Japanese lawmakers rejected legislation to split up and sell the nation's postal service Monday, leading Prime Minister Junichiro Koizumi (search) to call snap elections next month. He promised to make the vote a referendum on his reform plan and pledged to resign if it fails.

The showdown could shake the ruling Liberal Democratic Party's grip on power, since defections from Koizumi's LDP helped defeat the postal plan on a 125-108 vote in the upper house of Parliament.

It was a painful setback for the prime minister's longtime quest to privatize the postal service's savings and insurance businesses and open their $2.9 trillion in deposits to private investors. He hoped the move would provide a boost for the struggling economy, which is only now emerging from a decade-long slowdown.

"The upper house decided that postal privatization is not needed. So I would like to ask the general public whether it supports or opposes it. That's why I dissolved Parliament," Koizumi told reporters. "I will do my best to win the elections so that I can continue the reforms."

Koizumi said he would resign if the LDP did not win a majority in Parliament with its coalition partner, the New Komeito Party (search) in the Sept. 11 vote. Campaigning for the lower chamber's 480 seats begins Aug. 30.

Dissent over postal privatization revealed deep divisions within the LDP, which has held onto power almost without interruption since its founding in 1955. Some analysts speculated the reform debate during the campaign could split the LDP into separate camps.

The legislative package would have created the world's largest private bank, but opposition was strong among lawmakers who said the measure would cut postal services to rural areas and lead to layoffs among the 400,000 postal system workers.

They also said the huge new private bank to be created would drive other financial institutions out of business.

Proponents were disheartened.

"These were the bills that put us at the crossroads, whether Japan can create a small government or it is headed toward creating a big government," said Economy Minister Heizo Takenaka, the main architect of the reform. "The rejection is a major blow to Japan's future and its economy."

The opposition Democratic Party started gearing up for the Sept. 11 election, hoping to building on the strong gains it made in last year's upper house elections and in the previous lower house ballot in 2003.

"We've been steadily making efforts for this day," Democratic Party leader Katsuya Okada told members. "Now we have finally came to this opportunity to change the government."

Top LDP lawmakers tried to persuade Koizumi over the weekend not to go ahead with his threat to call elections if the postal reform was voted down, worrying about the divisions within their party.

"The results show the conscience of the upper house," said Shizuka Kamei, a leading LDP opponent of the reforms. "The prime minister should come to his senses. It will be bad for Japan if we do something like this over and over."

Parliament's lower house approved the postal bill last month by a razor-thin margin. The package would have privatized Japan Post by 2017, dividing it into private companies handling mail delivery, banking and insurance.

The $2.9 trillion in savings and insurance deposits held by the postal service have financed the massive public works projects that are central to the LDP's pork-barrel system, while the network of unionized postal workers has long been a bastion of support for the party.

Some opponents also said they were tired of Koizumi's heavy-handed attitude.

"It is extremely abnormal to tell lawmakers to vote for the bills or Parliament will be dissolved," said Tatsuo Kawabata, secretary-general of the Democratic party.

The vote could change the face of Japanese politics if, as some predict, the LDP splits over the reform plan.

The political crisis stirred memories of an eight-month period between 1993 and 1994 when a group of LDP lawmakers broke with the party and led to a non-LDP bloc holding control of the government for the only time in 50 years.