Can Japan Raise the Sales Tax Without Tanking Growth?

(Bloomberg Businessweek) -- While the world’s become accustomed to thinking of Japan’s economy as sickly, it’s heading into next year with a shot at racking up the longest expansion since the asset-price bubble ended in 1991.

Deflation no longer stalks the country, corporate profits keep rising, and companies are ramping up investment at the fastest pace in a decade. Even wages, which have remained stagnant for years, are finally edging higher.

Japan will need every bit of its newfound strength when Prime Minister Shinzo Abe presses ahead with a risky plan to increase the nation’s sales tax next October. Raising the unpopular levy—which the government has done twice since it was introduced in 1989—has sent the economy into reverse and incited political revolts. “Increasing the sales tax is important for Japan’s credibility in addressing government debt,” says Bloomberg Economics’ Yuki Masujima. “Yet any deterioration in consumer confidence will be a problem.”

Abe is aware of the dangers, having watched consumption slump after he bumped the impost to 8 percent from 5 percent four years ago. The economy shrank in the quarter the levy went up, then crept sideways before slowly righting itself. Chastened, Abe repeatedly postponed plans to lift the tax to 10 percent.

But with the ruling party recently reaffirming its support for his leadership, he’s seized on next year as the best time to bolster the government’s revenue base without tipping the economy into recession. The construction boom for the 2020 Summer Olympics in Tokyo is set to roll on, exports look likely to hold up, and gross domestic product is forecast to expand by just more than 1 percent—a healthy number by Japanese standards.

The window of opportunity will close soon, though. The expectation is that GDP growth will slow noticeably as soon as 2020, as the end of the Olympic stimulus coincides with a global downturn that damps demand for Japan’s exports. Abe is also motivated to act before his tenure as premier comes to an end. Most observers see him stepping aside in 2021, by which time he’ll have become Japan’s longest-serving prime minister.

To sell the hike to the electorate, Abe has pledged that about half of the revenue from the increase will go toward education and social spending. The government wants to make preschool free and to pick up the tab on child care for low-income families with children up to 2 years old. The remainder of the funds will help cover the government’s deficit as it struggles with the costs of its aging population and a debt load equal to about 240 percent of GDP—the heaviest burden among major economies.

Most food will be exempt from the increase, which will soften the blow on the average household. Alcohol will take the full hit, as will meals served at restaurants. The government is said to be considering a host of other measures, including rolling out tax breaks for big-ticket purchases such as homes and cars and pressuring credit card companies to reduce transaction fees. Speaking in his capacity as chairman of the country’s carmakers’ association, Toyota Motor Corp. President Akio Toyoda warned in September that 90,000 auto industry jobs could be on the line.

Bank of Japan Governor Haruhiko Kuroda, who admits to underestimating the fallout from the 2014 tax increase, told Bloomberg News in a recent interview that this time “the government is determined to avoid excessive impact on the economy.” While the BOJ is tapering asset purchases, it’s pledged to keep borrowing costs extremely low until the impact of the tax hike is known.

A majority of economists expect the pain to be confined largely to a drop in fourth-quarter GDP. A minority see the contraction lasting for two quarters, meeting the common definition of a recession. The 2014 hike was initially shown to have caused a recession before an upward revision in the data erased the stain.

To contact the editor responsible for this story: Cristina Lindblad at mlindblad1@bloomberg.net

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