National / Politics | ANALYSIS

As voters welcome Japan's tax-hike delay, experts warn on costs

by Reiji Yoshida

Staff Writer

Prime Minister Shinzo Abe’s announcement to shelve the planned second stage of the consumption tax hike may be a crowd-pleaser ahead of an Upper House election next month. Few people like paying more tax.

However, experts are divided.

Economists such as Nobel laureates Joseph Stiglitz and Paul Krugman urged Abe to delay the hike at a time of weakness in the economy, for fear that it would trigger deflation.

Others, including many mainstream Japanese economists, are concerned more about the long-term effects of delaying the tax hike, saying it will increase the burden on future generations and could seriously erode market confidence in Japanese government bonds.

But one thing seems clear: Abe’s decision is likely to make it even harder for future leaders to raise the unpopular tax, given that polls show Abe leads one of the most popular administrations in decades.

“If the Abe administration, which is a very powerful government, does not raise the consumption tax, no administration in the future would dare do it,” said Yoshimitsu Kobayashi, head of Japan Association of Corporate Executives, one of the nation’s most influential business lobby groups.

Kobayashi, also chairman of Mitsubishi Chemical Holdings Corp., points out that Japan needs to secure huge funds to cover swelling social security costs for aging baby-boomers, born in the late 1940s and early 50s.

Moreover, Japan’s public debt has exceeded a staggering ¥1,000 trillion. This is more than double the country’s gross domestic product and is the worst of any developed nation.

“I have a sense of crisis, fearing Japan could actually go bankrupt,” Kobayashi told a news conference on May 17.

Most economists agree Japan faces a serious debt problem that could result in significant fiscal trouble.

If the market starts doubting the government’s ability to pay back its debts, it will shun Japanese government bonds and long-term interest rates would surge. That would drastically increase the costs of servicing debt and could, in a worst-case scenario, bankrupt the nation.

But no one is sure about when the tipping point would come, and economists are split over how urgently Japan needs to address the matter.

Toshihiro Nagahama, chief economist at Dai-ichi Life Research Institute Inc., believes Japan should first tackle deflation before raising the consumption tax and avoid further weakening fragile consumer spending, which he says is still suffering badly from lingering effects from the first stage of the consumption tax hike, from 5 percent to 8 percent in April 2014.

“Individual consumption has remained weak since the consumption tax hike. The effects have lingered far longer than those from the Lehman shock or the 2011 Great East Japan Earthquake,” Nagahama said, referring to the 2008 global financial crisis triggered by the collapse of U.S. securities firm Lehman Brothers.

Nagahama says the market has already factored in the postponement of the consumption tax hike, but he notes that both the long-term interest rate and the credit default swap (CDS) of Japanese government bonds remain low.

CDS is an insurance against debt nonpayment and its price can be seen as an indicator of market confidence in the debtor in question.

“This means the market doesn’t believe Japan is facing a fiscal crisis,” Nagahama said.

“I believe Prime Minister Abe has made the right decision.”

Indeed, as of Tuesday, the long-term interest rate represented by the 10-year Japanese government bond was minus 0.12 percent, a historically low level, showing no signs of disturbance so far.

But Takero Doi, professor of economics at Keio University in Tokyo, argues that the long-interest rate has been kept low by the Bank of Japan, which, in coordination with Abe’s government, is purchasing Japanese government bonds to the tune of around ¥80 trillion a year.

Few economists believe the central bank can continue this ultra-loose monetary policy forever, and some even predict that the BOJ will buy up all available government bonds within a few years.

Doi also pointed out the BOJ has pledged to achieve an annual inflation target of 2 percent by the end of fiscal 2017. If this is realized, it will push up the interest rate accordingly.

“It’s true that interest rates have been very low in the past three to four years. But that’s only a temporary phenomenon until Japan breaks away from deflation,” Doi said. “So now, while interest rates are low, we need to reform the government fiscal structure so that it can withstand payments for higher interest rates.”

Meanwhile, fiscal science expert Toshihiro Ihori, an emeritus professor at the University of Tokyo, maintains that Abe’s decision to delay the tax hike will only impose a heavier financial burden on future generations because Japan will need to raise it eventually to finance growing social security costs.

“Given the rapidly shrinking population, Japan is likely to see zero or even negative economic growth in the 2020s. So the economic environment for future generations will be harsher than for us,” Ihori said.

According to Ihori’s simulation, the government would need to raise the consumption tax rate to 25 to 30 percent in the 2020s if it does not drastically cut spending in the meantime. This assumes that interest rates rise significantly and economic growth remains low.

“Even if the government cuts expenditure and succeeds in raising Japan’s growth potential through deregulation, it would still need to raise the tax rate to at least 15 percent in the not-too-distant future,” he said.

Abe pledged that the government will raise the consumption tax rate to 10 percent in October 2019. But he will probably no longer be in office by then because his term as the president of the ruling Liberal Democratic Party will expire in September 2018.

Ihori doubts that the next prime minister will raise the tax rate as promised, as consumption tax has long been a political taboo in Japan and opposition to it has usually helped politicians win an election.

The hike from 8 to 10 percent was originally planned for October 2015.

In November 2014, Abe postponed it until April 2017 and then dissolved the Lower House to call a snap election. The LDP scored a landslide victory in the election in the following month.

Observers believe this time Abe is trying to repeat the tactic by announcing the second postponement just ahead of an Upper House election, which is expected to take place in early July.

Abe should be well aware of recent polls suggesting a majority of voters would welcome delay in the tax hike.

A poll for the Mainichi Shimbun newspaper on Saturday and Sunday found that two-thirds of people approve of postponing the hike. One in four oppose a delay.

“Politicians stop addressing a consumption tax raise before an election because it’s an unpopular issue,” Ihori said.

“They are putting political games before policy affairs.”