On March 31, Japan’s National Diet enacted a comprehensive tax reform package, marking a significant shift in the nation’s fiscal policy. The reforms encompass a range of measures, including the introduction of a 4 percent Special Defense Corporation Tax, alignment with the OECD’s global minimum tax framework through the implementation of the Undertaxed Profits Rule (UTPR) and Qualified Domestic Minimum Top-Up Tax (QDMTT), and revisions to lease accounting standards. In doing so, the reforms not only promote corporate transparency and international alignment, but also represent a response to domestic pressures, from rising defense needs to the urgent task of supporting Japan’s shrinking and aging population.
The 4 percent surtax with regards to defense is particularly unusual given the historical context of the Japanese military. Since the end of World War II, Japanese society has been both culturally and legally pacifist, with severe restrictions imposed by Article 9 of Japan’s Constitution. However, Foreign Minister Iwaya Takeshi has stated that “Japan now faces the most severe and complex security environment since the end of World War II.” As a result, Japan has been undergoing a transition toward more robust defense policies.
Back in 2014, during the tenure of the late Abe Shinzo, Japan took a significant step by reinterpreting its constitution to allow for the “right of collective self-defense,” which gives the Japanese military permission to assist an ally that has been attacked by an adversary. Later during his time as prime minister, Abe made efforts to completely repeal Article 9, as he believed – along with other nationalists – that this part of the constitution severely restrained Japan’s armed forces in light of recent threats from North Korea and China.
In the last few years, Japan has made significant strides to increase defense spending in order to bolster its posture against its nearby adversaries. Last year, defense spending increased by more than 21 percent to $55.3 billion, reaching 1.4 percent of GDP. This was the largest annual increase since 1952, the year that Japan reclaimed its sovereignty from the United States. In that light, the recent surtax is simply another tool to generate revenue to ensure military readiness. Ultimately, the government of Japan is hoping that this surtax will provide additional funding in order to increase the defense budget to 2 percent of GDP by 2027.
This goal is not arbitrary. U.S. President Donald Trump has previously pressured allies to increase defense spending to meet NATO’s 2 percent target. In response, even non-NATO countries like Japan have moved in that direction, with the Japanese government now projecting that defense spending will reach 1.8 percent of GDP this year.
But while defense spending has dominated headlines, an equally important, though quieter, motivation behind Japan’s 2025 tax reforms is demographic survival. With one of the world’s fastest-aging populations and a shrinking workforce, the Japanese government is increasingly turning to tax policy as a lever to support families and encourage workforce participation. Recent reforms have expanded income thresholds for dependents, increased basic tax deductions, and extended housing incentives, measures aimed not only at easing financial pressures, but also at revitalizing household stability in a country facing long-term population decline.
In particular, the 2025 tax reforms introduce targeted measures to alleviate financial burdens on families, particularly those with college-aged dependents. A notable change is the introduction of a “special deduction for specific dependents,” allowing taxpayers to claim deductions for dependents aged 19 to 22 even if their income exceeds previous thresholds. This adjustment acknowledges the financial realities faced by students and their families, aiming to provide continued tax relief and support for higher education expenses. This special deduction is not unique to Japan; during the U.S. presidential campaign last year, both current Vice President J.D. Vance and former Vice President Kamala Harris proposed expanding tax credits as a means to raise the nation’s declining birthrate.
While tax deductions offer direct support to families, Japan’s adoption of UTPR and QDMTT under the OECD’s Pillar Two framework plays a more structural role in stabilizing public finances. These provisions ensure that large multinational companies pay at least a 15 percent effective tax rate on profits generated in Japan, limiting the ability to shift earnings to low-tax jurisdictions. With births falling another 5 percent in 2024 and social security costs rising alongside a rapidly aging population, securing a reliable tax base has become a fiscal imperative. By closing international tax loopholes, these reforms help Japan protect the revenue needed to sustain public services, including pensions and healthcare, in a society where fewer workers are supporting more retirees.
Japan’s tax reform efforts must also be understood in light of its staggering public debt, which is now over 200 percent of GDP, the highest among developed nations. This debt load peaked in 2020, reaching 261 percent of GDP before declining modestly after the COVID-19 pandemic ended. Nonetheless, with such a fiscal overhang, policymakers face a delicate balancing act: offering tax relief to families and small businesses on one hand, while protecting the national tax base from erosion on the other. While the expanded deductions for dependents and low-income earners will reduce near-term revenues, the implementation of QDMTT and UTPR is expected to recapture a portion of that loss by ensuring that multinational corporations contribute a fair minimum tax. Although it’s unlikely that Pillar Two compliance alone will fully offset the revenue impact of demographic incentives, it helps Japan shift the tax burden away from households and toward globally mobile capital, an essential step in maintaining fiscal sustainability without further depressing domestic consumption.
Japan’s 2025 tax reforms, then, are not a collection of fiscal adjustments but a statement of intent. Faced with unprecedented demographic pressures, geopolitical uncertainty, and the burden of record-breaking public debt, Japan is using tax policy not only to stabilize its economy, but to redefine its role in the global order. From incentivizing family growth to enforcing corporate responsibility through global tax rules, the reforms reflect a country actively repositioning itself for the challenges of the 21st century. Whether these measures will be enough remains uncertain, but the ambition behind them signals a shift from reactive governance to proactive nation-building, one deduction, surtax, and structural safeguard at a time.
