With the enactment of a law to raise the consumption tax rate, Prime Minister Yoshihiko Noda may feel relieved and believe that he has done something good. But one wonders whether he has given serious thought to the effects that the tax hike will have on the economy, which has been suffering from persistent deflation.

Under the law, the consumption tax rate will be increased from the current 5 percent to 8 percent from April 2014 and raised to 10 percent from October 2015. It is estimated that when the consumption tax rate rises to 10 percent, tax revenue will increase by ¥13.5 trillion annually. But there is a danger that the tax hike could cause consumers to tighten their purse strings, leading to a contraction of the economy, which in turn would lead to a decrease in total tax revenues. Such an outcome would further delay the financial reconstruction of the state, contrary to the desire of the Finance Ministry.

The planned consumption tax hike could be greatly damaging to small businesses, which play a critical role in local economies. Unlike large firms, most small companies do not have the ability to offset the tax increase by raising the price of their products for consumers. Stung by the tax increase, consumers will also be looking for cheaper goods, which are mainly produced by large companies. This will further strengthen the deflationary trend.

Due to the economic conditions dictated by the strong yen, export-oriented large manufactures are applying strong pressure on smaller firms to reduce the cost of the parts they produce for them. As the small firms will not be able to pass the higher costs caused by the tax hike to the large manufactures, their profits will fall. In fact, there is a real danger that the consumption tax hike could end up causing many small enterprises to go bankrupt.

A majority of Japanese people work for medium-size and small businesses. Government leaders should realize that if these companies are hit hard by the consumption tax hike, the backbone of the Japanese economy will be broken. The government must make every effort to achieve the goal of nominal and real economic growth of 3 percent and 2 percent, respectively, as incorporated in the tax raise bill.

Government leaders should also remember that the most important economic goal for Japan at this stage is to end deflation. The role of the Bank of Japan will be especially important. It should not hesitate to use its monetary policy tools flexibly to achieve this goal.

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