Tax Credit

Although tax credits and income deductions have similar names, their tax-saving mechanisms are fundamentally different. An income deduction subtracts a fixed amount from taxable income, so the actual tax savings equals "deduction amount x tax rate." For example, a 100,000 yen income deduction at a 20% tax rate saves 20,000 yen. A tax credit, on the other hand, is subtracted directly from the calculated tax, so the deduction amount equals the tax savings. A 100,000 yen tax credit saves 100,000 yen regardless of the tax rate.

This difference affects high-income and low-income earners differently. Income deductions provide greater tax savings for those with higher tax rates, favoring high earners. Tax credits provide a uniform effect regardless of tax rate, making them less prone to income-based inequality. The increasing policy adoption of tax credits is driven by this fairness consideration.

Representative tax credits in Japan's tax system include the mortgage deduction (special deduction for housing loans), the dividend credit, and the foreign tax credit. The mortgage deduction allows 0.7% of the year-end loan balance to be deducted from income tax for up to 13 years, with any excess partially deductible from resident tax. The special resident tax deduction for Furusato Nouzei is also a type of tax credit, applied in a two-tier structure alongside the income tax donation deduction (income deduction).

A practical consideration is that tax credits have an application order. When combining the mortgage deduction with Furusato Nouzei, the mortgage deduction is applied first. If the mortgage deduction exceeds the income tax, the excess carries over to resident tax, potentially squeezing the Furusato Nouzei deduction allowance. To maximize both, it is essential to accurately determine the deduction ceiling through advance simulation.