Prime Minister Shinzo Abe's Cabinet endorsed a nearly 5 trillion yen ($42 billion) defence budget for the year beginning in April as part of a record 96.3 trillion yen ($814 billion) total budget.
The budget must still be approved by parliament, but Abe's coalition holds majorities in both houses.
The 2 per cent rise in defence spending is the third annual increase under Abe, who took office in December 2012 and ended 11 straight years of defence budget cuts.
The increase mainly covers new equipment, including P-1 surveillance aircraft, F-35 fighter jets and amphibious vehicles for a new unit similar to the U.S. Marine Corps. The aim is to boost Japan's capacity to defend uninhabited islands in the East China Sea that it controls but which are also claimed by China.
The 2015 budget also covers the cost of purchasing parts of "Global Hawk" drones, planned for deployment in 2019, two Aegis radar-equipped destroyers and missile defence system development with Washington.
Abe favours a stronger role for Japan's military, despite a commitment to pacifism enshrined in the U.S.-inspired constitution drawn up after the country's defeat in World War II. Japan's defence guidelines were revised in December 2013 as tensions rose over the East China Sea islands.
Chinese patrol boats often visit waters near the islands, which are known as the Senkakus in Japan and as the Diaoyu islands in China.
China has been stepping up military spending, which rose 12.2 per cent to $132 billion last year, second only to the U.S. It also has a large and sophisticated defence industry.
Japan, meanwhile, is seeking to build up its defence industries with an eye toward the global market.
The defence budget is designed to achieve "seamless and mobile" defence capability that can respond to various contingencies, the ministry said in the Cabinet-approved budget plan. It will provide effective deterrence and contribute to stability in the Asia-Pacific region and improvement of the global security environment, the ministry said.
Abe's government must tread a fine line between spending enough to support economic growth and defence and slowing the rise in Japan's debt, which is the highest, proportionately, among industrialized countries.
As Japan's population quickly ages, welfare costs are soaring. Social security spending will account for about a third of the budget. The economy is in recession but the government has forecast growth at 1.5 per cent this year, after an estimated 0.5 per cent contraction in 2014.
To balance his conflicting priorities, Abe is increasing outlays targeting families and other households that are struggling as wages lag behind price increases. But he also intends to cut corporate income taxes by 2.5 percentage points in the fiscal year that begins April 1, to 32.11 per cent. Further cuts are planned.
The government is also tweaking tax rules to encourage elderly Japanese, who hold about 60 per cent of the country's 1.6 quadrillion yen ($13.6 trillion) in private savings, to spend more on their children and grandchildren.