Recession Returns to Japan

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As news has swirled around whether Japanese Prime Minister Shinzo Abe will commit to the October 2015 sales tax increase or opt out with the calling of a snap election, it would appear that the decision has been all but made for him. Prior to the release on Monday of the country’s third quarter growth figures, the government was already leaking information about preparations to postpone the tax hike to April 2017. Abe has said that he will make a decision on Tuesday about the tax increase once the quarterly economic data is released, and that afterward he would decide on a December election for the House of Representatives.

On Friday, sources that spoke with the Asahi Shimbun said that the relevant government agencies and ministries had been “ordered to modify their preparations so that the [sales tax] increase from the current 8 percent to 10 percent will start in April 2017.” While that was not overly surprising, the leading opposition party, the Democratic Party of Japan (DPJ), which led the process of designing the two part tax hike in 2012, is on board with the plan as well. The DPJ’s approval removes the final political roadblock to the delay.

The main reason to expect Abe to postpone the tax, call elections and shore up support before what is likely to be a difficult ordinary Diet session next year is the economic data released today. Despite a survey of economists done by Bloomberg that predicted 2.2 percent annualized growth for the third quarter, Japan’s economy actually shrank 1.6 percent. If the adjustment for price changes is excluded, the economy actually contracted by 3 percent year on year. One of Abe’s advisors, Etsuro Honda, told reporters last week that unless growth reached 3.8 percent, a tax increase was not possible.

It does not seem that there is any real reason to hold on the previous tax hike schedule, as doing so would likely put Abe’s premiership in jeopardy. Additionally, a discussion paper from the ruling LDP shows that an 18-month delay could add 0.5 percent of growth, which panel leader Kozo Yamamoto estimated “would have a bigger impact on the amount of tax raised than increasing the levy and risking another economic contraction.”

As the resolve and the rationale for the tax hike crumbles, the only remaining question is how likely the government will be to stick to a new timetable, especially one that puts the tax increase over two years away. The same set of conditions can be expected to be in place, giving the prime minister the power to delay if the economic situation warrants. However, when the two-step tax increase was put in place, the leaders only envisioned a delay if an economic problem on the scale of the 2008 financial crisis occurred. While the current recession is painful, it has yet to reach those proportions. The next tax increase delay could be even easier to make.

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