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 forecasted in October 2013. Japan’s Prime minister Abe Shinzo’s aggressive monetary policy did help Japan to escape from its continuing deflation, and 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. 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.

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.

4 thoughts on “Japan’s increase in sales tax – right decision?

  1. wyna

    The sales-tax raise was already announced at the beginning of the Abenomics plan. So there should not be a big surprise to the Japanese. And although BOJ expects steady growth in inflation, but if you actually see the volatility of inflation rate in Japan for the past 30 year time span, the volatility is very high. BOJ’s announcement could be just to reassure people and prevent any negative herd sentiment.

    As for Nikkei index rose 57% last year, but it already declined 9% past 3 months. However, they MUST raise taxes otherwise they will face unsustainable amount of budget deficit. Their debt to gdp is already at 227%, meaning they owe more than two and a quarter times the amount of their income. So in that regards it is definitely a right decision.

    I wrote on the same subject if you are interested in reading.

  2. nickcoll

    I agree that the consumption tax adds another burden on Japan but from recent articles, it seems like it has actually increased consumption in February and March as people looked forward. Many citizens stocked up on many necessities before the sales tax increased.

  3. fanglue

    Interesting post. If the sales tax continues to grow, consumer surplus will decrease. This will also have an effect on the domestic demand which may lead to a negative effect on its GDP. A good way to deal with the aggregate demand is to increase the foreign demand of Japanese goods. Therefore, it is good to start stimulate its exports.

  4. psseo

    Nice post on Japanese economy. I also agree with you that this sales tax may hurt Japanese economy. Considering still unstable economic situation, this tax increase is likely to hurt consumption and Abenomics.

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