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A ‘stewpid’ time to raise VAT

by Kevin Rafferty

The International Monetary Fund has joined Japan’s Prime Minister Yoshihiko Noda and leading politicians and bureaucrats in laying down a remorseless softening up barrage of facts, figures, argument and just plain determination that the country’s consumption tax should rise as quickly as possible.

Noda wants to increase the tax from the current 5 percent to 8 percent by 2014 and 10 percent by October 2015. The IMF is arguing for 15 percent in steps.

Other economists claim that the tax may have to go to 20 percent or even higher to bring Japan’s debts under control. It’s tempting to ask who’s going to bid 22.5 or 25 or 30 percent.

But the way Noda, pushed by bureaucrats and now aided and abetted by the IMF, is doing things is — if I may coin a word — “stewpid,” meaning stupid to the point where his brain must have been boiled until stewed.

This is not to deny Japan’s economic plight, which is actually cancerously worse than most politicians understand. Recent news items show Japan beginning to unravel economically.

The government budget makes grim reading. For the fourth year in succession, revenue from issuing bonds will exceed the amount taken in taxes, and total outstanding government debt will hit ¥937 trillion (or $12.17 trillion, way more than twice Japan’s gross domestic product of $5.5 trillion).

For the first time in 30 years the country recorded a trade deficit last year, as the current account surplus plunged to the lowest level for 15 years. Japan was hit hard by the earthquake, tsunami and nuclear meltdown at home, and by flood damage to Japanese factories in Thailand.

Trade and current account surpluses are not sacred, and there have to be deficit countries to match surplus ones. But for Japan, where struggling economic growth has only been propped up by exports, the deficit is a cause for concern. The figures also show rising income from overseas investment, suggesting continuing hollowing out of Japan’s manufacturing industry and the prospect of further future trade deficits. The yen has remained at 76-77 against the dollar, encouraging big Japanese industrial companies to move production offshore.

The very pillars of Japan’s industry, including motorcars and electronics, have been badly hit. The three electronics giants, Sony, Sharp and Panasonic, are expected to make a combined loss of $17 billion in the first quarter of this year. Manufacturing has dropped to 15 percent of Japan’s GDP, but further hollowing out will do little for the economy or for jobs.

This is all bad enough, but the government predicted that Japan’s population, already declining, will fall from 128 million today to 87 million by 2060. That is an unprecedented decline for any modern country. More than 40 percent of the Japanese people living then will be over 65, a burden that no country has had to cope with.

The IMF coldly and clinically exposed the problems with Japan’s public finances. Debts are more than 200 percent of GDP, spending is running out of control because of ballooning health and welfare payments, and is going to get worse as the population ages.

Japan’s economy has performed poorly and overall tax revenue has fallen to 17 percent of GDP, the lowest in the Organization for Economic Cooperation and Development, the club of rich industrial nations, except for Mexico. Denmark is the highest at close to 50 percent, but most mainstream European countries are close to 25 to 30 percent, apart from Greece and Turkey.

Consumption tax is an easy revenue target, not least because it is so low. Japan’s rate is by far the lowest of all those countries that have a VAT-like tax on spending. The OECD average is just over 18 percent. The clinical IMF medicine is that Japan should use the four-S formula for the tax: to raise it “sooner rather than later”; in a stepwise fashion; in a sustained way; and keep it simple, meaning no exceptions for food, newspapers or children’s clothes, as apply, for example, in the United Kingdom.

The other advantage of using the consumption tax is that it is difficult to avoid, especially if it is imposed on everything, including everyday necessities. By imposing it on a step-by-step basis, to 8 percent, then 10 percent as Noda proposes, or 10, then 15, as the IMF would prefer, the theory is that might tempt people into spending more, rather than curbing purchases, in an attempt to buy before the tax goes up again. The IMF denied that the previous rise, from 3 to 5 percent, choked off Japan’s recovery in the 1990s.

Consumption taxes hit the poor and the elderly relatively harder than the high-earning employed, but one of the lessons of rapidly aging Japan is that the elderly are protected by welfare benefits that the country will not be able to afford for the coming generation.

The IMF notes: “Those over age 60 in 2005 are expected to receive ¥100 million more in net social benefits over their lifetimes than are those not yet born.”

But the IMF also has a track record of not being able to comprehend “the animal spirits”, the political sensitivities of people it reports on. This seems the case now. Opinion polls have consistently shown popular Japanese opposition to any tax rise. Peter Tasker of Arcus Research points out that, “You can’t get blood out of a stone.” He contends that the real cause of Japan’s fiscal deterioration has been the protracted economic slump and that higher taxes may yield less revenue.

Common sense might warn Noda and the IMF that if you signal a rise in the consumption tax in two years time and a bigger one in three years, people will be tempted to make big purchases now, stimulating the economy immediately, and then stop, risking a slump in two years time. People with limited budgets will cut spending even on essentials, risking recession and blowing a hole in the tax hopes.

Political common sense, if they had any, would tell Noda and his bureaucrats that they would have a better chance of gaining acceptance of tax increases if they took the Japanese people into their confidence instead of treating them like mushrooms. It is time for Noda to come clean and to spell out the economic and taxation options in an imaginative way.

This means crunching all the numbers and showing them to the people in detail, with alternatives, and encouraging a national debate. It means thinking beyond pork-barrel or big projects, like expensive fighter jets or shinkansen to nowhere, to prime the economy.

It means examining the plusses and minuses of sending manufacturing jobs offshore. Work done recently at Harvard Business School suggests that outsourcing cost U.S. company Kodak its competitive edge and threatens its life.

It means looking at economic reforms that will stimulate and reward the talents of the Japanese people, not just shunt them into dead-end or temporary jobs. It means raising the retirement age, and urging younger Japanese to think beyond their computer games that retreat into the virtual reality of the Galapagos.

Or that is what Japan will become, thanks to stewpid politicians and bureaucrats, aided and abetted by the IMF.

Kevin Rafferty is author of “Inside Japan’s Power Houses”, a study of Japan Inc and internationalization.