The wallets of Japanese residents may get a little lighter next year, as the prices of most goods and services are set to rise under a new consumption tax system starting in October 2019.
Under this new system, consumers may have at least some reprieve, as taxes on important household items — mostly food and beverages — will remain at the existing 8 percent rate, while levies on almost all other goods and services will rise to 10 percent.
Although adopting a consumption tax with multiple rates can lighten the burden on those with lower incomes, there is growing confusion over how to differentiate which items will be taxed at the regular or preferential rates.
The Abe government pushed for a multiple tax rate system, paired with other new stimulus measures, to help shield the economy from the deleterious effects of the tax hikes.
And government forecasters and international institutions appear confident that these measures will help avoid a repeat of the 2014 consumption tax hike, which caused a larger-than-expected economic downturn.
But if history is any guide, predicting the actual extent of economic damage caused by higher consumption taxes is likely to be a tricky task.
What is a reduced tax rate system?
Consumption taxes are widely seen as being “regressive,” meaning they are a form of taxation that has a larger impact on low-income earners. Thus, to alleviate the burden of these taxes, many countries institute lower levies for daily necessities.
Policymakers have defined the necessities that will retain the current tax rate of 8 percent as food and drink, excluding alcohol and dining-out services. Newspapers, defined as publications distributed twice or more a week, will also receive reduced tax rates.
Other countries have a vastly different view of what goods and services are worthy of lower tax rates.
In Sweden, where the consumption tax is 25 percent, food at both restaurants and supermarkets is taxed at 12 percent, movies are taxed at 6 percent and medicine is completely exempt. France, meanwhile, where the consumption tax is 20 percent, gives tax carve-outs from everything from fertilizer to hotel lodging. For instance, food is taxed at 5.5 percent, while newspapers and medicine are taxed at 2.1 percent.
Deciding which items receive lower rates can be a contentious process with different industries jockeying for more favorable treatment.
Where is the line drawn in regard to which items receive lower rates?
That’s a tricky question. While the reduced tax rate sounds good in theory, there are many practical difficulties to implementing such a system.
Take for example convenience stores, many of which are a crossover between a supermarket and a restaurant.
If you buy a lunch box at a convenience store but eat it outside, will it be taxed at 8 percent? If you eat the same bento in the convenience store, will it be taxed at 10 percent?
According to government guidelines updated in January, this will depend on whether the convenience store customer expresses their “intention” to eat in the store.
If a customer says they want to eat a convenience store meal outside the store, they will be charged the 8 percent tax rate.
The guidelines also state that if a store places a sign reading, “Please say if you intend to use the eat-in space,” then customers will simply be assumed to be taking the food outside the store and will be charged the reduced 8 percent rate.
Another potentially confusing application of the new multitiered tax rates includes newspapers, which are taxed at the 8 percent rate only if purchased through a subscription.
Are consumption taxes high in Japan?
No, Japan’s consumption tax rate is extremely low compared to other developed nations.
The average consumption tax rate among advanced countries is 19.2 percent, with Denmark, Sweden and Norway all adopting rates as high as 25 percent, according to a 2016 report on consumption tax trends published by the Organization for Economic Cooperation and Development.
This does not mean that Japan is a complete laggard on tax collection.
Tax revenue as a percentage of GDP was 30.7 percent in 2015, which was only slightly behind the OECD average in the same year. Japan’s tax revenue as a percentage of GDP ranked ahead of the U.S. (26.2 percent), Switzerland (27.7 percent) and Ireland (23.1 percent).
Who supports higher tax rates?
With the highest central government debt among advanced nations — a debt to GDP ratio of close to 240 percent — many observers see Japan’s comparatively low consumption taxes as the only way to fill a hole in the country’s finances.
In a research note published in July of 2017, the International Monetary Fund (IMF) stated that raising the consumption tax is a “preferred option for raising additional revenue” because in their view it does less damage to the economy, is currently low comparative to other countries, and can also target the retired population which often avoids other taxes.
Other international institutions, such as the OECD, also recommend that Japan should raise the consumption tax under the assumption that it causes less economic damage than tax hikes on income or corporations. OECD Secretary-General Angel Gurria stated his support for raising the consumption tax during a visit to Tokyo in April of this year
But not everyone is on board with the logic that consumption tax hikes are the best solution to Japan’s debt problem.
Prior to becoming the current deputy governor at the Bank of Japan, Masazumi Wakatabe outlined arguments against raising the consumption tax to 10 percent in an article published in Forbes in February 2016 .
“The best strategy for the government is to reduce, not increase the consumption tax,” wrote Wakatabe, who was then a professor of economics at Waseda University, adding that increasing the consumption tax to 10 percent could have “deleterious effects” on the economy.
Other prominent economists, including Joseph Stiglitz and Paul Krugman have also previously cautioned the Japanese government against raising the consumption tax in deference to economic growth.
The electorate itself is almost evenly split over the upcoming tax increase. A poll jointly conducted by the local daily Nihon Keizai Shinbun and TV Tokyo conducted from Oct. 26 to 28 showed that support is at 47 percent, with opposition at 46 percent.
Where does the tax revenue end up?
Under the new system, 7.8 percent of the consumption tax will be collected by the central government, with the remaining 2.2 percent left for municipalities.
Japan, which did not introduce a consumption tax until 1989, has traditionally relied on income tax receipts to finance the government.
This has changed drastically in the past three decades, with consumption tax now accounting for 18 percent of government revenue, the second largest form of government income behind the income tax, which accounts for 19.5 percent, according to the Finance Ministry data for fiscal 2018 budget.
Despite raising consumption taxes, the government had to issue ¥33.7 trillion in Japanese government bonds in fiscal 2018 because it did not have enough tax revenue to pay its bills.
How much more will consumers pay?
The new taxes will cost the average family about ¥44,000 ($390) more for goods and services a year, according to Toshihiro Nagahama, chief economist at Dai-ichi Life Research Institute.
An April 2018 report released by the BOJ estimated that the overall tax burden would translate to about ¥2.2 trillion when factoring in tax breaks, welfare benefits and education expense increases. By comparison, the overall tax burden of the 2014 consumption tax hike was far higher, at about ¥8 trillion.
Will the tax damage the economy?
Yes, but predicting exactly how far growth will decline in fiscal 2019 is a difficult task.
In the run-up to the tax increase, consumers are likely to rush to make purchases of expensive good such as cars or houses, which in turn is likely to push up economic growth prior to the tax increase. However, shortly thereafter, consumers are likely to tighten their belts as prices rise.
According to BOJ forecasts released in July, economic growth is set to slow to 0.8 percent in fiscal 2019, down considerably from 1.5 percent growth predicted for fiscal 2018.
Both the government and the IMF were notoriously sanguine in their previous prediction of economic performance following a consumption tax increase.
Before the 2014 hike, the IMF predicted that the economy would grow 1.6 percent over the 2014 calendar year, far off the mark of the actual growth rate of 0.3 percent.
The Cabinet Office, which conducts its analysis using the fiscal year, meanwhile predicted 1.4 percent growth for fiscal 2014. The economy would end up contracting by 0.3 percent over this period.
Both organizations were wrong for the same reason: They failed to see the extent to which consumption would slump as individuals tightened their purse strings due to higher prices.
Even four years after the last tax hike, household consumption in the second quarter of 2018 has not recovered to the level seen in the first quarter of 2014, just before the last tax rise.
With the effects of the previous tax increase still lingering four years later, the big question is whether consumers will keep spending or cut back as prices rise once again.
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