Photographer: Kiyoshi Ota/Bloomberg

Can Japan Afford to Increase Sales Tax?

  • Prior recessions lead to calls for postponing April 2017 hike
  • Decision could impact BOJ's reinflation goals, Abe's election

A little more than a year from a planned Japanese sales-tax increase, a debate is deepening in the corridors of power in Tokyo over whether the nation’s economy can withstand the blow.

Giving some inside and outside government cold feet is the memory of a 2014 rise that tipped the economy into a recession and appeared to spook consumers through last year. The damage came despite efforts by policy makers and companies to do a better job of preparation, after a similar hike in 1997 helped trigger an economic contraction.

This time around, officials are debating how to alleviate the impact by exempting some items -- like food -- from what would be an increase in the levy to 10 percent from the current 8 percent. If those tweaks aren’t ready, the 2 percentage-point bump shouldn’t go forward as planned in April 2017, said a ruling Liberal Democratic Party lawmaker familiar with the discussions who asked not to be identified because the deliberations aren’t public.

“If the domestic economy remains sluggish and significant downside risks to the global economy continue to loom, there is a good chance that Abe could play his sales-tax hike deferral card and call a double election,” said Ryutaro Kono, the chief Japan economist at BNP Paribas SA in Tokyo, referring to Prime Minister Shinzo Abe.

The coming tax boost was originally scheduled for October 2015. Abe put off that hike to April 2017 after seeing the damage from the 2014 move. After announcing the delay, he called a snap election to win voters’ backing for the decision -- which had been unpopular among fiscal hawks, including at the Finance Ministry, who saw higher taxes as crucial in their drive to reduce the world’s largest public-debt burden.

Even with that delay, retail sales declined in 0.4 percent in 2015 from the previous year, trade ministry data showed on Thursday.

Kono at BNP said Abe could go for the same strategy again, and delay the 2017 increase while calling another election for the powerful lower house of Parliament in July, when a ballot for the upper house is already scheduled. Kono put odds of that scenario as high as 40 percent.

The government won’t go through with the increase if economic conditions worsen, said another LDP lawmaker who asked not to be identified.

Former economy minister Heizo Takenaka this week said instead of raising the sales tax in April 2017, the government should focus on cutting expenditures. Takatoshi Ito, a former colleague of Bank of Japan Governor Haruhiko Kuroda, said there’s a possibility that the government will postpone if a reduced tax rate system for most food isn’t ready.

“Japan should postpone the sales-tax increase,” Takenaka, a member of the government’s panel that maps out the nation’s growth strategy, said in an interview this week. “Japan should lay out a near-term goal on something like reining in spending, instead of a tax increase.”

Meanwhile, Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo, is among those who see little possibility of putting off the increase. Ueno correctly predicted Abe’s decision for a delay in the second round of the sales-tax hike.

Inflation Implications

The debate is not an academic one; it’s being closely watched by consumers and businesses. An increase could complicate Abe’s reflationary plan if households cut spending, though delaying the tax risks creating a revenue hole that hurts Japan’s credit profile.

“If the tax rise does not happen, and if there are no equivalent offsetting structural fiscal measures, that would suggest the outlook for public debt sustainability was weaker than before,” said Andrew Colquhoun, the head of Asia Pacific sovereigns at Fitch Ratings in Hong Kong. “That would weigh on the credit profile and ratings.”

Still, one data point gives heart to Finance Ministry austerians: Tax revenue has been rising despite lackluster growth since the last sales tax increase.

The decision on whether to delay has implications for the Bank of Japan and Kuroda’s attempts to propel inflation and growth. If a higher sales tax leads to an economic slump, it could further put off reaching the central bank’s 2 percent price target, and mean that the BOJ will have to prolong its monetary easing program. The board Thursday kicks off a two-day meeting in which people familiar with BOJ discussions said the bank will consider again pushing back the time frame for hitting the inflation target.

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