Why Japan Is Risking a Tax Hike in a Slow Economy

(Bloomberg) -- While tax hikes are rarely popular anywhere, in Japan increases in the national sales tax have proved especially toxic, squelching economic growth and damaging political careers. Yet Prime Minister Shinzo Abe let the tax rise again on Oct. 1, after two delays, plowing on against a backdrop of escalating trade tensions. He has taken steps to soften the blow to consumers and says the government stands ready to do more to prop up growth if needed.

1. Why is Japan raising the sales tax?

The government is looking to ease the world’s biggest debt load and strengthen the social safety net. Japan’s public debt has grown to more than twice the country’s annual gross domestic product as the cost of caring for its aging population balloons. (A higher proportion of Japan’s population is aged 65 or older than in any other country.) Lawmakers agreed in 2012 to double the tax rate to 10% in two stages (the first step, to 8%, came in 2014). That’s well below the 20% rate in the U.K. and on par with Australia’s 10%. In a bid to spread the benefits wider, some of the additional tax revenue this time will also be used to fund free preschool education and day care.

2. Why is the tax so problematic?

Since its introduction in 1989, the tax on goods and services has been blamed for squeezing consumption and adding to the economic malaise in a country where people have long been inclined to save rather than spend. The tax has prompted recessions, alienated voters and contributed to the fall of at least three prime ministers, most recently then-Prime Minister Yoshihiko Noda, who lost the 2012 election to Abe after putting forward the increases. Abe’s election victory in July means he won’t have to worry about facing voters for some time, but the economic climate is still perilous.

3. Is the tax working?

Somewhat. The extra revenue has slowed the increase in the nation’s debt but it hasn’t stopped it. The government had to push back its target for achieving a budget surplus, excluding interest on debt, and social security costs are projected to keep expanding. Undoubtedly, the sales tax has offered a growing stream of revenue to bolster Japan’s finances. It’s expected to account for 33% of total tax revenue for the fiscal year ending in March 2020, up from 18% in fiscal 1988.

4. Can the economy withstand a hike?

Economists think a contraction is inevitable in the final quarter of this year. The question is how quickly and strongly the economy will rebound. Policy makers and economists both note that any spike in demand ahead of the tax implementation has been less marked than it was in 2014, meaning that a post-hike slide in consumption may be more limited too. Government measures to soften the blow to consumers include tax breaks on purchases of new cars and homes. To reduce the impact on lower-income households, food and drink will be exempted from the latest increase. Still, the tax hike comes at a time when the global economy is slowing and as trade tussles including the U.S.-China trade war and Japan’s spat with South Korea leave the country’s export-driven economy vulnerable.

The Reference Shelf

• A list of measures the government is taking to ensure people will keep spending despite the tax hike.
• QuickTakes on Japan’s aging population, its spat with South Korea and another on Abenomics.
• How Japan is becoming a one-party state.
• The tax hike could have implications for the Bank of Japan.

--With assistance from Grant Clark and Yoshiaki Nohara.

To contact the reporters on this story: Yuko Takeo in Tokyo at ytakeo2@bloomberg.net;Isabel Reynolds in Tokyo at ireynolds1@bloomberg.net

To contact the editors responsible for this story: Daniel Ten Kate at dtenkate@bloomberg.net, ;Malcolm Scott at mscott23@bloomberg.net, Grant Clark, Henry Hoenig

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