📊 In August 2025, Japan's fiscal balance was projected to show a ¥3.6 trillion surplus. Just six months later, it has plunged to an ¥800 billion deficit. What happened?
Under Prime Minister Takaichi's "responsible expansionary fiscal policy," an over ¥18 trillion supplementary budget is shaking the foundations of Japan's fiscal equilibrium.
Why Primary Balance Matters
The primary balance (PB) measures how much of a country's policy expenditures can be covered by tax revenues without relying on government bonds. A surplus means the government can fund its services for that year without borrowing.
The Japanese government has long targeted achieving a PB surplus by FY2025 as its fiscal health goal. In July 2024, strong corporate performance and rising tax revenues finally brought this target within reach—or so it seemed.
The Dramatic Reversal to ¥800 Billion Deficit
On January 22, 2026, the Cabinet Office delivered a shocking projection at the Council on Economic and Fiscal Policy: Japan's primary balance for FY2026 would fall into an ¥800 billion deficit.
Compared to the August 2025 estimate forecasting a ¥3.6 trillion surplus, this represents a deterioration of approximately ¥4.4 trillion—equivalent to 0.7% of nominal GDP.
Key Factors Behind the Deficit
Massive Supplementary Budget
The primary culprit is the expansion of the FY2025 supplementary budget. The Takaichi administration assembled a package exceeding ¥18 trillion in general account spending—the largest since the COVID-19 pandemic. This economic stimulus package alone represents a ¥5.2 trillion drag on the primary balance.
"Income Wall" Tax Relief
The FY2025 tax reform raised the income tax exemption threshold (the so-called "1.03 million yen wall" increased to "1.23 million yen"), reducing tax revenues by approximately ¥700 billion.
FY2025 Deficit Also Worsens
The deterioration isn't limited to FY2026. The FY2025 deficit projection has also expanded dramatically from ¥3.2 trillion to ¥7 trillion. The government's target of achieving surplus by FY2025 has effectively become impossible to meet.
The Reality of "Responsible Expansionary Fiscal Policy"
Since taking office, Prime Minister Takaichi has championed "responsible expansionary fiscal policy" as her administration's cornerstone. She has moved to abandon single-year PB surplus targets in favor of a new framework that evaluates fiscal balance over multiple years.
Interestingly, the FY2026 initial budget (general account basis) actually shows a surplus of ¥1.3429 trillion—the first in 28 years since FY1998. However, this is strictly an "initial budget" figure; the picture looks different when supplementary budgets and actual settlement accounts are included.
Fiscal experts have raised questions about this "dual structure." The pattern of showing surpluses in initial budgets while maintaining deficits in combined national and local accounts has been criticized as evidence that fiscal health targets have become "formalities without substance."
Market Response and Interest Rate Risk
Concerns about fiscal discipline have contributed to rising long-term interest rates in financial markets. Japan's government debt stands at approximately 230% of GDP—by far the highest among G7 nations (even Italy, the worst among the rest, sits at around 136%).
The FY2026 budget allocates over ¥31 trillion for debt servicing, with the burden of rising interest rates becoming increasingly apparent. Market participants worry that further fiscal expansion could trigger credit rating downgrades.
Looking Ahead
The government aims to submit the FY2026 budget to the regular Diet session and secure early passage. However, with a minority ruling coalition, securing opposition cooperation may invite further spending pressures.
At the Council on Economic and Fiscal Policy, private-sector members have called for developing scenarios to "stably reduce the debt-to-GDP ratio." While the Takaichi administration has signaled a shift "from supplementary to initial budgets," whether the FY2026 supplementary budget can be constrained will be a crucial factor determining the trajectory of fiscal consolidation.
In Japan, the debate continues over balancing fiscal health with economic growth. Will "responsible expansionary fiscal policy" lead to sustainable economic management, or will it burden future generations? How does your country approach discussions about fiscal deficits and national debt? We'd love to hear your thoughts!
