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

Key Chapter Title List

1. General Overview of Public Finance
2. Challenges in Formulating the Budget for Fiscal Year Reiwa 8 (2026)
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, Small and Medium Enterprises, etc.
11. Digital

Document Introduction

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, aiming to provide fundamental policy recommendations for the formulation of the budget for Fiscal Year Reiwa 8 (2026) 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-oriented economy, the report emphasizes that in the new environment of supply constraints, rising prices, and increasing interest rates, it is essential to balance the dual goals of economic revitalization and fiscal consolidation to build a resilient economy.

The main body of the report is divided into two major parts. The first part, the 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 fiscal year 2034, equivalent to the current scale of social security-related expenses. The report reiterates the necessity to ensure fiscal space for responding to unforeseen future events and to maintain the credit rating of government bonds, which is crucial for the financing costs of both the nation and private enterprises, while strategically investing in key areas (such as defense, GX, AI/semiconductors).

The second part, Challenges in Formulating the Budget for Fiscal Year Reiwa 8, provides detailed budget formulation and reform recommendations for various policy areas. 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 restraining the social insurance premium burden on the working-age 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-sharing based on ability rather than age. This includes reviewing the co-payment ratio for elderly patients, the insurance premium burden for future beneficiaries of medical expenses, and the consideration of financial assets in ability-to-pay assessments. Regarding local public finance, the report notes that the financial situation of local governments has significantly improved, 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 through the correction of tax source concentration.

The report also delves into defense and diplomacy issues in dedicated chapters. The defense section emphasizes that amidst the increasingly severe security environment surrounding Japan, it is imperative to ensure that defense-related expenditures reach the target of 2% of GDP by fiscal year 2027, based on the National Security Strategy and the Defense Buildup Plan. The report simultaneously demands that defense budget formulation pursue efficiency and rationality, reform cost management in equipment procurement (e.g., utilizing cost databases, optimizing QCD evaluation) and the research and development system, and optimize the Self-Defense Forces organization and improve personnel treatment amidst the trend of population decline. The diplomacy section points out that in a complex international environment, Official Development Assistance (ODA), as a primary diplomatic tool, needs to enhance project management capabilities and achieve funding diversification to maintain international coordination. Throughout the report, extensive charts and data are used for support, reflecting the principle of Evidence-Based Policy Making (EBPM), aiming to provide the government with a strategic and urgent framework for formulating the fiscal year 2026 budget.