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As Japan Recovers, Fears That Tax Increase Could Halt Progress Tax Increase Proposal Raises Fear of a Slowdown in Japan
(about 7 hours later)
TOKYO — Japan is on a roll. Its economy is growing at a robust rate of 3.8 percent, thanks to the bold monetary and economic policies of Prime Minister Shinzo Abe. Japanese stocks are up 40 percent this year, and the country is on the cusp of overcoming 15 years of deflation. To boot, Tokyo has just won in its bid to hold the 2020 Summer Olympics, raising hopes of an investment and construction boom. TOKYO — Japan is on a roll. Its economy is growing at a robust 3.8 percent, the stock market is up by 40 percent this year, and the country is on the cusp of overcoming 15 years of deflation. Adding to the positive trend, Tokyo just won its bid to host the 2020 Summer Olympics, raising hopes of an investment and construction boom.
But some economists worry that a plan to raise taxes is coming at the worst possible moment — and could demolish the foundations of a recovery. What could possibly go wrong?
“It’s nonsense. Japan is only midway to recovery and hasn’t fully escaped deflation,” said Goushi Kataoka, chief economist at Mitsubishi UFJ Research & Consulting, which is affiliated with Japan’s largest bank, Mitsubishi UFJ Financial Group. A plan to raise taxes at the worst conceivable moment, economists warned.
“Just as we are beginning to see the light, we’re threatening to snuff it out,” Mr. Kataoka added. “We’re trying to roast the pig before it’s fat enough to eat.” “It’s nonsense. Japan is only midway to recovery, and hasn’t fully escaped deflation,” said Goushi Kataoka, chief economist at Mitsubishi UFJ Research and Consulting, which is affiliated with Japan’s largest bank, the Mitsubishi UFJ Financial Group.
After weeks of debate, Mr. Abe appears set to go ahead with a plan to raise the sales tax rate in April to 8 percent from 5 percent — part of his bid to rein in the country’s public debt, which has surged to more than twice the size of the economy. “Just as we are beginning to see the light, we’re threatening to snuff it out,” Mr. Kataoka said. “We’re trying to roasting the pig before it’s fat enough to eat.”
Opponents say raising taxes on spending is premature, especially because it could dampen consumer spending, considered the weakest link in Japan’s nascent recovery. If spending slumps, Japan could slide back into the deflationary morass that has dogged it during the past 15 years, putting the brakes on some of the most promising growth this year among the world’s developed economies. After weeks of debate, Prime Minister Shinzo Abe appears ready to go ahead with a plan to raise Japan’s national sales tax rate in April, to 8 percent from 5 percent — part of his bid to rein in the country’s rising public debt, which has surged to more than twice the size of its economy.
Still, proponents of raising the tax are pushing for action now because they fear a return to the dysfunction that has marred Japanese politics over the last several years, with a revolving door of prime ministers, said Noah Smith, an assistant professor of finance at Stony Brook University in New York. But opponents say that raising taxes on spending is premature, especially because it could damp consumer spending, considered the weakest link in Japan’s nascent recovery. If spending slumps, Japan could slide back into the deflationary morass that has dogged it for 15 years.
Mr. Abe, with solid support, could be the last prime minister in a while to be able to push through unpopular overhauls, he said. Such a misstep threatens to bring down the curtain prematurely on Japan’s economic revival this year, led by Mr. Abe’s bold set of monetary and economic policies, called “Abenomics,” which has brought about one of the most unexpected turnarounds in recent years. Japan is now one of the most promising engines of growth this year among the world’s developed economies
“The optimal policy is to wait to raise the consumption tax, maybe a year. But given Japan’s political dysfunction, many people are afraid that if you wait too long, that will never get done,” Mr. Smith said. “The idea is that if we see a chance to make unpopular structural reforms, we need to take it now, even though it’s not the optimal time.” Still, proponents of raising the tax are pushing for action now because they still fear a return to the dysfunction that has marred Japanese politics for several years through a succession of prime ministers, said Noah Smith, an assistant professor of finance at Stony Brook University.
To soften the blow, the Japanese government is considering putting together a stimulus package of as much as ¥5 trillion, or about $50 billion, a sum that would return the equivalent of two percentage points of the tax rate increase to consumers and companies, local news reports have said — though Mr. Abe has said he will not a make an official decision on the matter until early October. Japan’s business lobby has also called on the government to cut the country’s relatively high corporate tax rates to make up for a decline in consumption. Mr. Abe, with solid support, could be the last prime minister in a while to be able to push through unpopular reforms, he said. “The optimal policy is to wait to raise the consumption tax, maybe a year. But given Japan’s political dysfunction, many people are afraid that if you wait too long, that will never get done,” Mr. Smith said. “The idea is that if we see a chance to make unpopular structural reforms, we need to take it now, even though it’s not the optimal time.”
