(Revised) Japan’s increase in sales tax – right decision?

In my previous blog post Japanese economic growth – now time to stimulate export, I wrote about how Abenomics has not been successfully increasing the Japanese export. Furthermore, I was concerned about Japanese economic recovery, as Japan’s recovery is mainly driven from increase in domestic consumption. In April 1st 2014, Japan’s domestic sales tax rose from 5% to 8%, as announced at the beginning of Abenomics plan. Japan’s Prime minister Abe Shinzo’s aggressive monetary policy did help Japan to escape from its continuing deflation, yet I am worried if this rise in sales tax will go against Abe’s monetary policy.

According to the Wall Street Journal article Japan’s Sales-Tax Boost Will Test Abenomics, Japanese government’s decision to increase sales tax worries many economists. As it can be seen from the graph below, Japan have once increased its sales tax in 1997 from 3% to 5%. The result was disappointing, as Japan suffered from a decrease in consumption and continuing deflation and recession for more than 18 months. Bank of Japan forecasts that Japan’s Consumer Price Index will be at its steady rise of 1.3% for remainder of 2014 and then reach its target rate of 2.0% by 2015, while private economists forecast that Japan might go back to its long-time deflation, with rate lower than 1%.

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The article from Reuters Abe bets he can break Japan sales tax jinx with April 1 rise points out that the main reason for this increase in sales tax is to curb Japan’s massive public debt. From the FRED graph below, it is obvious that Japan’s public debt is increasing drastically. Jesper Kroll, head of equities research at JP Morgan insists that “2014 is not 1997”, saying the probability of success (in rising sales tax) is better than ever. He cited a tight labor market, increased household and small-business burrowing and a $53.44 billion extra budget enacted in last December will cushion the impact of the sales tax rise.

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However, I am still concerned about this tax rise. As I have already mentioned in my previous blog post Japanese economic growth – now time to stimulate export, Japan’s economic recovery in 2013 was driven from domestic consumption (not international trade) despite aggressive Abenomics. While Yen is still strong, Japan’s export is unlikely to boost in a huge amount in 2014 as well. Therefore, if Japan’s domestic consumption is reduced due to an increase in sales tax, then it is probable that Japan will be unable to maintain the fast rate of economic recovery from 2013. Therefore, I think it is extremely important for Japanese government to keep an eye on Japanese economy (especially its domestic consumption and CPI index) and execute necessary monetary and fiscal policies if increase in sales tax goes to an opposite direction to where Abenomics is heading.

3 thoughts on “(Revised) Japan’s increase in sales tax – right decision?

  1. lippmanb

    Interesting post. I wrote one about this as well. As I said in mine, all we can do is play the waiting game. There is no guarantee about what will or will not happen.

  2. gaochen

    I agree with your points. Although the increasing tax could curb the public debt, it might affect the domestic consumption which might make the economy even worse.

  3. agolicz

    Interesting post. I also addressed many of the same issues in one of my posts. I think it’s important to note that 1) it’s hard to know if the 1997’s economic woes were directly caused by the increase in the sales tax (also, I’m not sure how this would cause deflation – isn’t this typically a monetary policy rather than a fiscal policy problem?) and 2) Japan’s aging population may mean that national savings rates will drop in the near future as retirees begin to withdraw from their accounts. Most of Japan’s debt is currently funded by domestic investment, so if national savings dry up after a wave of aging citizens enter retirement perhaps the Japanese government will run out of investors to buy up its debt – so maybe it’s better to try and pay some of it off now? It’s a pretty complicated problem, and not one to envy, so it’ll be important to watch this situation unravel closely.

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