Report of the Japanese Fiscal System Council on Recommendations for Fiscal Year Budget Formulation

List of Key Chapter Titles

1. General Overview of Public Finance
2. Issues in Formulating the FY2026 (Reiwa 8) Budget
3. Social Security
4. Local Public Finance
5. Defense
6. Diplomacy
7. Culture, Education, Science and Technology
8. Social Infrastructure Development
9. Agriculture, Forestry and Fisheries
10. Domestic Investment and Small and Medium Enterprises
11. Digital

Document Overview

This report was submitted by the Japanese Fiscal System Council and its Fiscal System Subcommittee to the Minister of Finance on December 2, Reiwa 7, with the aim of providing fundamental policy recommendations for the formulation of the FY2026 (Reiwa 8) budget and future fiscal management. Against the backdrop of the Japanese economy being at a critical juncture of transitioning from a "deflationary cost-cutting economy" to a sustainable "growth economy," the report emphasizes the necessity of balancing the dual objectives of economic revitalization and fiscal consolidation under the new environment of supply constraints, rising prices, and increasing interest rates, in order to build a "resilient economy."

The main body of the report is divided into two major parts. The first part, "General Overview of Public Finance," systematically assesses the current economic and price trends, the status of fiscal consolidation, and the basic approach to future fiscal management. The report points out that nominal GDP has exceeded 600 trillion yen, and the GDP gap has turned positive for the first time in a year and a half, suggesting that the Japanese economy is facing supply constraints. Although the primary balance (PB) deficit for the national and local governments has narrowed significantly, the debt-to-GDP ratio remains high (205.3%). The report focuses on analyzing the significant pressure that rising interest rates place on fiscal sustainability, warning that if interest rates are 1% higher than expected, interest payments could increase to 34.4 trillion yen by FY2034, equivalent to the current scale of social security-related expenses. The report reiterates the need to ensure strategic investment in key areas (such as defense, GX, AI/semiconductors) while reserving fiscal space to respond to unforeseen future "contingencies" and ensuring the credit rating of government bonds, which is crucial for the financing costs of both the nation and private enterprises.

The second part, "Issues in Formulating the FY2026 Budget," provides detailed budget formulation and reform recommendations for each policy area. Its core focus is on addressing the declining birthrate, aging population, and population decrease to ensure the sustainability of the social security system. The report strongly advocates for curbing the social insurance premium burden on the working generation, calls for structural reforms to the benefit and remuneration systems of medical and nursing care services to improve efficiency, and promotes the principle of "burden based on ability, not age." This includes reviewing the co-payment ratio for elderly patients, the insurance premium burden for late-stage elderly medical expenses, and the consideration of financial assets in ability-to-pay assessments. Regarding local public finance, the report notes that local fiscal conditions have improved significantly, but the disparity in fiscal capacity and administrative services among local governments due to tax revenue growth, particularly the issue of excessive concentration in Tokyo, needs urgent resolution, requiring the correction of tax source concentration.

The report also delves into defense and diplomacy issues in dedicated chapters. The defense section emphasizes that, against the backdrop of an increasingly severe security environment around Japan, it is essential to ensure that defense-related expenditures reach the target of 2% of GDP by FY2027, based on the National Security Strategy and the Defense Buildup Plan. The report also calls for the pursuit of efficiency and rationalization in defense budget formulation, reforming cost management in equipment procurement (e.g., utilizing cost databases, optimizing QCD evaluation) and the research and development system, and optimizing the Self-Defense Forces organization and improving personnel treatment amidst the population decline trend. The diplomacy section points out that in a complex international environment, Official Development Assistance (ODA), as a primary diplomatic tool, needs enhanced project management capabilities and funding diversification to maintain international coordination. Throughout, the report is supported by extensive charts and data, embodying the principle of Evidence-Based Policy Making (EBPM), aiming to provide the government with a strategic and urgent framework for formulating the FY2026 budget.