On April 1, the consumption tax rate will be raised from 5 percent to 8 percent. The extra income the government accrues from this increase will be a source of revenue for the nation’s social welfare system.
In addition to providing a robust social welfare system, the government must mitigate any negative impact the tax hike may have on the economy to ensure that the recovery does not lose steam this spring and beyond.
The effects of the Abenomics policies of Prime Minister Shinzo Abe’s administration have helped the economy get back on its feet. However, the work to shake off the shackles of deflation and generate genuine economic growth is not complete. Japan’s economy now faces a moment of truth.
The Liberal Democratic Party, New Komeito and the Democratic Party of Japan signed off on the higher consumption tax rate as part of a three-party agreement on unified reform of the social security and tax systems. After the rate is increased to 8 percent, it is scheduled to be jacked up to 10 percent in October 2015.
Give future generations a break
Japan’s national debt exceeds ¥1 quadrillion. Its fiscal situation is the gloomiest among advanced nations. The chronically low birthrate and aging population, combined with a declining working population, have conspicuously resulted in snowballing social welfare expenses for medical, pension, nursing care and child-rearing costs.
Social welfare expenditures have already reached ¥30 trillion annually and are expected to go up by an additional ¥1 trillion each year.
Meeting these costs through a massive issuance of debt-covering government bonds, which leaves future generations with the bill, must not continue any longer.
By increasing the consumption tax, which can be collected widely from all consumers, the government can ensure a steady tax revenue stream for maintaining and improving Japan’s social welfare system. The significance of this point should not be underestimated.
The government plans to spend the extra revenue generated by the tax increase mainly on strengthening medical and nursing care services that support the elderly, assistance for people raising children, and steps to combat the low birthrate.
Given that each citizen will be required to shoulder an extra financial burden, the government in turn must implement effective policies to help them. It needs to quickly consider additional steps, including curbing medical, nursing care and pension benefits to help stabilize the social welfare system.
In the months before the tax hike went into effect, many consumers splashed out on durable goods such as bicycles and home appliances, and stocked up on a wide range of foods and household goods. This boosted demand and expanded consumption. As a result, Japan’s economic growth rate is predicted to be about 5 percent in January-March this year. The big question will be what happens to the economy after the consumption tax hike kicks in.
Learn from previous hikes
Japan’s economy tanked after the consumption tax rate was increased from 3 percent to 5 percent in April 1997. The situation was exacerbated by the Asian currency and financial crisis as well as financial insecurity.
Most analysts expect that Japan’s economy will also experience negative growth in the April-June quarter, partly due to the likely drop in demand after last-minute shopping sprees before the tax increase. Growth is forecast to return to positive territory in the July-September quarter, but the outlook does not warrant unbridled optimism.
Abe said, “We will do everything we can to minimize any negative effects of the consumption tax rise, and quickly get the economy back on a growth path.” His comment is absolutely right.
The aces up the government’s sleeve for buoying the economy are the ¥5.5 trillion fiscal 2013 supplementary budget, which centered on public works projects, and the initial general account budget for fiscal 2014, which will total a record-high ¥95.9 trillion.
The government wants this earmarked money spent ahead of schedule. To achieve this, it has set the numerical target of implementing “at least 60 percent” of budget spending on public works projects and other outlays in the fiscal 2014 budget before the end of September.
By quickly carrying out these projects, the government expects to avoid strangling the economic recovery. However, it is worrisome that a labor shortage at construction sites and rising building material costs have caused some projects to attract few bidders.
Corporate investment in equipment and exports are major drivers of economic growth, but these still lack oomph.
Companies will need to brace for a dip in sales and other unfavorable conditions in April and beyond. It seems the ability of private-sector demand to orchestrate a robust economic recovery will be tested for some time to come.
All this makes the second round of the government’s economic growth strategy, which will be unveiled in June, even more important. We hope the new strategy will shore up the foundations of the economy by incorporating a significant cut in the corporate tax rate, and regulatory reforms that stimulate business activity and encourage the development of new industries.
It also is important that the government and local authorities step up their monitoring to ensure that businesses can smoothly pass on the full tax rise to customers through higher retail prices.
Pass on hike through prices
Steps must be taken to prevent large companies from exploiting their advantageous position to force suppliers to absorb the tax increase while freezing their own purchase prices.
At the same time, it is problematic that government efforts to assist households whose budgets will be stretched by the higher consumption tax rate remain insufficient. The government has decided to provide low-income earners with a special cash benefit.
However, this will be a one-off payment to selected recipients, so it will have only a limited effect on reducing their economic burden.
Abe plans to decide at the end of this year whether to go ahead and lift the consumption tax rate to 10 percent in October 2015. His decision will undoubtedly hinge on the economic growth rate logged in the July-September quarter.
If the consumption tax rate is indeed bumped up to 10 percent, we think the government should introduce a reduced tax rate for some daily necessities. The LDP and Komeito have restarted talks on such a reduced rate. The two parties should quickly decide to introduce a lower levy when the rate is increased to 10 percent, and select which items should qualify for it.