlier packages in August, 1992, and April, 1993.

Masamichi Omori, an economist with Daiwa Research Institute, forecast a modest stimulative effect and said consumption would “stabilize the economy and make the basis for an autonomous recovery.”

Hosokawa said the cut was not geared simply to stimulate the economy but also to reform the tax system in the face of Japan’s aging population.

Japan is aging faster than any nation in the world, and policy-makers have been scrambling to adjust to the changes by making government revenues less dependent on income taxes. Raising more revenue through consumption rather than income taxes will help insulate the national treasury when the number of retirees begins to mount.

“The current tax system is preponderantly based on personal income, and the burden on workers is large,” Hosokawa said.

Television commentators noted that the normally polished Hosokawa appeared weak and ill-at-ease during his news conference, and they speculated that he was over his head on economic issues.

The tax package represents the latest slap at the Socialists, the seven-party coalition’s single largest group. Earlier decisions to open Japan’s rice market and enact a political reform package over Socialist opposition infuriated party members. But Murayama and other leaders put up with the slights to maintain coalition unity. The tax increase, however, looks likely to prove the final straw.

If the Socialists bolt from the coalition, Hosokawa will be forced to rely on the opposition Liberal Democratic Party to help enact the budget, complete the reform package and other key policies.

Times staff writer James Gerstenzang in Washington contributed to this report.