On track for a tax increase

The Abe administration appears inclined to raise the consumption tax from April 2014. The consumption tax increase bill, enacted in the summer of 2012, includes a clause that the consumption tax rate will be increased from the current 5 percent to 8 percent next April if the economy grows 3 percent in nominal terms and 2 percent in real terms.

In its latest move toward the tax hike, the government succeeded in persuading the Diet to enact a bill to help small and medium-size companies pass on the increased tax burden to consumers. The government hopes to have the bill take effect from October.

The move is seen as laying the foundation for increasing the consumption tax rate. But the government must handle the issue of the consumption tax raise by carefully considering Japan’s economic condition.

Gross domestic product in the January-March period grew 1.0 percent from the previous quarter for an annualized 4.1 percent. Consumer spending increased 0.9 percent in the January-March quarter, up from the 0.4 percent rise in the previous quarter, for the second straight quarterly rise. Exports expanded by 3.8 percent for the first expansion in four quarters.

Although the economy appears to be on track to recovery, the Abe administration should not be overly optimistic and should not rush to the conclusion that the economy is strong enough to absorb the impact of a consumption tax increase. It should instead learn a lesson from past experience and be aware of the possibility that increasing the consumption tax rate will have the effect of nipping the economic recovery in the bud.

In 1997, the Japanese economy started to pick up thanks to those projects related to reconstruction of areas devastated by the 1995 Kobe earthquake. Obsessed with the idea of carrying out financial reconstruction through a higher consumption tax rate — an idea promoted by Finance Ministry bureaucrats — then Prime Minister Ryutaro Hashimoto went ahead with plans to increase the consumption tax from 3 to 5 percent.

The Finance Ministry had expected that the tax hike would increase total tax revenues, thus contributing to the government’s financial reconstruction. What happened was the opposite. Although consumption tax revenues went up, total tax revenues fell because the tax raise broke the back of the economic recovery. Companies posted losses and people’s disposable income dropped.

Although the nation must reconstruct its finances, the Abe administration should not be misled by the idea that a tax increase will bring about financial reconstruction. Government leaders and officials must recognize that increased tax revenues from enlivened economic activities play a key role in reducing financial deficits.

For now, the government should concentrate on measures to ensure Japan achieves sustainable economic growth. Once the recovery is firm, it can reconsider raising the consumption tax.

  • Japan must repeal the increase in the sales tax.