Japan Boosts Sales Tax, May Test Abe’s Policies

Japanese citizens across the country have been rushing to the malls and supermarkets ahead of the sales tax increase this Tuesday. According to George Nishiyama of the Wall Street Journal, Japan plans to implement a sales tax increase from 5% to 8%, which was designed to help pay for the nation’s exploding social welfare costs and public debt. It is expected that citizens will begin to rein in their spending habits after the tax increase, which appears to contradict Prime Minister Abe’s plan to stimulate the economy. As Nishiyama points out, in 1997, the last time Japan initiated a sales tax increase from 3% to 5%, Japan ended up plunging into a recession lasting 18 months. He also points to a poll by the Kyodo new agency that suggests that

“66% of respondents plan to cut spending, while 33% said they don’t plan any changes. Nearly 80% expressed worry about the economic outlook.”

Overall, Nishiyama seems to suggest that the sales tax rise may be dangerous, in that it could contribute to factors leading to a failure by Abenomics to lift the economy, which in his words “has already faced criticism that it is a policy of exiting deflation by creating a bubble through easy money at the expense of ordinary Japanese.”

Whether this was a causal relationship is yet to be seen, but in any case it seems as though there may be unforeseen consequences of issuing sales tax increase is arriving at the wrong time, and, on one hand, that it has the potential to weaken Abe’s efforts to boost the Japanese economy.

On the other hand, the Economist appears more impartial than the Wall Street Journal to the idea of the sales tax increase, considering fiscal consolidation over the longer term a “fourth dart in the quiver” against Japan’s anticipated financial woes. According to the Economist, Japan’s national public debt issue is one of them most pressing problems in the Japanese economy, as the national debt is anticipated to exceed 240% of national GDP later this year. The Liberal Democratic Party of Japan (LDP) last year cooperated with the Democratic Party of Japan (DPJ) to pass the sales-tax bill. This will reportedly increase the sales tax from 5% to 8% this April, and to 10% in October of this year. Prior to Prime Minister Abe’s inauguration, this policy initially looked like it would help get the country on track; it would reportedly cut the Japanese budget deficit to around 3.2% of GDP. This was, of course, before Prime Minister Abe’s stimulus package that would make hitting the 3.2% of GDP target improbable.

The authors don’t appear very worried about the potential negative effects of Abenomics on the  Japanese debt market. They mention that yields on Japanese government bonds (JGBs) are currently historically low, and that the market for the bonds is dominated by Japanese savers and institutions, which are more loyal and less “flighty” than foreigners who would demand high yields. This would make it less likely that there would be a rapid escape from Japanese bonds over worries that the nation could not pay its debts, and therefore may make the market more stable. Furthermore, the Bank of Japan is currently purchasing 70% of new JGBs issued annually. Essentially, much of Japan’s debt is being paid for with money that the Bank of Japan prints, that the rest is mostly in the hands of Japanese citizens, and that this is not an immediate problem. The economist also points out that while Abe’s policies may hurt Japan in the near-term, that it should boost economic activity, both raising tax revenues and making it easier for the government to raise the consumption tax.

If I were forced to pick a side, I’d stick with the Economist on this issue. First, like in many situations in Economics, it’s difficult to discern causality between events, especially one time events. This throws a bit of doubt into whether the tax increase would inevitably lead to further financial problems for the Japanese economy. The tax increase would mean that Japanese citizens would have less disposable income to spend on consumption, but Abe’s current stimulus policy may be large enough to take the edge off and could make it less likely that a subsequent recession will occur. Furthermore, it may be advantageous use the increased tax revenues to wind down the Japanese debt problem now rather than later. As another Economist article points out, the Japanese also face an aging population that in the near future will begin to withdraw money from their retirement plans. This will mean that the national savings rate could decrease in the near future and make it difficult for the Japanese government to find able citizens to buy up its debt. A tax increase now may be a proactive way to reduce this burden before things get bad. Of course, this is a contentious issue in Japanese politics, and the effects of Japan’s current policies are uncertain, so in the end it will be important for both sides to proceed cautiously.