Sales tax increase in Japan

The Wall Street Journal introduced some interesting story of Hideo Noda, an ordinary Japanese office worker, who recently bought expensive smartphone and other stuffs. The reason why he suddenly went shopping those goods is to avoid paying more sales tax later. Japanese government will raise sales tax rate to 8% from 5%. My question is whether it is the appropriate time to raise sales tax now in Japan.

I worry that this sales tax increase is very likely to hurt recovery of Japanese economy and, weaken Abenomics to stimulate Japanese economy. As we learned from basic economic theory, tax increase will cause consumption and output to decrease as disposable income decreases. The Wall Street Journal also reported that in the past, Japan already experienced serious decrease of consumption due to the increase of sales tax. In 1997, Japanese government increased sales tax rate from 5% to 3% and this really hurt consumption along with the effects of Asian financial crisis.

The main reason for the increase of sales tax is to reduce huge pile of Japanese government debt, which is the largest among the advanced economies. As we can see from the examples of other countries like some peripheral euro countries which are suffering from debt problems, debt crisis can really hurt its economy. But even though the government debt is a serious problem in the Japanese economy, I think that more urgent issue for the Japanese economy is to escape from deflation and stimulate consumption.

Japanese government can solve government debt problem more effectively when economy is in better situation. They can raise tax more easily with less damage on the consumption and general welfare of its people after economy gets better. Normally, when economy is in boom, government tax revenue increases even without increasing tax rate. Also, it is known that, in Japanese case, majority of government debt is held by its own people not by foreign lenders. This contribute to reduction of possibility of debt crisis in Japan. And Japanese government can use easy monetary policy to easily revolve its debt by making Bank of Japan buy more government bonds. So, having a large debt is not such an immediate threat to Japanese economy.

With aggressive economic policy aka Abenomics since end of 2012, Japanese economy showed some strong signs of recovery with 4% growth in the first half of 2013, and also began to escape from deflation with the consumer price recording a rise of 1.3% in February for the three consecutive months.

Some criticize Abenomics for its easy money policy. Also, export competing countries with Japan complain about its easy money policy and depreciation of Japanese Yen. But, I think this Abenomics is quite reasonable policy choice from the perspective of Japanese government. So, I worry that this tax increase may cause more harm than good for Japanese economy.