Japan's Planned Sales Tax Hike

Few matters provoke a more visceral reaction than the subject of taxes. For the most part, the potential for drama centers around three considerations: who is taxed, how much is taxed, and what items are being taxed.

Recently, Prime Minister Shinzo Abe announced a series of sales tax hikes, increasing rates to 10 percent. This move certainly seems strange: after all, much of the Japanese economy has recovered from the famous “Lost Decade” of the 1990s and 2000s, characterized by economic stagnation and rampant inflation (which gave rise to the now-infamous term “stagflation”).

Today, Japan has come very far. Unemployment is so low that it can barely be registered as a real number, while other indicators of progress, such as GDP per working-age adult, have grown impressively. Further, the most recent statistics estimate that some 85.2 percent of Japanese women are working.

With such a bright economic picture, perhaps it’s understandable that Abe has waited until now to hike the sales tax. But it’s unclear what effects this will have on the growing Japanese economy, especially in areas like consumer goods and tourism. It’s also unclear whether this will deflate growth by discouraging would-be buyers from indulging themselves--or whether it’s even necessary in the first place. Will such a drastic hike help boost government revenue, especially as the population ages?

To be fair, Japan’s consumption tax, which has hovered around 8 percent, has traditionally been lower than those of other advanced nations. As Kidera Hajime explains, before the advent of World War II, government funds in Japan came primarily from indirect taxes such as liquor duties. After the war, faced with high inflation and unpopular, heavy-handed business taxes, authorities instead introduced income taxes, which then became the pillar of a new government revenue system.

With the rise of the Liberal Democratic Party (LDP), the organization to which Abe belongs, economists began to reconsider the idea of indirect taxation through consumption taxes. In 2014, Abe postponed the tax hike twice; it was only after he and his party won a landslide election in 2017 that he agreed to finally push through the sales tax hike. The only changes were slightly lower rates for items like food, beverages, and newspaper subscriptions, a concession to coalition partner Komeito, a centrist party comprised primarily of some 8 million middle-class and lower-income Buddhists who often vote as a bloc.

That Abe’s victory owed more to the disorganized opposition than his own plummeting popularity was irrelevant. Instead, Abe cleverly used the snap elections of 2017 as a referendum on the sales tax hike, promising voters that the extra revenue would be funneled towards free kindergarten and day care services, as well as social assistance for disadvantaged college students. Indeed, justifying the hike with the promise of an improved safety net turned out to be a winning idea for the LDP.

Unfortunately, it remains unclear whether this will, as some economists put it, “take the bottom out of the economy.” And there’s plenty of reason to worry that a tax hike would do just that. In previous years, Abe advocated pairing the sales tax hike with corporate tax cuts (at the time, the rate was around 36 percent), in the assumption that such moves will encourage companies to raise pay.

Yet as with the United States, lower business taxes didn’t necessarily translate to higher wages: despite being at nearly full employment, wages have barely moved. This year, salaries are projected to grow barely 1 percent--well below the United States (2.9 percent) and the Eurozone (1.6 percent). At least part of this is due to the massive cash reserves of corporations (an institutional legacy of the stagflation during the Lost Decade); even as retained earnings grew, profits allotted to labor have not followed suit.

All this makes for a unique situation: massive corporate prosperity, low unemployment, low wages, and an increased sales tax. Sadly, there is further evidence that the tax hikes will further hurt the average household. Thanks to flat wages, household spending grew 2.4 percent in 2014, forcing many families to dip into their savings. Just a year later, the country’s savings rate, once the envy of the developed world, fell to negative: 40 percent of unmarried adults (and 30 percent of families) lived paycheck-to-paycheck. This was a 10 percent increase from a decade ago.

Though Abe claims that raising the sales tax to 10 percent will have less of an impact than the previous hike (which raised rates from 5 to 8 percent), it’s unclear whether this will actually be the case. Yet analysts are already concerned about already-low private consumption, especially as it could negatively affect the construction boom running up to the 2020 Tokyo Olympics. From 2013-2016, private consumption fell some 6 percentage points, a trend that some experts blamed on the Abe administration shifting the tax burden from businesses to households.

Unfortunately, this has only continued. In 2018, household spending continued to shrink, driven largely by thrifty Millennials who did not have the benefits of lifetime employment like their fathers and grandfathers before them, as well as pensioners on tight budgets. Millennial households spent some 30 percent less, and close to 60 percent of high school students viewed frugality, rather than generosity, as a desirable trait.

Taking all this into account, it’s surprising that Abe still wishes to continue with his sales tax hike, even in face of stretched finances. After all, prematurely hiking the value-added tax (VAT) in 2014 plunged Japan into a recession, forcing the economy to contract by 1.6 percent in the third quarter. Moreover, Abe has postponed the tax increases several times before, mostly due to fears of dragging down consumer spending; the latest delay occurred in 2016, mostly due to concerns about killing the economic recovery before it reached full steam.

Overall, it’s hard to say that hiking the sales tax will prove beneficial for Japan’s economy or society. Even if the nation is finally past its Lost Decades, the fact remains that lingering problems remain, especially where it concerns the general financial health of the population A negative savings rates and low wages, in particular, don’t bode well for increased consumption; and without buyers, there cannot be economic growth. To throw in a sales tax hike now, at all times, would only worsen the picture--not for corporations sitting pretty on stockpiles of cash, but for the average consumer.

Copyright © 2017 Symphony Financial Partners (Singapore) Pte Ltd.