Japan’s record number of elderly will be asked to pay a little more after Prime Minister Shinzo Abe virtually committed to a consumption tax hike next April. However, with measures being planned to offset the impact, economists are not expecting a rerun of the 1997 post-increase downturn.
“In contrast to the situation in 1997 when the last sales tax increase was implemented, labor and price conditions are on a positive trend. The Abe administration’s relatively reflationary stance on fiscal spending is also a positive driver in shoring up Japanese business activity,” Junko Nishioka, RBS chief economist Japan, told The Diplomat.
“We basically believe the impact of the consumption tax hike will be short lived, and the Japanese economy will recover to show sustained growth from the second half of 2014.”
Abe has reportedly told government officials to compile a plan by the end of this month to offset a 3 percentage point increase in the consumption tax rate to 8 percent in April 2014, although his official decision is not expected until October 1.
The tax hike could shave 4 trillion yen ($40 billion) off nominal GDP, impose a 6 trillion yen burden on consumers and wipe out an estimated 3.7 trillion yen of revenues from the nation’s top 50 companies – 10 times as much as Tokyo’s Olympic construction spending.
Offsetting this tax impost will be a stimulus plan worth up to 5 trillion yen, including a potential cut in the corporate tax rate, family assistance for low-income households and other measures. At 35.6 percent, Japan’s corporate tax rate compares with 30 percent in Germany, 25 percent in China and 17 percent in Singapore.
“We and the Finance Ministry may have a different opinion on what our finances will allow, but in any case, we will take the best and most appropriate policy within this limit,” Economy Minister Akira Amari told Bloomberg News.
With GDP growth revised up to 3.8 percent in the second quarter and consumer prices posting their biggest increase since 2008, the government considers the economy strong enough to withstand the sales tax hike. At 8 percent, the consumption tax rate would still be half the average for developed economies.
Critics have pointed to the effects of the previous increase in 1997, when a hike in the tax rate from 3 to 5 percent caused consumption to dive 13 percent the next quarter. The move helped spark a recession, costing the Liberal Democratic Party its Upper House majority and forcing then Prime Minister Ryutaro Hashimoto to resign.
By contrast, the introduction in April 1989 of a 3 percent consumption tax caused consumption to ease by a milder 7 percent in the subsequent quarter, albeit near the peak of the “bubble economy.”
Elderly Bill
The nation marked Monday its Respect for the Aged Day national holiday amid news that one in four citizens were now aged 65 years and over, up 1.1 million from the prior year to nearly 32 million. While 6 million remain in the work force, including 1 million in the agricultural sector, the welfare bill is expected to rise further with one in three people forecast to be aged over 65 by 2035.
The impact is already being seen in government finances, with welfare spending accounting for around a third of the record fiscal 2014 general account budget requests of 99 trillion yen. Largest among them was the demand from the Welfare Ministry for more than 30 trillion yen for the second year in a row, due to increased medical and nursing care spending.
Rising welfare costs and stimulus measures aimed at breaking the back of a protracted deflationary downturn have conspired to drive gross public debt to more than 200 percent of gross domestic product, the worst among developed nations. Amid warnings from the International Monetary Fund and credit rating agencies, the Abe administration has committed to turning the primary balance into a surplus by fiscal 2020.
Nevertheless, the planned tax hike to 8 percent and then 10 percent in October 2015 is still not expected to deliver the planned surplus, with critics warning of a potential sell-off of Japanese bonds triggering a surge in interest rates.
On Tuesday, Abe told a meeting of investors that Japan was clearly a “buy” due to its economic recovery and planned deregulatory measures. While conditions are vastly different from previous tax hikes, Abe and his government will be hoping investors and consumers party like 1989, not 1997.