(Bloomberg) -- Japan hopes it has finally learned its lessons from the painful sales tax shocks of the past.
Overly optimistic views of how the economy would ride out the sales tax in 2014 left red faces in government offices and the Bank of Japan when the economy shrank 7.3% in its aftermath. This time round, Prime Minister Shinzo Abe’s administration has bent over backwards to ensure that the tax hike doesn’t upend the economy at a highly vulnerable time.
Still, analysts are divided on how well the economy will fare. Consumers have been propping up economic growth in recent quarters as weaker global demand and trade war fireworks hit exports and pummel the nation’s big manufacturers. If the squeezing of household incomes through the higher tax combines with a further slowdown overseas, the consequences for the economy could still be ugly.
The median of economists’ forecasts is for a 2.9% contraction in the quarter following the hike, but individual views vary considerably from a slide of 6.2% to growth of 2.6%.
Charts below highlight the key differences between 2014 and 2019 for the world’s third-largest economy.
The economy nose-dived after the 2014 tax hike when consumer spending tanked. In the month before the increase, household spending jumped by the most on record for data stretching back to 2001, as consumers snapped up durable goods in the rush before the tax went up to 8% from 5%. The recovery from the whiplash of demand took much longer than expected.
This time, Abe has lined up a series of counter-measures such as tax breaks on car purchases and homes after the tax hike to limit front-loaded demand for big ticket items. But it still remains to be seen how much the really last-minute spending catches fire this month.
As a result of the measures and the smaller 2 percentage-point increase, the net increase in the overall tax burden for individuals is expected to be much smaller this time compared with previous hikes in 1997 and 2014.
BOJ figures from a report last year showed that a government decision to cut a tax break at the same time as the tax increase in 1997 amplified the extra tax burden, contributing to the economic hit that occurred then. While Abe avoided making the same mistake in 2014, he didn’t avoid a contraction, prompting his administration to try to remove the burden altogether in 2019.
Economy Minister Toshimitsu Motegi estimates the extra tax burden at around 2 trillion yen this time after considering the exempting of essential items such as food and the use of some of the additional tax proceeds to pay for pre-school education. In addition to those ongoing measures, he says temporary measures to even out demand over the coming year, including public works and a points-credit program for cashless payments, reduce the burden by another 2.3 trillion yen.
In short, the overall strain on households should be around zero in the first year of the higher tax, he has said.
Another key difference that may help keep a lid on last-minute buying is the government’s stance on cut-price sales after the tax hike. In 2014, when the BOJ was still looking at a two-year time frame for hitting 2% inflation, companies were under pressure to pass higher prices onto consumers. Abe’s administration outlawed the “tax-back” sales that were popular in 1997, a stance that likely fueled rush demand in 2014. Spending for household appliances and goods exploded by a record 83% in March 2014, the month before the tax increase.
The government’s communication strategy is very different this time. “This time, it seems it’s just up to companies what they do,” said Naoko Ogata, senior economist at the Japan Research Institute.
Still, no matter how much the government can curtail rush demand, the higher prices resulting from the tax will compress disposable incomes adjusted for inflation. That means a drop in consumption is inevitable at a time when the global economy itself could be in rough waters, keeping open the possibility of Japan falling into recession.
Abe will be hoping the decision to exempt food and other essential household items from the tax increase should ease the squeeze on pocket books this time.
Household spending has been solid so far this year, helped by a greater number of public holidays, and by a growing number of people in work. More people, especially women and senior citizens, are in the labor market, compared with 2014, as companies hire to deal with a severe labor shortage. That should make households more resilient to the tax hike, according to Takeshi Minami, chief economist at Norinchukin Research Institute.
But Minami also flags that falling wages this year will eventually hit expectations for future income and spending. If prices are also kept in check by sales, that could weigh further on inflation expectations too, he said.
Other residual problems of the tax hike include the possibility of an additional slump in consumption when the bonus points program on cashless sales runs out in the summer of 2020 and other counter-measures expire.
“I think people will stay in a saving mode rather than a recovery mode after the tax hike,” said Koya Miyamae, senior economist at SMBC Nikko Securities.
What Bloomberg’s Economists Say
“There’s some evidence of extra spending by consumers ahead of the sales tax despite some noise in recent data. Still, it doesn’t seem strong so far, so while the economy is likely to shrink in the quarter after the sales tax, the contraction will probably be around 3% in annualized terms, less than half what we saw in 2014.”
--Yuki Masujima, economist
Click here for more commentary on Japan’s outlook.
©2019 Bloomberg L.P.
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