Speaking at a government panel on economic and fiscal policy on Friday, Mr. Abe suggested that Japan’s recovery was robust and that its economy was already escaping deflation. He also said that both government and private sector spending before the 2020 Tokyo Games would further bolster economic recovery. To soften the blow, the Japanese government is considering putting together a stimulus package of as much as 5 trillion yen, a sum that would return the equivalent of 2 percentage points of the tax rate increase to consumers and companies, local news reports have said. Mr. Abe has said he will not a make an official decision on the matter until early October. Japan’s business lobby has also called on the government to slash the country’s relatively high corporate tax rates to make up for an anticipated drop in consumption.
The Games “will be a catalyst that will clear away 15 years of deflation and shrinking,” he told the panel. He stressed that he had made no decision on a tax increase yet. Speaking at a government panel on economic and fiscal policy on Friday, Mr. Abe suggested that Japan’s recovery was robust and its economy was already escaping deflation. He also said that both government and private sector spending ahead of the 2020 Tokyo Games would further bolster economic recovery.
Backers of a higher sales tax, including Japan’s powerful Finance Ministry, say the move is necessary to rein in the country’s public debt, which by all measures is gargantuan, thanks in large part to the costs of caring for Japan’s swelling ranks of the elderly. This year, national debt topped ¥1 quadrillion for the first time — more than twice the size of Japan’s economy and larger than the economies of Britain, France and Germany combined. The Games “will be a catalyst that will clear away 15 years of deflation and shrinking,” he told the panel. He stressed he had made no decision on a tax increase yet.
The size of Japan’s debt worries many observers, who say any loss of confidence by markets in Japan’s fiscal sustainability — brought about, for example, by postponing plans to raise taxes — could cause interest rates to rise, which might cripple Japan’s ability to service its debt or even set off a sovereign crisis. Supporters of a higher sales tax, including Japan’s powerful Finance Ministry, say the move is necessary to rein in the country’s public debt. By all measures it is gargantuan, in large part because of the costs of caring for Japan’s increasing elderly population. Earlier this year, national debt topped 1 quadrillion yen, or $10 trillion, for the first time — more than twice the size of Japan’s economy, and larger than the economies of Germany, France and Britain combined.
Even supporters of a tax increase, however, acknowledge that a 3 percent rise in the consumption tax — which is expected to generate about ¥8 trillion in additional tax revenue a year — will not go very far in addressing Japan’s debt. But it was still important to “at least give the appearance” that the country was doing something about its mounting obligations, Hajime Takata, chief economist of Mizuho Research Institute, said after he took part in the government’s forum this month. “The reason why we don’t see bonds issued by a government more than ¥1 quadrillion in debt go into nosedive is because of an unspoken trust the Japanese people hold in Japanese bonds and its government.” The size of Japan’s debt worries many economists and investors, who say that any loss of confidence by markets in Japan’s fiscal sustainability — brought about, for example, by postponing plans to increase taxes — could cause a rise in interest rates that could cripple Japan’s ability to service its debt.
That trust, Mr. Takata warned, could be broken if Japan reneged on plans to start putting its finances in order by raising the consumption tax. Even supporters of a tax increase, however, acknowledge that a 3 percent rise in the consumption tax will not go very far in addressing Japan’s debt. It is expected to raise about 8 trillion yen annually in additional tax revenue. But it was still important to “at least give the appearance” that the country was doing something about its mounting obligations, Hajime Takata, chief economist of Mizuho Research Institute, said in a statement after he took part in the government’s forum earlier this month.
Mr. Takata was among a vast majority of pro-tax-increase voices in a 60-member forum that presented its views to government officials before Mr. Abe’s decision on the tax increase. Over six days of discussions, only three of the forum’s participants opposed any increase in the consumption tax, arguing that the poor would be hit disproportionately hard because they spend a bigger percentage of their income on necessities they cannot cut back on. “The reason we don’t see bonds issued by a government more than 1 quadrillion yen in debt go into nose-dive is because of an unspoken trust the Japanese people hold in Japanese bonds and its government,” he said. That trust, Mr. Takata warned, could be broken if Japan reneged on plans to start putting its finances in order by taking the tough step of raising the consumption tax.
