Prime Minister Shinzo Abe has indicated that his administration will go ahead with raising the consumption tax hike from the current 8 percent to 10 percent in October 2019 as planned. He said the additional revenue from the tax hike will both finance his promised reform of the social security system into one “geared to all generations” and contribute to fiscal reconstruction. He also said the administration will mobilize all measures possible to prevent the tax hike from hurting the economy — reflecting on the last consumption tax raise four years ago, which badly dented consumer spending and threatened to derail a nascent recovery.
However, Abe’s decision only confirms that the tax hike, which had been postponed twice for a total delay of four years, will finally take place next year. The two-stage hike to 10 percent had been decided as far back as 2012 and, if implemented, would represent just another step toward fiscal rehabilitation. Government estimates show that the new goal of achieving a primary budget surplus by fiscal 2025 — already pushed back by five years — is still far off unless more stringent efforts are made to curb expenses. Doubts persist as to whether a consumption tax hike to 10 percent will be sufficient to cover the mushrooming social security costs of the rapidly aging population.
The economy appears to be in good shape. Japan’s gross domestic product in the April-June period expanded an annualized 3.0 percent — after a 0.6 percent decline in the January-March period that followed eight consecutive quarters of GDP growth. Even though growth in consumer spending continues to be weak and uneven, the situation does not seem to warrant another delay in boosting the consumption tax.
Nevertheless, the sensitivities that surrounded next year’s hike reflect the Abe administration’s trauma over the April 2014 increase from 5 percent to 8 percent — the first jump in the consumption tax rate in 17 years — when personal consumption was severely hit and economic growth ground to a halt. Abe, whose administration’s steady popular support has depended a lot on the economic recovery, has since postponed the second-stage hike to 10 percent twice — first from October 2015 to April 2017 and then again to October 2019.
When the two-stage consumption tax hike was featured in the “integrated reform of the social security and tax” systems in 2012, much of the roughly ¥5 trillion in additional revenue from the hike to 10 percent was to be used to reduce the fiscal deficit. Ahead of the Lower House election in fall 2017, however, the Abe administration announced that it would divert nearly ¥2 trillion of the fresh revenue to policy spending on preschool education and day care expenses as a measure to support child-rearing young families.
Abe says the government will take every step to make sure that the consumption tax hike next year will not disrupt consumer spending, like it did four years ago. That may be a necessary step to prevent the next hike from turning into another economically and politically traumatic experience — which could stifle discussions over any further hikes in the future. Still, any heavy fiscal spending in an attempt to offset the impact of the tax increase could defeat the purpose of the hike itself. The government needs to focus on more efficient spending and nonfiscal measures such as regulatory reforms.
In fact, the negative impact of next year’s hike on household finances is not expected to be as large as in previous increases. The 1997 hike from 3 percent to 5 percent is estimated to have increased the household burden by ¥8.5 trillion, and the 2014 hike from 5 percent to 8 percent by ¥8 trillion — each time prompting consumers to tighten their purse strings. This time, however, the impact is projected to be around ¥2.2 trillion, since the rate on food and drinks is to be kept at 8 percent and the increased fiscal spending on education and other allowances will balance out part of the tax increase. An overreaction to the tax hike should not lead to a spending spree that runs counter to the efforts for fiscal consolidation.
The government should instead begin discussions on medium- to longer-term efforts toward fiscal rehabilitation, including what steps will need to be taken after the tax hike. That needs to involve a potentially painful reform of the social security programs to curb their expenses, which today account for 30 percent of the government’s annual policy expenditures. Near-term measures to contain the impact of the imminent tax hike will be important, but also needed will be a clearer prospect of longer-term fiscal health.