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Legislation’s OK just start of long, rough road ahead

by Jun Hongo

Staff Writer

The countdown to raising the sales tax officially began Friday with the Diet passing the necessary legislation, but the move is just the start of a long road that still lies ahead.

Even the welfare ministry acknowledges that the consumption tax must be increased to 17.1 percent by 2075 if public pension reforms and a basic pension payout to raise benefits for low-income households are implemented as planned.

Some economists go as far as to argue that pushing the levy to between 20 and 25 percent will be necessary to dig Japan out of its deep fiscal hole.

The key bill that cleared the Upper House on Friday afternoon will see the current 5 percent sales tax climb to 8 percent in 2014 and then to 10 percent in 2015. Hiking the levy by 1 percentage point would generate an estimated ¥2.5 trillion in additional income to rein in public welfare costs that are swelling by ¥1 trillion a year as the population ages.

Prime Minister Yoshihiko Noda told a Diet committee the same day that raising the tax was a significant first step toward restoring Japan’s public finances by securing additional income to cover soaring social welfare costs.

But Tomoya Kondo, senior economist at Daiwa Institute of Research, pointed out that “cutting spending, as well as hiking the tax rate further, will both need to take place” if the government is serious about achieving a primary balance surplus in the near future.

Government officials and economists share the view that the nation still faces a tough battle in the years — and probably decades — ahead, especially since Japan’s workforce is shrinking as its society rapidly grays.

Because of the country’s low birthrate, which has remained below 1.4 for more than a decade, and the increasing life expectancy of Japanese, one out of every four citizens will be aged 75 or above by 2060, according to the Cabinet Office’s latest statistics.

While only 4.9 percent of the populace was 65 or older in 1950, the figure is projected to soar more than seven-fold to 39.9 percent by 2060, meaning health and other welfare payments will skyrocket in the coming decades.

Aside from the long-term fiscal challenges, analysts say hiking the sales tax will almost certainly have a negative impact on the economy in the near term.

“Obviously, consumer spending will fall while the government’s fiscal balance will improve” when the tax rate goes up, Daiwa’s Kondo told a seminar in Tokyo on Thursday.

History indicates the economy may pick up speed in the runup to the tax hike’s introduction, with consumers rushing to stock up on goods before the higher rate kicks in. For example, new residential construction spiked 11.8 percent in 1996 ahead of a scheduled sales tax increase from 3 to 5 percent the following year.

In a report released in May, Nomura Securities Co. projected that fiscal 2012 and 2013 will see “consumer spending, as well as housing and equipment investment, go up due to the rush” to spend prior to the hike.

But the pendulum could swiftly and violently swing back the other way, as was the case in 1997 — the most recent time the levy was raised — when the number of new housing starts fell 15.6 percent and another 13.6 percent the year after that.

The last consumption tax rise caused the economy to slip into a recession as soon as the new rate took effect and chilled consumer spending. With Dai-ichi Life Research Institute calculating the hike will impose an additional burden of around ¥165,000 per year on a family of four, some experts fear the same effect could happen all over again.

The economy “has caught a cold and is still sick in bed. If the government were to splash cold water (on it), that will induce a worse scenario” than even the 1997 downturn, Kensho Sasaki, a Japanese Communist Party lawmaker from the Lower House, told a Diet committee on tax reform in May.

Still, others claim that increasing the tax won’t have that much of a negative impact.

In his book “Shohi-zei ga Nihon wo Sukuu” (“Consumption Tax Will Save Japan”), which was published in June, economist Mitsumaru Kumagai argues that similar sales tax hikes in European countries since the 1980s resulted in only limited damage to their economic growth.

Meanwhile, Daiwa Institute of Research released a midterm economic outlook in July that predicted Japan would experience average gross domestic product growth of 1.4 percent over the next decade. The first five years after a tax hike is implemented would be volatile, the report warned, due to its short-term impact on consumer spending and as state-funded reconstruction work in the Tohoku region declines. However, it forecast that economic growth would subsequently pick up again.

One of the few issues most economists agree on is that the envisioned 10 percent levy is not nearly enough to cut the country’s ever-expanding fiscal deficit, which now exceeds 200 percent of GDP. And as bond issuances will exceed tax revenues for a third straight year in fiscal 2012, Japan’s mountain of debt will likely just keep on growing.