Another dozen participants, including Mr. Kataoka at Mitsubishi UFJ Research, suggested postponing or otherwise modifying how the increase was handled. The tax — which would be levied equally on all goods and services — is considered easy to collect, causes less distortion to the overall economy and is a more stable source of revenue than an income tax in aging Japan, because everyone must consume. And at 5 percent, Japan’s sales tax is among the lowest in the world, providing ample room for raising additional tax revenue, supporters say.
The tax — which would be levied equally on all goods and services — is considered easy to collect, causes less economic distortion and is a stable source of revenue even in aging Japan, because everyone must consume. And at 5 percent, Japan’s sales tax is among the lowest in the world, providing ample scope for raising additional tax revenue, backers say. A second stage of the plan, laid out by the previous government of Yoshihiko Noda, would raise the rate to 10 percent in October 2015.
A second stage of the tax increase plans, laid out by the previous government of Yoshihiko Noda, would raise the rate to 10 percent in October 2015. Public opinion has been divided. A survey of 1,658 voters published by the Asahi newspaper last month showed 43 percent of respondents in favor of initially raising the sales tax to 8 percent as planned, and 49 percent opposed.
Public opinion has been split on the issue. A survey of 1,658 voters published by the Asahi newspaper last month showed 43 percent of respondents in favor of initially raising the sales tax to 8 percent as planned, while 49 percent were opposed to an increase. Still, outside Japan, many of the world’s top economists are siding with opponents of the increase. Koichi Hamada, professor emeritus of economics at Yale University and a confidant of Mr. Abe, has called for a more gradual tax increase that would raise the consumption tax rate by 1 percentage point a year to limit adverse effects on the bond market and economic growth.
Still, outside Japan, many of the world’s top economists are throwing their weight behind opponents of the increase. Such economists are less worried about any imminent risks posed by Japan’s fiscal woes to the bond market. For over a decade, Japanese bond prices have withstood numerous downgrades by credit rating agencies, as well as the debt crisis in Europe. In fact, global financial turmoil has tended to lower yields on Japanese government bonds, as Japan became a safe haven.
Koichi Hamada, a professor emeritus of economics at Yale University and a confidant to Mr. Abe, has called for a more gradual tax increase that would raise the tax rate by one percentage point a year to limit the effects on the bond market and also any adverse effects on economic growth. The bigger risk for these economists is a slowing economy that would hurt tax revenue, and in that way, imperil Japan’s finances. The naysayers have historical precedent to back up their fears.
Such economists are less concerned about any imminent risks posed by Japan’s fiscal woes to the bond market. For more than a decade, Japanese bond prices have remained resilient to numerous downgrades by credit ratings agencies, as well as the debt crisis in Europe. In fact, global financial turmoil has tended to lower yields on Japanese government bonds, as Japan became a haven. The last time Japan raised its consumption tax, to 5 percent, from 3 percent, in April 1997, its economy soon plunged into recession. Retail sales rose significantly in the months before the tax increase, as consumers loaded their pantries and made big-ticket purchases, but plummeted in April and never quite recovered. Consumer prices, adjusted for the tax increase, plunged afterward and have hardly grown since.
The bigger risk as these economists see it is a slowing economy that would hurt tax revenue, imperiling Japan’s finances. And the naysayers have historical precedent to back up their fears. Still, Japan has something now that it didn’t have back then, said Nicholas Smith, a strategist at CLSA Asia-Pacific Markets: an aggressive central bank willing to do “whatever it takes” to prop up the economy should a higher sales tax start taking its toll. The aggressive action of Haruhiko Kuroda, the Bank of Japan governor, has already helped the country’s current economic expansion.
The last time Japan raised its consumption tax, to 5 percent from 3 percent in April 1997, its economy soon plunged into recession. Retail sales increased dramatically in the months before the tax increase, as consumers loaded their pantries and made big-ticket purchases, but plummeted in April and never quite recovered. Consumer prices, adjusted for the increase, plunged afterward and have hardly grown since. A year ago, Mr. Smith wrote in a note published Friday, he was concerned that a consumption tax increase would kill growth. “Abenomics has changed that picture entirely,” he said.
Still, Japan has something now that it did not have back then, said Nicholas Smith, strategist at CLSA Asia-Pacific Markets: an aggressive central bank willing to do “whatever it takes” to prop up the economy should a higher sales tax start taking its toll. The aggressive moves by Haruhiko Kuroda, the governor of the central bank, the Bank of Japan, have already helped kick-start much of the country’s current growth.
A year ago, Mr. Smith wrote in a note published Friday, he was concerned that a consumption tax increase would kill growth.
“Abenomics has changed that picture entirely,” he said in the note.