It’s only been three months since the consumption tax was hiked to 8 percent, but the ruling coalition is already expediting talks on another increase scheduled to come into effect in October next year.
Concerned that the tax hikes could harm consumer confidence, the ruling camp is mulling ways to alleviate the impact on low-income households, possibly by reducing the tax rate on daily necessities.
European countries have implemented such a system, but it has not been credited as an effective way to reduce the burden on the poor.
Furthermore, the Abe administration has not identified any alternate source to make up for the lost tax revenues.
Here are some issues about the special tax system:
Why reduce the sales tax on some categories?
Sales taxes are considered “regressive,” meaning they have a harsher effect on low-income people. Reducing the tax rates on items considered vital to everyday life, such as food and utilities, is supposed to offset this impact.
According to the OECD, 31 out of 33 of its member countries with a value added tax (VAT) or consumption tax have reduced rates ranging between 0 and 18 percent.
For example, France implemented VAT in 1967 and the current rate is 20 percent. Yet lower tax rates are applied to items such as newspapers, magazines and drugs (2.1 percent), books and food (5.5 percent), and public transportation, accommodations and dining out (10 percent.)
Other countries with reduced tax rates include Britain. While its current sales tax rate is 20 percent, it imposes a lower levy of 5 percent on domestic fuel and electricity. Furthermore, certain foods, water, newspapers, books, domestic public transportation and drugs carry no tax at all.
Why is it being discussed in Japan?
The first sales tax in Japan — at a rate 3 percent — came into effect in 1989, but since then reduced tax rates have never been implemented.
New Komeito, the junior partner of the ruling Liberal Democratic Party, insisted on introducing reduced rates when the consumption tax was raised in April, as it places emphasis on welfare.
While no reduced rates were included with April’s hike, the coalition camp did reach an agreement last year that lower rates on items for daily necessity will take effect “sometime” after the sales tax goes up to 10 percent.
The ruling camp earlier this month started conducting hearings with industries across the board as it will need some support from them to implement the system. With Prime Minister Shinzo Abe scheduled to decide by the year’s end whether or not to implement the second phase of the tax hikes in October 2015, the decision on reduced tax rates will have to be reflected in the ruling coalition’s tax guideline by the end of this year.
Reactions are mixed in the business community.
Groups such as Keidanren and the Japan Department Stores Association are against it, citing the ineffectiveness and complex nature of such systems. But other organizations such as the Central Union of Agricultural Cooperatives (JA-Zenchu) and the Japan Fisheries Cooperatives support it, hoping it will shore up consumption.
What are the points at issue?
The government is likely to apply reduced rates on food and beverages, which they consider to be daily necessities. Specific items might rice, soy sauce, miso paste, fresh produce, alcohol, processed food, dining out and snacks.
But it is difficult to define exactly what “daily necessities” are. For instance, a reduced rate may apply to luxury foods or expensive gourmet foods, which is not necessarily considered a daily necessity by many people. Others argue items such as dining out and alcohol are also not daily necessities. At the same time, it is unclear if takeout from a fast-food chain or pre-cooked meals from a supermarket are considered dining out or buying processed foods.
Deciding on exactly what are reduced tax items is so complicated that in several countries, for example, Britain, there are several lawsuits in progress.
In Britain, tax rates vary depending on the temperature of food and the law states that a supply of hot food is standard-rated if it “has been heated for the purposes of enabling it to be consumed at a temperature above the ambient air temperature.” Those items include tea and coffee. No tax is levied on purchases of cold food such as sandwiches, wraps, cakes and some cold milk-based drinks.
How will reduced tax rates impact tax revenues?
Last month, the ruling coalition’s tax panel presented eight potential models on how it would affect tax revenues.
According to their scenarios, the introduction of a reduced rate would incur losses in tax revenues ranging from a low of ¥20 billion to as much as ¥660 billion.
For example, if a tax rate cut of 1 percentage point is applied to all food and beverages, including alcohol, there would be an annual loss of ¥660 billion in tax revenue. The government’s coffers would lose ¥20 billion if a lower rate is applied to polished rice only or to rice, miso paste and soy sauce. If dining out and alcohol are eliminated from the reduced rates, the government would lose out on ¥490 billion in tax revenue.
Although the primary purpose of the sales tax hike is to fund the ever-increasing costs of welfare, the ruling coalition and the administration have not presented any alternate funding sources to mitigate those losses.
Would the accounting system have to be changed?
European countries with reduced tax rates have an invoice system in which the rate or amount of tax for each product is logged.
Experts say Japan needs a similar system because now the bills only log net amounts and do not separately specify details about the tax rate or amount.
If different sales tax rates are introduced, it would be necessary to log how much tax is imposed on each item in order for the government to collect taxes and prevent evasion.
However, some small and medium-size enterprises oppose introduction of such a system as they say it would lead to heavier administrative costs.
With all the efforts, will the reduced tax rates be effective to offset the harm to low-income earners?
OECD studies cite that most experts view reduced VAT rates are neither socially effective nor economically wise.
Toshihiro Nagahama, chief economist in Dai-ichi Life Research Institute’s economic research department, said reduced tax rates on food actually benefit high-income earners because well-off people tend to spend more on food.
“The system will not be effective in mitigating the negative impact on low-income people despite the amount of administrative work it requires,” Nagahama said. “But a reduced tax rate would appeal more to voters as it’s more visible and easier to understand.”
Would it be more efficient to redistribute the tax burden fairly among everyone, both rich and poor?
Some economists, including Nagahama, advocate tax credits in accordance with people’s salaries and asset levels rather than adopting reduced tax rates across all income levels.
In fact, when the consumption tax was raised to 8 percent in April, the government extended tax credits to some low-income people who at the time were not paying local taxes.
But it will be hard for the government to keep tabs on everyone’s incomes until 2016 when the Japanese version of a social security number system — dubbed “my number” — to keep track of incomes is brought in.
Even after the implementation, it will be hard to treat everyone completely fairly. That is because the “my number” system does not register one’s assets in a detailed manner. Therefore, people who have considerable assets but do not work could receive tax rebates.
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