Published in Japan Forward 8/11/2018
In twelve months’ time, Japan’s consumption tax is scheduled to rise from 8% to 10%. That may not seem like very much, but the two previous hikes were followed by recessions.
True, Japan’s economic performance has strengthened significantly in recent years, yet personal consumption remains a weak spot. Indeed, consumer confidence has yet to recover from the last hike in 2014.
The October 2019 tax hike was originally set for April 2017, but Prime Minister Abe took the wise decision to delay the implementation. This time he is committed to going ahead. Or is he? He and Finance Minister Taro Aso appear to have left themselves some wiggle room in the event of “a serious shock, such as the Lehman crisis”
There are at least five good reasons for delaying it again.
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 tail-end 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.
Secondly, 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 and 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 reduce the government’s deficit by raising taxes would likely backfire as companies cut investment to match lower demand.
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 Trump and 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 twenty five 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.
Fourth, the tax hikes will be unpopular. 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 seventy 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. Tax hikes could hurt household spending, reduce the Prime Minister’s support rate and thus imperil the constitutional revision project.
Fifth, consumption taxes increase inequality and incentivize illegal activity. Finance ministries everywhere love “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 (Value Added Tax) inevitably leads to big government, whether people want it or not.
Poor people spend more of their income than wealthy people, which makes VAT naturally “regressive,” particularly in comparison 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 introducing exemptions and delays for certain categories. Complicated taxes always cause inefficiencies and distortions. Should caviar attract a lower rate because it is a raw foodstuff?
The higher VAT goes, the greater the incentive to avoid it. In the case of corporate and income taxes, there are various “grey 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 their eye-watering levels of VAT have created 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.
Why not just forget it?