The Abe administration has begun fielding expert opinions on whether the nation’s economic condition can endure the second phase of the consumption tax hike next year. The Japanese economy has been losing steam in recent months as consumer spending remains sluggish following a hike in the tax rate to 8 percent in April, and some lawmakers belonging to the ruling Liberal Democratic Party and other parties are becoming more vocal in urging the government to postpone the planned additional hike to 10 percent in October 2015.
It is speculated that the Bank of Japan’s surprise move last week to sharply expand its monetary stimulus measures is aimed at setting the stage for the Abe administration to go ahead with the tax hike. The government is also reportedly weighing an extra budget to the tune of ¥3 trillion by the end of the year to shore up the economy’s sagging momentum.
Prime Minister Shinzo Abe is expected to make a final decision after reviewing the gross domestic product data for the July-September period, the preliminary figures of which will be out in mid-November and the revised data in early December. Either way, Abe will need to explain why he thinks the decision he plans to make is the right path for the economy.
There are reasons to take a cautious view on raising the consumption tax. Japan’s economy contracted by 7.1 percent in the April-June period from the preceding three months — the sharpest drop since the January-March period of 2009 — due to a fallback in demand from the previous quarter, when people rushed to buy ahead of the April tax hike. Consumer spending has continued to fall year-on-year for six months, with expenditures in September down 5.6 percent from a year ago as prices have risen faster than wages due to the tax hike and higher cost of imports. While GDP data for the July-September period is forecast to return to modest growth, concern lingers that the recovery is still too fragile to risk a second consumption tax hike in two years.
While BOJ Gov. Haruhiko Kuroda has denied such an intention, the split decision by the central bank’s policy board to increase its annual target for raising the monetary base to ¥80 trillion is widely viewed as a step to encourage the Abe administration to go ahead with the tax hike by maintaining the recovery’s momentum. The additional monetary step by the BOJ itself testifies to the concern over the health of the economy. The BOJ’s move to expand the already unprecedented monetary stimulus, coming on the heels of the U.S. Federal Reserve’s decision to end its own quantitative easing program, immediately pushed down the yen sharply against the dollar and caused share prices to shoot up on expectations of increased earnings for export-oriented firms. Still, a further decline of the yen could increase the financial pain of consumers and businesses that are already hurting from the rising cost of imports.
These and other concerns about the economy’s health need to be addressed before a decision is made on whether to go ahead with the 2-percentage point hike in the consumption tax, which, it is estimated, will impose an additional ¥5 trillion a year burden on households.
But what also needs to be addressed is the question of why the consumption tax is being raised in the first place. The tax increase was supposed to stabilize the finances of the social security system, whose costs continue to mushroom as the population rapidly ages, and to help rebuild the government’s fiscal health — the worst among major industrialized economies. Tax hikes alone will not resolve this problem; social security system reforms will also be required.
The cost of sustaining the public pension, medical and nursing care systems is sharply rising, with expense estimated to hit ¥150 trillion in 2025 — when the youngest members of the postwar baby boomer generation turn 75 — compared to roughly ¥110 trillion in 2012. Premiums now pay for only about 60 percent of the cost, with the rest covered by tax revenue and government debts — which pass the bills on to future generations.
Any of the possible steps to reform this structure — either to have the elderly pay for more of the cost of benefits and services they get, to reduce the benefits and services, or have the working-age population shoulder a greater burden of the cost — will be painful. While raising the consumption tax to 8 percent this year, the Abe administration has so far done little to embark on these painful reforms and reduce uncertainties over the future of the social security system.
The administration also does not appear eager to embark on rebuilding the government’s fiscal health. Of the roughly ¥96 trillion budget for fiscal 2014, the government relies on debt for about 40 percent of the revenue. Around ¥23 trillion of the expenses, or about a quarter of the total, are spent on servicing of the government’s past debt. A Cabinet Office estimate shows that the target of eliminating the primary balance deficits of the national and local governments combined by 2020 will be unattainable even if the consumption tax rate is hiked to 10 percent.
There may be mixed views as to whether postponing the hike to 10 percent next year will damage trust in Japan’s fiscal discipline. Still, if Abe ultimately decides to postpone the additional tax hike, he will need to explain what his administration plans to do about the situation that is supposed to have necessitated the tax hike.