In 12 months’ time, Japan’s consumption tax is scheduled to rise from 8% to 10%.
That may not seem like very much. But recession followed on the previous two occasions that the tax was hiked.
True, Japan’s economic performance has strengthened significantly in recent years. Yet, personal consumption remains a weak spot. Indeed, the consumer confidence indicators have yet to recover fully from the last hike in 2014.
The October 2019 tax hike was originally set for April 2017, but Prime Minister Shinzo Abe took the wise decision to delay the implementation.
There are at least five good reasons for delaying it again.
Already Healthy Growth in Economy
The most important reason is that tax hikes are unnecessary.
Tax revenues have surged in recent years, thanks to the healthy growth in the economy. They now stand at the highest levels seen since the tailend of the bubble.
The best way to bring in more tax revenues is through further increases in company profits, numbers of people in work, wages and household consumption — in other words, by continuing to prioritize growth.
Deficit Already Balanced by Surplus Savings
Second, the tax hikes are based on the profoundly mistaken view that Japan as a country is facing some sort of debt crisis.
Japan is the world’s largest creditor nation with vast holdings of U.S. bonds. It has recorded current account surpluses every year since 1980.
To put it another way, Japan’s enormous governmental deficit is balanced by an even more enormous surplus of savings in the corporate sector.
Any attempt to cut the deficit by raising taxes would likely backfire as companies cut investment to match lower demand.
Better to Stimulate Consumption
Third, there could be damage to Japan’s all-important relationship with the United States.
Prime Minister Abe has carefully built a constructive partnership with President Donald Trump. So far, Japan has escaped the broadsides aimed not just at China, but at friendly countries like Germany and Canada, too.
However, the fact remains that, in purely economic terms, Japan now has a greater imbalance than China.
China’s current account surplus has fallen to less than 1% of GDP, the lowest level in 25 years, whereas Japan’s amounts to a historically high 4%. That is similar to the level that triggered the drastic revaluation of the yen mandated by the Plaza and Louvre Accords of the mid-1980s.
In order to prevent a recurrence of trade friction, Japan needs to stimulate consumption, not douse it with cold water.
Conflict with Other Priorities
Fourth, Prime Minister Abe has set himself the goal of revising Japan’s U.S.-imposed pacifist Constitution — the only one in the world to remain unchanged over the last 70 years.
Bringing the Constitution into line with modern-day realities is long overdue. But, in order to accomplish the task, Abe will have to win a national referendum.
Referendums can be tricky operations, as former British Prime Minister David Cameron found out when he had to resign the day after unexpectedly losing the Brexit vote.
Unpopular tax hikes could hurt household spending, reduce the Prime Minister’s support rate, and thus imperil the constitutional revision project.
Social Inequity and Black Economies
Fifth, consumption taxes increase inequality and incentivize illegal activity.
Finance ministries everywhere love VAT — “value added taxes” (as Japan’s consumption tax is more properly termed) — because they are hard to dodge legally and the job of collecting them is outsourced to all the companies in the country.
Furthermore, once the public has got used to the idea, finance ministries can present further hikes as “inevitable” — until Scandinavian levels of 25% are reached. VAT inevitably leads to big government, whether people want it or not.
Poor people spend a greater share of their income than wealthy people, which makes VAT naturally regressive. It is particularly so when compared to income tax, which in most developed countries levies higher rates on richer people.
Politicians commonly try to soften the blow, as Japan is planning to do, by making exemptions for food and other categories. This introduces a whole new series of problems and distortions. Should caviar attract a lower rate because it is a raw foodstuff?
Wiser to Reconsider Tax Hike
In the case of corporate and income taxes, there are various “gray zone” ways of reducing the tax burden while remaining within the letter of the law. In the case of VAT there is no such leeway.
You can only reduce your tax burden by not reporting taxable transactions — an outright breach of the law.
The Scandinavian countries generally have good reputations for governance and social ethics, but the eye-watering levels of VAT have led to huge black economies. According to a World Bank study, the four Scandinavian countries have black economies equivalent to 17-18% of their “official” GDP, which compares to 10% for Japan and 8% for the United States.
So, hiking the consumption tax is unnecessary and potentially damaging to economic growth, international relations, and the government’s political agenda.
It could also increase inequality and illegal activities.
Author: Peter Tasker