Japan boasts the lowest sales tax rate in the developed world, at 5 per cent. After scrapping an early version and going for decades without one, the government reintroduced a 3 per cent sales tax – technically a value-added tax – at the height of the bubble in 1989. Collapsing growth made officials nervous about tweaking it, but by 1997, ballooning debt prompted the government to raise the rate to 5 per cent. The economy slid into a recession, pushing Japan deeper into deflation and prompting a severe fall in fiscal revenue.
In truth, the reasons for the collapse after 1989 and the 1997 recession lie elsewhere. Huge domestic deleveraging pressures and recessions in the US, and subsequently in emerging Asia, were probably the real causes. But the impression sits deep.
At the very least, higher consumption taxes prompted a sharp wiggle in household spending. The first time around, spending roared by an annualised 12.6 per cent immediately before its implementation and contracted by 7 per cent in the quarter after. Similarly, in 1997, it jumped by 8.8 per cent and then fell by 13.2 per cent – hardly what an already fragile economy needs.
The Cabinet Office has raised its GDP forecast for 2013-2014 from 2.5 per cent to 2.8 per cent, but the expansion is bound to slow
If anything, raising revenue is an even more pressing need today. Gross public debt is by far the highest among advanced economies – almost 240 per cent of GDP. Without a boost to revenues, things will only get worse given ballooning social costs driven by a rapidly ageing population. In 2012, the previous government pushed through a law requiring the consumption tax to be hiked to 8 per cent in April 2014, then to 10 per cent in October 2015.
Strong, stimulus-fuelled growth over the first half of 2013 should make this easier to implement, but there are signs the growth is decelerating. True, the Cabinet Office has raised its GDP forecast for 2013-2014 from 2.5 per cent to 2.8 per cent, but the expansion is bound to slow. What’s more, officials warn that the current tax-hike plan would push growth down to 1 per cent in 2014-2015.
At least this implies that the tax hikes will not trigger another recession. Still, the voices for postponement are growing louder and the Prime Minister Shinzo Abe has deferred a final ruling, with press reports suggesting he could delay the decision until October 2013.
There are several options other than indefinite delay or full implementation. One is to raise the tax rate by 1 percentage point each year until 2018. This would presumably be less of a psychological blow to consumers than bigger, more immediate hikes, but it would also defer revenue gains further into the future.
Another idea is to stick to the current schedule but add another fiscal stimulus – perhaps 4 to 5 trillion yen. That’s roughly 1 per cent of GDP and about half the massive boost delivered in the January 2013 package.
But Japan really has two choices: start consolidating its huge fiscal imbalances as soon as possible or put off the pain and push debt yet higher for years to come. Even the Cabinet Office’s optimistic projections for implementing the tax hike as planned would not deliver a balanced primary budget balance by 2020.
This research was first published on 5 August 2013.