Growth Acceleration through AI; Fiscal Balance should be attained in both the Earned Income Tax Credits (EITC) and the Defense Expenditures Increases

Hidenobu ISHIBASHI

  Principal Economist

Takashi MIYAZAKI

  Principal Economist

Mayuko ABE

  Senior Economist

Yuzuru FUKUSHI

  Principal Economist

Yuto KAJITA

  Principal Economist

Katsuaki OCHIAI

  Specially Appointed Fellow

2026/03/24

　We examine the Reform Scenario that simultaneously considers the expanded use of AI and policy reforms in our medium term economic forecast from FY2025 to FY2040. The Baseline scenario is a benchmark that assumes no further reforms and no changes of economic surroundings.
　While the expanded use of generative AI and the introduction of next-generation AI (Artificial General Intelligence, AGI) is expected, Japan’s relatively slow response compared with other countries and intensifying competition with China and others are likely to erode Japan’s competitiveness. As a result, the productivity gains from AI are projected to fall below their theoretical potential.
　On the policy side, an earned income tax credit (EITC) will be implemented at an early stage. To secure additional fiscal resources, an increase in household burdens—such as higher income taxation on high-income earners—is assumed. Consumption tax cuts are not adopted. In addition, the defense expenditures will be increased to 3.5% of nominal GDP by FY2035 (an increase of approximately ¥15 trillion compared with the initial budget for FY2026). The primary source of funding will be an increase in the Special Defense Corporate Tax, with overall fiscal balance assumed. Ultimately, it will be necessary to review taxation frameworks from the perspective of the responsibilities borne by both citizens and corporations in national defense.
　As a result, both potential and real GDP growth rates are expected to rise, but only to around 1%. The primary balance (PB) is projected to turn positive by FY2035, and the ratio of debt to nominal GDP shows signs of decline toward the end of the 2030s. Further reductions would require secured funding sources alongside measures to raise growth potential, particularly through expanded AI investment, startup support, work‑style reforms, wage increases, and higher public expenditure on education.