On April Fool’s Day, April 1st, Japan will increase its sales tax rate from 5% to 8%. This is the first time Japan has raised sales taxes in about a decade and a half. Interestingly enough, the Japanese economy has responded to this proactively. The Wall Street Journal and Washington Post both published articles about consumers and producers being proactive towards this tax hike. In the month of February, industrial production fell from the last month. This was due to bad weather, which hit the car industry the hardest. Before this, there was a surge in output since firms were trying to take advantage of increases in demand before the tax hike. The car industry is not the only one taking advantage of high pre-tax demand. Retailers used this as their chance to attract customers before sales taxes go up.
In a video interview in the New York Times, reasons why this tax hike is good are discussed. One reason is that Japan’s government is one of the most indebted in the world. The government needs more revenue to pay off pensions and health care, which are experiencing sharp rises in prices. Furthermore, the government needs more tax revenue to help with stimulus spending because the country needs to recover. The central bank also intends to increase its purchase of assets to help the economy recover.
In theory, this tax hike just might work. When the government has more money, it can do more government spending, which is the G component of the GDP equation (C+I+G+NX). This would help increase output for the country, thus helping the recovery. When the central bank buys bonds, interest rates decrease, therefore investment, the I component, will also increase. This could help add to the increase in output.
From a more practical standpoint, all that we can do is play the waiting game. Sure, one can make speculations that could happen. A Japanese super-market general manager believes that sales will decrease in the beginning, but will pick up again in the near future. I would say that this guess is about as good as anyone else’s. There is no way to predict how each person’s consumption patterns will react to this tax hike. As previously mentioned, all we can do it wait. All of that being said, I do think that this is a high-risk-high-reward decision. If consumption does not decrease by too much, or if it bounces back, then Japan can carry on wit its agenda to help its economy recover. If the country falls into a recession, then it could be in even more trouble than it is now. Consumption will decrease, therefore output will decrease. Plus, the government will generate less tax revenue, and it would not be able to help stimulate its economy. Japan would put itself into a recession.