References
Reactions in Japan
They say PB surplus is the first in 28 years, but that's only the initial budget, right? It ends up in deficit with supplementary budgets anyway. Feels like they're trying to fool citizens with number tricks.
There's a theory that stimulating the economy with expansionary policy then paying back through increased tax revenue, but I honestly doubt it'll work in today's Japan. Interest rates are rising too.
Fiscal hawks always ignore how austerity worsens the economy. Escaping deflation comes first. The PB surplus target itself is misguided.
800 billion yen deficit sounds big, but it's only about 0.1% of GDP. Not worth panicking over. Economic growth should be the priority.
I wish they'd stop calling it 'national debt.' Government liability is also citizens' assets. Don't we need an MMT perspective too?
18 trillion yen supplementary budget is insane. Every year they lowball the initial budget then inflate it with supplements. Fiscal discipline is a joke.
Benefits and tax cuts were necessary for inflation relief. But fiscal deterioration is the natural consequence. Prioritizing is a political decision.
Rising long-term rates are scary. If bond interest payments keep growing and squeezing social security and other budgets, we're in trouble.
What's 'responsible' about Takaichi's 'responsible expansionary fiscal policy'? Seems like just pushing debt onto the next generation.
What happened to raising the income wall from 1.03 to 1.78 million? That would increase the deficit even more. Where's the funding coming from?
They've been saying Japan's finances are in trouble for decades, but we haven't collapsed yet. It's like the boy who cried wolf.
Defense spending and free education are necessary but revenues aren't growing proportionally. I want politicians to seriously discuss how to solve this dilemma.
Yen depreciation raises import prices and hurts people's lives. Fiscal stimulus provides temporary relief but doesn't feel like a fundamental solution.
MOF's tax hike agenda is problematic, but so is scatter-shot spending. Without smart expenditure paired with growth strategy, it's all meaningless.
Social security costs keep rising with aging population while tax revenues decline with population decrease. Without solving this structural issue, discussing PB is pointless.
Japan's 230% debt-to-GDP is mind-boggling. Even the US is only around 120%. But with the BOJ buying up so many bonds, it hasn't been an issue so far.
As a German, Japan's fiscal situation is hard to believe. We've valued 'Schwarze Null' (balanced budget). Though lately, even Germany is debating relaxing fiscal discipline.
The relationship between Japan's 'lost 30 years' and fiscal deficits is debated among economists. Some say austerity prolonged the recession; others say stimulus was insufficient.
Brazil also struggles with inflation and deficits. But Japan manages massive fiscal spending while maintaining low inflation. Must be the difference in national credibility.
Korea is also rapidly aging, so Japan's fiscal issues aren't someone else's problem. I'm watching closely how Japan navigates this challenge.
MMT supporters often cite Japan as a success story, but with long-term rates starting to rise, that argument might need revisiting.
Sweden recovered from its 90s fiscal crisis. Japan can also balance structural reform with fiscal consolidation. It's a matter of political will.
China also faces local government debt issues. There's much to learn from Japan's experience, though simple comparisons are difficult given different economic structures.
Italy has high debt-to-GDP too, but not like Japan. Yet we're bound by EU fiscal rules. Japan has flexibility with its own currency.
I heard most Japanese bonds are held domestically. That might contribute to fiscal stability. Canada has more foreign investors, so we're more vulnerable to market pressure.
In Denmark, we have high taxes but robust welfare. Japan tries to maintain low taxes while funding social security—isn't fiscal deficit inevitable?
India is growing fast, but Japan's aging demographics are our future challenge too. Balancing development with fiscal health is tough for any country.
Poland's economy grew partly with EU funding. Japan has no external support and must handle everything alone—that must be tough.
Mexico tries hard to control deficits, but we can't borrow at low rates like Japan. Seems like a developed country privilege.
Vietnam needs infrastructure investment for development. Japan's past public investment experience is instructive. But we must also learn that debt bills come due later.