With the consumption tax rate raised from 5 percent to 8 percent on April 1, attention is focusing on whether the economic uptrend can survive the increased burden on households and the expected falloff in consumer spending. But it also needs to be closely watched whether the tax hike — the first of a planned two-stage increase that would eventually raise the tax rate to 10 percent from October 2015 — will be matched by other efforts to improve the nation’s dire fiscal conditions and ensure the sustainability of its social security systems.
The first hike in the consumption tax in 17 years comes just as prices are rising under Prime Minister Shinzo Abe’s quest to end the state of deflation that has plagued the economy. It is estimated that the tax hike plus the higher costs of imports and utility charges due to the weak yen will raise the financial burden on households by an average 4 percent. Although some leading firms with improved earnings have given employees their highest raises in years, the overall wage increase for the nation’s workforce is unlikely to cover rising costs.
While consumer spending is estimated to have picked up in the last quarter as people rushed to buy ahead of the tax hike, the anticipated slump in consumption starting this month is widely forecast to put the nation’s economic growth in negative territory in the April-June period.
The Abe administration says it’s ready to mobilize policy measures — including front-loading of government spending for fiscal 2014 — to keep the recovery from losing steam. The prime minister is supposed to decide by the year’s end whether to go ahead with the second phase of the tax hike by monitoring the course of the economy in the coming months.
Despite concerns about the negative effects of the consumption tax raise, the government says the tax hike is necessary to cover rising social security costs and rebuild the fiscal health of the nation, whose debts have climbed to the worst level among industrialized economies.
By law, all the additional consumption tax revenue is to be used on social security programs such as pensions, medical services and nursing care. While a 3 percentage point hike in the tax is estimated to generate ¥8.1 trillion a year, the revenue increase in fiscal 2014 is expected to be ¥5.1 trillion due to the gap in government and business accounting years.
But the tax hike does not necessarily translate into improved social security services. In fact, only 10 percent of the revenue increase will be spent in fiscal 2014 on expanding the services, including some ¥300 billion budgeted for building day-care facilities for children. Much of the remainder is to be used to cover part of the funding shortfalls in existing programs that had earlier been covered by government debts.
The government’s social security expenses continue to rise by roughly ¥1 trillion each year because of the rapid aging of population and topped ¥30 trillion in the fiscal 2014 budget. The consumption tax hike was supposed to be coupled with fundamental reforms of the welfare programs to cut expenses, but such efforts are lagging.
Since the consumption tax was last increased in 1997, the government debts have tripled to top ¥1,000 trillion. The Abe administration has implemented aggressive fiscal spending in its bid to end deflation and put the economy on a recovery path. Ostensibly to contain the negative impact of the tax hike, the government in February implemented a stimulus package, including public-works projects, that amounted to more than the estimated increased in tax revenue. The government budget for fiscal 2014 also reached a record ¥95.88 trillion. Apparently fiscal discipline is not this government’s priority.
The consumption tax hike alone obviously will not resolve the nation’s fiscal and social security woes. It needs to be matched not only by reforms in welfare programs but also by efforts to rein in government spending.