Prime Minister Yoshihiko Noda risks stalling the economy by pushing through his consumption tax increase, which may dampen spending even as it aids efforts to tame the world’s largest debt burden.
The recovery after last year’s earthquake and tsunami could grind to a halt in 2014 when the first increase will take effect, according to UBS AG and Itochu Corp.
The slump would be a repeat of 1997, when an increase in the tax contributed to pushing the economy into a 20-month recession, costing then Prime Minister Ryutaro Hashimoto his job.
“If there are no economic stimulus measures along with a consumption hike, we can see around zero percent growth in fiscal 2014,” said Takuji Aida, a Tokyo-based economist at UBS AG, who raised his growth forecast for the year ending in March 2014 to 2.9 percent from 2.2 percent because he sees a ¥4 trillion rise in consumption and investment ahead of the tax increase.
The Lower House on Tuesday approved a bill to raise the tax to 8 percent and then 10 percent in 2015 from 5 percent now.
A 1 percentage point increase in the tax would cut growth in real gross domestic product by 0.32 percentage point in the year after implementation, according to the Cabinet Office’s Economic and Social Research Institute.
Even with the tax increase, the government said in January it will probably miss its goal of achieving a primary balance surplus, which excludes debt-servicing costs, by fiscal 2020. It forecast a primary deficit of between 1.9 percent and 3.1 percent of GDP in that year, compared with the fiscal 2011 deficit of 7.4 percent.
Gross public debt will be 223 percent of GDP next year, up from the projected 214 percent in 2012, “pushing Japan’s public finances further into uncharted territory,” the OECD said in a report last month.
Japan’s benchmark 10-year yield was 0.805 percent at 12:50 p.m Wednesday. It reached 0.79 percent June 4, the lowest since June 2003 and the least globally after Switzerland’s. Five-year credit-default swaps for Japan’s bonds were 94 basis points Tuesday, having slid 12 basis points since Noda took office in September, according to data compiled by Bloomberg.
“Higher taxes will automatically shore up tax revenues even though an accompanying economic slowdown will somewhat reduce the amount collected,” said Hiroshi Watanabe, a senior economist at SMBC Nikko Securities. “Even so, Japan must raise the consumption tax to 16 to 17 percent if it wants to eliminate the budget deficit with taxes alone,” he said, adding that “the government simply has to slash spending.”
Moody’s Investors Service on June 20 said the government won’t eliminate the primary deficit without further reforms. It added that Japan may reach a “tipping point” where the market demands a risk premium for Japanese government bonds if the current political gridlock is not eliminated. Thomas Byrne, a senior vice president of the rating company, said the passage of the legislation was “credit positive,” although Japan still needs to increase revenue further.
“The upcoming sales tax increase would be a very tiny step forward for Japan’s fiscal reform,” said Azusa Kato, an economist at BNP Paribas in Tokyo. “Japan would need to increase the sales tax up to 25 percent just to avoid any further expansion of snowballed debt and avert a jump in bond yields.”
The bill was passed despite opposition from some ruling-party members who argued it may discourage spending. The legislation now goes to the opposition-dominated Upper House, where it is expected to be passed. Yet even Diet approval doesn’t necessarily mean the increase will be implemented.
The bill has a nonbinding stipulation that the higher tax rate will only go into effect if economic circumstances have improved. This could make the increase politically difficult to implement if growth decelerates next year from this year’s pace, which some economists expect.
“I really doubt they would dare raise taxes if we had growth at zero,” said Naomi Fink, head of Japan strategy at Jefferies Japan Ltd.
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