The ruling coalition agreement for introducing a lower tax rate on food products when the consumption tax is raised in April 2017 is a compromise that appears to have prioritized political interests over both the nation’s fiscal sustainability and efforts to reduce the impact of the increased tax burden on low-income people.

The decision last weekend by Prime Minister Shinzo Abe’s Liberal Democratic Party and its junior coalition partner Komeito to keep the current 8 percent rate on food and beverages, except for alcoholic drinks and dining in restaurants, when the consumption tax rate is hiked to 10 percent may be intended to ease the regressive nature of the consumption tax, which will proportionately hit poorer households more severely than wealthy ones. Low-income people spend a greater portion of their income on daily necessities such as food than do the wealthy. Many European economies that impose a value-added tax of over 20 percent have either reduced or eliminated taxes on such necessities, and a similar system may make sense for Japan as it raises the consumption tax to 10 percent — and possibly even higher in the future.

But many experts contend that the reduced tax rate on food will likely benefit the rich more than the poor because wealthy consumers typically spend more on meals. They say special allowances or other forms of tax breaks for low-income households would better serve the purpose of easing the impact of the consumption tax hike on them.

Talks between the LDP and Komeito on the introduction of a lower consumption tax rate on daily necessities began shortly after the coalition partners returned to power in December 2012 — following the decision by the previous Democratic Party of Japan-led government for a two-stage hike in the consumption tax from 5 percent to 8 percent in April 2014 and to 10 percent in October 2015. The second phase was postponed by 18 months by Abe last year after the April hike — the first in 17 years — resulted in a deep slump in consumer spending. But the discussions made little headway until recently as the two parties differed over the scope of products to be covered by the reduced rates, with the LDP wary of cuts in the tax revenue and fearful of the ire of businesses that opposed the increased clerical burden that multiple tax rates would cause.

As the deadline for a decision on the issue drew closer if the reduced rates were to start with the planned April 2017 consumption tax hike, the LDP initially said the lower rate should be restricted to fresh food, whereas Komeito insisted that it be applied to processed food as well — because a lower tax rate on daily necessities was the party’s key campaign agenda.

Abe and his close aides stepped in to break the impasse — mostly in favor of Komeito’s position. The prime minister reportedly put priority to solid relations with the junior coalition partner over the opposition of some LDP lawmakers ahead of the Upper House election next summer, when the LDP needs Komeito’s campaign support. Abe had made his position clear on the issue this fall when he replaced the chief of the LDP’s tax commission, who had long controlled the party’s discussions on the issue and opposed the introduction of a lower consumption tax rate on certain products.

Keeping the tax rate lower on food may indeed help sustain consumer spending when the consumption tax is raised in 2017. Imposing different rates on fresh food and processed food products would have created not only confusion among consumers but also political headaches from various food business interests. Still, the question remains of how to finance the gap in tax revenue created by the lower rate on food.

The two-stage consumption tax hike is meant to pay for the mushrooming social security costs of Japan’s rapidly aging population. The planned hike to 10 percent was estimated to bring roughly ¥5 trillion more revenue to government coffers. The lower rate on food and beverages is expected to cut ¥1 trillion of that amount — far more than the roughly ¥340 billion if its application was limited to fresh food.

The coalition agreement shelved the decision on how to make up for the revenue gap until the end of next year. But the LDP and Komeito reportedly agree that roughly ¥400 billion of the shortage should be covered by canceling a plan — originally intended for introduction when the consumption tax was hiked to 10 percent — to place a cap on the medical and nursing care expenses of low-income households. But canceling a plan to support low-income households in order to introduce the lower consumption tax rate on food, which will benefit wealthy consumers as much as or more than those who are poor, is clearly a policy contradiction.

The introduction of multiple rates of the consumption tax is deemed to make the use of invoices — which specifies item-by-item rate and the amount of tax — even more necessary for an accurate grasp of the tax amounts paid by businesses. But opposition from business circles for the invoice system, which requires changes to prevalent accounting practices and adds to the burden of retailers and small firms, has been a major source of headaches in the political discussion over differentiated consumption tax rates. The ruling coalition agreement calls for mandatory use of invoices beginning in April 2021 — and for the four years after the introduction of the multiple rates in 2017 will accept the use of a simplified system based on the current method.

Since its introduction in 1989, the consumption tax system has been tweaked to ease opposition from small businesses. Businesses with annual sales of ¥10 million or less are spared the consumption tax payment, while those with sales of up to ¥50 million are allowed to calculate the tax payment based on sales estimates. A problem with these practices is that some of the tax paid by consumers does not reach the state coffers. It’s estimated that these practices cost the government about ¥600 billion annually in lost income — and amount that may increase to ¥800 billion to ¥1 trillion when the consumption tax is hiked to 10 percent. Such loopholes need to be closed as quickly as possible to ensure fairness in the tax system.

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