Japan’s Consumption Tax


The Japanese government played extremely carefully on the last round of consumption tax hike on October 1, from 8 to 10%. It was only 2% but the government never forgets bitter memories of two hikes in the past, which made a significant dent on economic growth, at least temporarily. The consumption tax was first introduced in 1989 at 3%.  It had little effect on the economy, since it was done in the middle of a boom, or bubble economy. In the next round, however, the first hike from 3 to 5% in 1997 brought the economy into a recession. It was ill-timed amid an exacerbating banking crisis. That memory instilled a deep scare among politicians’ minds on consumption tax rate hikes. The Japanese household sector has an habit of reacting violently to a modest tax hike. Hikes always grab headlines for more than several months into its implementation, obviously with a significant impact on consumer psychology.


Therefore, PM Abe and his government took extra cautions on a hike this time around, and the economy still contracted by a shocking 6.3% on an annualized basis for the October - December quarter. On top of the consumption tax, damages done by a super-typhoon in October also hit the economy hard. It was the deepest quarterly decline in economic activity since the April - June quarter of 2014, the last time the consumption tax was raised. So the media tends to conclude that a hike was a failure and it should never have been done. Few politician would dare to raise taxes. This one, along with the last one, however, has been written in a law for a long time. This hike was originally scheduled in 2015, and PM Abe backed off. He postponed a hike to 10% twice already.  On the second postponement in 2017 he was worried about a macro economic environment that he felt was akin to the eve of the global financial crisis in the previous decade. Few in the financial markets shared his concern, however. In fact, the Japanese economy in 2017 was in a better shape than it was two years later. He simply didn’t want to do it ahead of a general election, and missed a chance. In 2019, postponing it again would have dealt him a heavy political price.


This consumption tax hike is only a short-term aspect of Japan’s problem. The real problem is a shortage of Abenomics. At the end of 2012, when Shinzo Abe led the Liberal Democratic Party to retake the government, he fought an election with a newly created economic policy (Abenomics) that consisted of three arrows: monetary policy, fiscal policy and growth strategy. The Bank of Japan embarked on an aggressive monetary easing, and it proved to be even more aggressive than Ben Bernanke’s QEs. Fiscal spending was boosted, though a consumption tax rate was raised in 2014. The third arrow has not been seen yet. The market has stopped expecting it lately. Growth strategy is not easy to deliver for any politician. Only genuine structural reforms drive growth. Deep structural reforms in the short run inflict acute pains to the majority of the population, separates winners and losers and there are many more losers than winners. Only after some pains, benefits of reforms can be felt by the majority. Politicians generally do not afford to do deep structural reforms. In Japan there are usually two elections in three years, at the Upper or the Lower chamber of the Diet. While PM Abe still has political capital, having been the longest-serving prime minister in the history of the country, he has a strong interest in another issue: amending the Constitution. If he needs to choose one out of the two, he definitely picks the Constitution. It would be still extremely difficult to deliver in his remaining term that runs through the fall of 2021, amid the climate of the public on this issue. Therefore, the third arrow will not be shot. He continues to keep kicking the can down the road. He has lifted the Japanese economy out of persisting deflation, but he has proved incapable of moving it much further.


About the author: Ichiro Suzuki is a retired senior investment banker and sits on several university boards.


Recommended reading: Beyond Abenomics https://www.project-syndicate.org/commentary/japan-beyond-abenomics-by-akira-kawamoto-2020-02

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