TOKYO (Reuters) - Japan's corporate tax rate is among the highest in the world and getting companies to use more of their earnings to invest and hire is crucial to the economic renaissance promised by Prime Minister Shinzo Abe.
Yet the idea of slashing the corporate tax, floated by the government earlier this month, has received a lukewarm reception from analysts and policymakers, because of doubts over whether it would unleash enough investment to justify the loss of revenue.
To offset the economic impact of a politically unpopular plan to double the sales tax from 5 percent, Abe is considering, according to a Nikkei newspaper report on August 13, cutting the corporate tax rate to between 25 and 30 percent.
Corporate leaders have long called for lower taxes as a measure to shore up Japan's waning economic competitiveness.
Set at 38 percent for a large Tokyo-based corporation, Japan's corporate tax rate is well above the global average of 24 percent, as tracked by KPMG.
Keizai Doyukai, a leading business lobby, has urged lowering the rate to 25 percent.
But, critics, including Finance Minister Taro Aso, question whether a tax cut would provide much of an economic boost, while others warn that it could worsen Japan's fiscal position.
SMBC Nikko estimates that lowering the corporate tax rate by 10 percentage points would cost the government some 2.5 trillion yen ($25.74 billion) in lost tax revenue, more than double the forecast 1 trillion yen boost to economic output.
Tomo Kinoshita, chief economist at Nomura Securities, said a corporate tax cut would help make Japan more competitive over the longer haul. "However, we need to recognize that it's costly," he said.
Keidanren, the lobby group considered the voice of big business in Japan, wants the Abe administration to consider reducing the tax as it begins work next month on a package of measures intended to spur growth.
Currently, the only planned cut in the corporate tax will come when a surcharge for rebuilding earthquake hit areas expires in 2015, which would bring it down to 35.6 percent.
Cutting corporate tax could prove politically controversial as Abe would effectively be asking consumers, paying a higher sales tax, to subsidize corporate earnings.
"If you lower the corporate tax rate on top of increasing fiscal spending you are eroding the meaning of raising the sales tax," said Masahiro Nishikawa, a fiscal policy expert in the securities division of Goldman Sachs in Japan.
Moreover, there is no guarantee that a tax cut would convince companies to invest more, given how much cash they have been hoarding.
Taken as a whole, Japan's corporations outside the financial sector had 225 trillion yen - almost $2.3 trillion - in cash as of the end of March, according to data from the Bank of Japan.
They have been building that surplus steadily since the 2008 credit crisis, suggesting a deep-seated caution about whether Japan's current recovery will be sustained.
For comparison, corporations in the much larger U.S. economy had liquid assets of just $1.8 trillion, according to the Federal Reserve.
After a decade of slow growth and deflation, fewer than 30 percent of companies actually pay corporate tax.
The rest are either unprofitable, or they are able to apply tax credits accumulated from losses incurred during the lean years.
The overhang of cumulative losses, which companies can use to defray future tax obligations, currently totals around 76 trillion yen ($776 billion), according to National Tax Agency data, having come down from a peak of 90 trillion yen in 2008.
Japan Airlines (9201.T), for example, is holding on to 348 billion yen in cumulative losses stemming from its bankruptcy in 2010.
Firms used 9.7 trillion yen of tax credits against those losses to lower their tax burden in the fiscal year that ended in March 2012, roughly equal to the total amount of corporate income tax that went into the state coffers.
Lowering the tax rate would require companies that have booked losses as deferred tax assets to write down the value of those assets to reflect expectations that income taxes will be lower in the future.
As earnings have improved some companies have run down their credits. Two of Japan's largest banks, for example, just started paying tax again last year following a tax-free decade.
Sony Corp (6758.T) and other struggling consumer electronics makers have in recent years written down tax assets to account for expectations of lower future taxable income, but the overall industry remains vulnerable to further write downs given a large overhang of tax credits, analysts said.
"Any company that has large deferred tax assets on its balance sheet will have an exercise of writing down those assets," said Marc Lim, partner at accounting firm PwC Japan.
"That is going to then be flushed to the bottom line and impact earnings per share." Lim said.
Write-downs stemming from a tax rate change are unlikely to be sizeable enough to be a serious problem for Japanese companies, but it could help widen the gap between strong and weak firms, said Jesper Koll, head of Japanese equity research at JPMorgan.
"It speeds up the good versus the bad. That's sort of a nice technicality about the whole thing," Koll said.
($1 = 98.0550 Japanese yen)
Additional reporting by Takaya Yamaguchi and Kevin Krolicki; Editing by Simon Cameron-Moore