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Japan has the grayest society among major developed countries, and the postwar baby boomers will all turn 75 by 2025. Simply, a 10 percent consumption tax will be inadequate to sustain the country’s social welfare system and additional hikes will be inevitable.
The hike to 10 percent from 8 percent on Oct. 1 is focused primarily on the expansion of social welfare services and will effectively do nothing to shore up the tattered national finances. To tackle the government’s mounting debt of over ¥1 quadrillion — more than twice the country’s gross domestic product — a further tax hike will become crucial.
For many, the first thing that comes to mind when discussing tax raises is the impact on the Japanese economy and its competitiveness.
This year’s tax hike will directly hit the nation’s purchasing power and the economy, but there are measures in place to mitigate the impact in the short term. Furthermore, the consumption tax is exempt for exports as the tax is returned when goods are shipped overseas, so even a consumption tax hike to 15 percent, for example, would not adversely impact export competitiveness.
The raise will generate ¥5.2 trillion of extra revenue annually. Of that, ¥3.2 trillion will be allocated to free preschool education for children age 3 to 5 as part of Prime Minister Shinzo Abe’s drive to expand child care support and boost the country’s perilously low birthrate. In addition, ¥2.3 trillion will be spent on points or rewards for cashless payments, and the expansion of housing-loan tax reductions.
In net terms, spending on benefits outweighs additional revenues from the tax hike by ¥300 billion a year for this fiscal year and the next, and I anticipate that the impact to the economy for 2019 and 2020 will be marginal.
Though the tax hike does not contribute to fiscal reconstruction, free preschool education will bring significant benefits to child-rearing households, encourage more parents to work, boost their income and possibly lead them to have more children, which could help stem the country’s biggest problem: the low birthrate.
But the importance of an additional tax hike from 10 percent is not to achieve the government’s fiscal 2025 goal of a surplus in the so-called primary budget — the government’s ability to meet expenditures, excluding interest payments — as that can be achieved by curbing government spending. There are growing calls for expanding social security, such as making university education free, in many political circles, and additional taxes would be essential for those things.
Whether to raise the consumption tax beyond 10 percent will ultimately be the choice of the public. If the Japanese people want more social security benefits, the consumption tax needs to be raised accordingly. At least half of the public pension, elderly nursing and medical care are financed by revenue from the consumption tax.
With advancements in medicine, new expensive drugs are becoming available. Some projections show the number of patients with dementia, including Alzheimer’s disease, will reach 10 million. If drugs for common diseases such as Alzheimer’s are developed, the government would have a difficult time refusing coverage under the national health insurance system, even if prices for the drugs are extremely high. The current consumption tax rate would hardly be sufficient in covering those costs.
If the public says they don’t want expanded social security services, then no tax hike would be necessary, though I’ve never heard such opinions expressed on the streets. If additional tax revenues are needed, then a consumption tax hike would be the only practical option.
An increasing number of people say that pensions should be raised to a level so that elderly people can live a comfortable life after a recent government report cited a ¥20 million shortfall for an average retired couple living to be 95. That, too, cannot be achieved without an additional hike of the consumption tax rate — there’s no such thing as a free lunch.
Many countries have much higher consumption tax rates than Japan. The rate for European Union member countries ranges from as low as 15 percent to as high as more than 20 percent. Some international bodies such as the Organisation for Economic Co-operation and Development are calling on Japan to raise the tax rate to up to 26 percent to restore financial stability and attain a primary surplus with its budget.
Certainly, the Japanese people would oppose a 30 percent consumption tax, but they are more or less resigned to the possibility that the tax rate may have to be raised to 20 percent at some point in the future.
Even if the consumption tax were to be raised by another 5 percentage points, it could be raised by 1 percentage point per year over several years to mitigate the impact on the economy. For example, if the Japanese people desire additional ¥2 trillion of social security, then the consumption tax should be raised by 1 percentage point, and so on.
To that end, the government should initiate discussions on the future of the consumption tax this year and hopefully reach a consensus next year in order to present options to the public. In truth, raising the tax by 1 percentage point a year from 2022 or 2023 to reach 15 percent or 16 percent in 2026 or 2027 to cushion the impact to the economy would achieve a primary budget surplus and help defray costs for social security, medical and nursing care for people over 75.
After Oct. 1, the consumption tax will have been raised twice under the Abe administration, but the prime minister cannot take credit for the first one as it was the Democratic Party in 2012 that finalized plans for the hike. The administration should leave a legacy of paving the way for raising the consumption tax rate to more than 10 percent in an effort to expand social security at a time when Abe has achieved little to no progress on foreign policy issues such as the Northern Territories off Hokkaido, in addition to poor ties with South Korea.
The country’s workforce have about 40 percent of their paycheck deducted for income tax and social security premiums payments, but when you retire, income tax is reduced to zero. The consumption tax, meanwhile, would be more equitable in that people over 65 would still need to pay their share.
Today’s younger generation sees Abe’s Liberal Democratic Party as the most vocal party with regards to raising the consumption tax to respond to mounting challenges such as rising health care costs and a need for free preschool education.
I served two years as the director of the consumption tax at the Finance Ministry when the tax was raised from 3 percent to 5 percent in 1997 and traveled around the country talking about the need for such a move.
Back then, when I went out to karaoke bars with ministry officials, the custom was that the higher up the ranks you are, the more you pay. But I always thought this should be changed to a system where you pay more based on the number of times you sing karaoke. The consumption tax is a system to make that happen in that the more you consume and enjoy something, the more you pay.
Shigeki Morinobu is a former senior official at the Ministry of Finance. He is currently research director at The Tokyo Foundation For Policy Research and a professor at Chuo Law School.
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