Commentary / Japan

The consumption tax hike delays painful spending reforms

by Yoichiro Sato

Contributing Writer

At the beginning of October, the government raised the consumption tax from 8 percent to 10 percent. Confusion lingers among consumers as the government kept the 8 percent rate on certain food and drink items in the name of relieving low-income people of an increased tax burden on daily necessities, while offering reward point programs for cashless payments to offset the tax hike.

The decision to apply the 10 percent rate on eating at restaurants and shops (as opposed to purchasing food for consuming at home, which is taxed at 8 percent) left definitional problems to be dealt with by the business establishments. Alcoholic beverages and cooking condiments are taxed at 10 percent, but the 8 percent rate applies to items containing low alcohol content. Daily newspaper subscriptions, but not occasionally purchased newspapers, are taxed at 8 percent because the lower rate for daily essentials is applied.

In short, the consumption tax was made more complex than it has been since its launch in 1989. This complexity robs it of one of its greatest advantages — simplicity.

Politicians as representatives of the people are expected to play a combination of internally contradictory roles. Pursuing a good policy for the “community” requires both developing good policy content and exercising political skills of persuasion. The two roles may be shared by politicians and bureaucrats, or divided between them.

The initial attempt to introduce a major indirect tax came amid a slowdown in economic growth following the oil crisis in 1973. Prime Minister Masayoshi Ohira in 1979 started preparation of a bill to introduce a “general consumption tax” but failed due to opposition in the ruling Liberal Democratic Party. Ohira was a Finance Ministry bureaucrat before joining politics and had a good understanding of tax policy. But he could not guide the party to accept an unpopular tax reform.

Prime Minister Yasuhiro Nakasone saw an opportunity to push through an unpopular new indirect tax as the economy headed toward the bubble boom of the late 1980s. But his earlier campaign promise not to introduce wide-ranging taxation became a liability when he proposed a multi-staged value-added sales tax.

The LDP Research Council on Tax System was composed of several politicians with tax expertise, such as Sadanori Yadmanaka, who understood the advantages and disadvantages of different indirect taxes. The burden of tax collection with the proposed sales tax broadly fell on small and medium-size enterprises — the LDP’s core support base that opposed the bill. Nakasone’s poor communication led the tax bill to its demise in 1987, with the disillusioned Yamanaka calling Nakasone a “chatter bug” (oshaberi).

Nakasone’s successor, Prime Minister Noboru Takeshita with his patient consensus-building efforts within the ruling party, finally succeeded in passing the consumption tax bill in 1988, and the new 3 percent tax was introduced the following year. Still highly controversial, the tax became one of the chief reasons for Takeshita’s short tenure in office.

Since 1989, the consumption tax has been hiked three times, and the previous two increases took a political toll on the ruling party and sitting prime minister. A growing collaboration between the pro-tax hike bureaucrats within the Finance Ministry and the politicians, however, resorted to a deceptive campaign to pitch the new consumption tax rate as a source of revenue to pay for the anticipated increase in social security and welfare spending.

An amendment in 2012 under Prime Minister Yoshihiko Noda of the Democratic Party of Japan — a liberal competitor to the LDP then — explicitly limited the use of the additional consumption tax revenue to social security and tax transfers to municipalities while raising the tax rate to 8 percent from 2014.

To pass the amendment through the Diet, Noda needed the LDP’s help, and the price for this cooperation he agreed to was dissolution of the Lower House and a general election, which the DPJ was certain to lose.

The tax rate was scheduled to rise again to 10 percent in 2015, but Prime Minister Shinzo Abe, fearing a repeat of the 2014 hike that took a heavy toll on the economy, twice postponed it before finally letting the increase take effect this month.

Linking the consumption tax to social security allows the government to avoid a comprehensive overhaul of social security programs to create a more self-sustaining system. Most importantly, the rapid aging of the population requires raising the starting age for payouts of public pension benefits — another unpopular reform for the growing population of senior citizens.

Collusion between the tax bureaucrats, who easily abandon “principles” of taxation (such as simplicity and equity) for the sake of passing the bill to increase revenue, and the politicians, who spare themselves painstaking consensus-building efforts, has characterized the two recent rate hikes.

The 3 percent rate was in place for eight years, the 5 percent rate for 17 years and the 8 percent rate for only five years. Abe says that another hike beyond 10 percent will not be necessary for the next 10 years. Implicitly he is leaving room for another increase in the future. Shigeru Ishiba, a former regional revitalization minister who has become a non-mainstream contender to Abe within the LDP, has criticized him by charging that the party needs to demonstrate how it is possible not to raise the consumption tax again.

Indeed, it is irresponsible of Abe to make such a statement, which will prove to be a liability for his successors. He should let future leaders discuss tax reform. Ishiba’s challenge, however, lacks the kind of expertise the party’s tax specialists of the 1980s possessed and data to disprove Abe’s claim.

The linking of the consumption tax and social security spending has made the rate hike more acceptable to voters, while politicians avoid having to undertake a comprehensive overhaul of the social security system.

Shifting the social security system into a more self-sustaining system without infusions from the general budget is urgently needed. A more transparent linkage between individual contributions and benefits upon reaching the eligible age must be established.

The rapid aging of the population requires raising the starting age for pension benefit payouts even though it may prove unpopular among the electorate. Kicking the can down the road should not be a policy option on the critical matter of social security reform. A consumption tax hike should not be a means for buying time on social security reform.

Yoichiro Sato is a professor at Ritsumeikan Asia Pacific University in Beppu, Oita Prefecture.

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