Photo/Illutration Prime Minister Sanae Takaichi and Democratic Party for the People leader Yuichiro Tamaki sign an agreement to raise the “annual income wall” in the Diet on Dec. 18. (Takeshi Iwashita)

The ruling Liberal Democratic Party and the opposition Democratic Party for the People on Dec. 18 agreed to raise the level at which income tax is levied to 1.78 million yen ($11,430) next year.

They also agreed to abolish the “environmental performance levy” in the automobile tax, which is incurred when one buys a vehicle.

Prime Minister Sanae Takaichi and DPP leader Yuichiro Tamaki exchanged a written agreement, pledging to “pass the fiscal 2026 tax reform bill and the fiscal 2026 budget early within this fiscal year.”

“I myself, from the perspective of building a strong economy, made the final decision in order to realize a virtuous cycle in which incomes are increased, consumer sentiment is improved, and business profits rise,” Takaichi told reporters after the meeting.

Regarding the government’s initial budget draft for the next fiscal year, Tamaki said at a news conference, “We would like to cooperate firmly toward its passage.”

TAX THRESHOLD INCREASE

The minimum level for income tax is a tax-exempt threshold that combines the “basic deduction,” based on the principle of not taxing minimum living expenses, and the “employment income deduction,” which subtracts an estimate of expenses for company employees and others.

This “annual income wall” had long been fixed at 1.03 million yen. But the three parties of the LDP, DPP and Komeito agreed late last year to raise the level, aiming for 1.78 million yen.

The threshold was increased to 1.6 million yen this year.

Under the LDP-DPP agreement, the minimum amounts for the basic deduction and employment income deductions will be raised by a total of 80,000 yen next year to account for price increases.

Furthermore, the parties agreed to add an extra 100,000 yen to the threshold for a limited time from 2026 to 2027.

At the DPP’s insistence, the extra amount was targeted not only at the low-income bracket but also at those with an annual income of up to 6.65 million yen. This covers about 80 percent of salary earners in Japan.

“Amid the current difficult situation with high prices, many taxpayers will see a definite increase in their take-home pay,” Takaichi said.

ENVIRONMENTAL LEVY ABOLISHED

The environmental performance levy ranges from zero to 3 percent of a vehicle’s price and is based on such things as fuel-efficiency.

The LDP’s Research Commission on the Tax System had planned to suspend the levy for fiscal 2026 and 2027.

However, the party decided to abolish it permanently in response to demands from the DPP, which has deep ties to the auto industry.

Automakers had been requesting its abolition to increase demand for replacement vehicles.

POLITICAL CALCULATIONS

However, the LDP-DPP agreement did not specify a funding source to compensate for the decrease in tax revenue.

The LDP is expected to compile its reform outline by Dec. 19.

The chairs of the tax system research commissions of both the LDP and DPP held intermittent discussions from the morning of Dec. 18.

The LDP wanted to limit the 1.78 million yen target to the low-income bracket, but the DPP demanded its expansion to the middle-income earners.

As the talks remained deadlocked, Takaichi instructed Itsunori Onodera, chair of the LDP’s Research Commission on the Tax System, to “work it out thoroughly to gain approval.”

The LDP then made a “complete concession” in a move aimed at securing passage of the fiscal 2026 budget.

Although the ruling coalition of the LDP and Nippon Ishin (Japan Innovation Party) has a majority in the Lower House, it remains six seats short of a majority in the Upper House.

The DPP holds 27 seats in the Lower House and 25 seats in the Upper House.

The tax reform is expected to reduce revenue by 650 billion yen, according to the government.

Officials said a funding source to cover the resulting shortfall was not specified because the expansion to middle-income earners is a temporary measure.

(This article was compiled from reports written by Tetsuya Kasai, Kohei Higashitani, Kanako Tanaka, Ryuhei Tsutsui and Yuki Minami.)

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