Business / Economy | The Argument: Consumption tax

The consumption tax raise hurts Japan and eviscerates Abenomics

by Etsuro Honda

Contributing writer

The Argument is a new feature dedicated to promoting dialogue and deeper understanding of contentious issues by introducing various viewpoints.

The consumption tax hike will absolutely chill consumption, slow down the Japanese economy and weaken Abenomics.

While the government has introduced temporary measures, such as a point reward program for cashless payments, to encourage consumption alongside a push toward a cashless society, they are just stopgap measures and too complicated to substantially absorb the shock stemming from the tax hike.

Prerequisite economic indicators for raising the consumption tax rate should be achieving the 2 percent inflation target in a stable manner, a roughly 2 percent real economic growth rate and sustainable 3.5 percent nominal economic growth. If those conditions were met, then nominal wage growth would be around 3 percent to 4 percent, making it possible to weather the impact of the tax hike.

But right now wage growth is flat and a tax raise at this point will obviously cause disposable income to drop, and with it, consumption. This is the worst possible timing when taking global and geopolitical risks into consideration.

The biggest mistake with raising the consumption tax on Oct. 1 is that it was decided based on the political calendar. The Abe administration pledged to do so three years ago and no one could anticipate today’s economic climate at that time. The actual date of the consumption tax hike should have been determined based on economic performance.

There’s no question that consumption will take a hit. But how fast it will fall depends on external factors such as the trade war between the United States and China, as well as the uncertainty surrounding Brexit. These two problems have worsened global economic sentiment.

Since Prime Minister Shinzo Abe has already postponed the tax increase twice, he may feel the increase needs to happen this time to secure the financial resources for his new initiatives, namely increased financial support for child rearing. The government should have waited for the country’s complete emergence from deflation in order to consolidate the fiscal conditions to provide financial resources for new policies.

The consumption tax issue goes to the heart of Abenomics, which was launched to pull Japan out of two decades of deflation. Under deflation, when consumption and prices fall, sales plunge as wages stagnate. Consumption then tanks further, creating a vicious cycle.

Before Abe assumed the role of prime minister in 2012, I visited him a few times to discuss the severity of deflation. He had the same understanding as I did.

So in January 2013, the Bank of Japan and the government released a joint statement unveiling the Abenomics policy mix. The BOJ set a 2 percent inflation target and started purchasing bonds at a pace of ¥50 trillion to ¥60 trillion a year to supply so-called base money to the economy. The government correspondingly increased fiscal spending. Because of that, the consumer price index rose to 1.5, which was much quicker than we had expected, before the government decided to increase the consumption tax from 5 percent to 8 percent in 2014.

I, of course, opposed the tax increase as a special adviser to the Cabinet and one of the chief architects of Abenomics. At the very least, I pleaded that the raise — if there was to be one — should be implemented gradually at about 1 percentage point per year. But there was optimism that the country was ready for a tax hike.

Consumption fell rapidly after the tax was raised to 8 percent. On top of that, oil prices declined after a Chinese economic downturn and a series of financial shocks in 2016 caused the yen to appreciate. These all caused the consumer price index to slump, which continues to this day.

I am not sure what Abe’s priority is for this consumption tax hike. I candidly give my advice to him, and he seems to take that advice seriously. But my friends and I sense that there are many people in the administration who are already content with the result of Abenomics, so for them it’s okay to raise the consumption tax to 10 percent.

Abenomics was aiming for 2 percent inflation — and full employment. The unemployment rate has come down to the lower half of 2 percent now, so there are some individuals in the administration who conclude that the outcome is better than they were targeting. That, however, is a complete misjudgment. The unemployment rate could be lowered further because, if we had reached full employment, the inflation rate should have reached around 2 percent by now.

Those who advocate for a consumption tax hike say that Japan will plunge into fiscal crisis without one.

But it has been proven that such an assertion is a mistake. Even the International Monetary Fund’s “Fiscal Monitor” indicates that Japan’s finances are sound — neither extremely bad nor extremely good.

Japan may have over ¥1 quadrillion in debt, but it also has ¥650 trillion in assets. Additionally, the BOJ has already purchased more than ¥460 trillion worth of long-term government bonds. If you combine the general account of the government and the BOJ’s, the total assets nearly cancel the debt out.

Some also argue that the tax should be raised because Japan hasn’t achieved a so-called primary balance — the government’s ability to meet expenditures, excluding interest payments. To balance the budget, the government either has to cut spending or increase taxes, both of which will slow down the economy and worsen deflation. But the fiscal situation is improving because of the increase in tax revenue thanks to economic growth, and there isn’t an immediate need to raise the tax.

Abe has insisted on using added consumption tax revenue to support a free preschool education program. While I support the program, I think the government should issue bonds instead. This is the best example of investment for the future generation. Japan’s current financial circumstances can afford to issue bonds, especially long-term bonds, as their circulation in the market is decreasing.

Consumption taxes are also regressive in nature, meaning people with lower incomes tend to be hit the hardest. Using a regressive tax to fund the free preschool education program, which is really the redistribution of income, is totally contradictory.

The OECD, along with scholars sharing the same view of very high consumption tax rates in some European countries, is proposing an eventual raise of Japan’s consumption tax to 25 percent or 26 percent.

That’s outrageous. The Japanese economy would be seriously damaged if the consumption tax percentage skyrockets to the upper 20s. If a tax hike is necessary, I would advise raising it on other taxable items, such as on inheritance or real estate.

Judging from my experience as a board member of the European Bank for Reconstruction and Development, it is very natural to be instructed by Tokyo on how to express our position. But internal economic policy decisions should be made independently and based on sovereign interests. Long-lasting deflation, as has happened in Japan, has been a rarity in other countries in recent years.

If Japan can’t shake off its deflationary mindset, gross domestic product will start to fall. In many ways, Japan’s future is on the line and the two lost decades could become the lost three to four decades. Thus, it is imperative to take action proactively.

Regarding the effects of the tax hike after Oct. 1, the government may have no option other than to launch a fiscal stimulus package — or even lower the tax rate back to 8 percent in a worst case scenario.

Etsuro Honda was an economic adviser to Prime Minister Shinzo Abe and former ambassador to Switzerland. He served as a career bureaucrat in the Ministry of Finance.

The Argument: The consumption tax — Should Japan raise it beyond 10 percent?

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