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The next time you hit the shops, what would you say to paying consumption tax of 8 per cent? Sound good? If you’re reading this in Europe, most parts of Canada or even a few high-tax US cities, it probably does. That rate would save you money – possibly a lot. UK value added tax is two and a half times as high; EU member states are obliged to extract VAT of at least 15 per cent, and most squeeze out much more.
To outsiders, then, the anxious debate in Japan about raising the national sales tax must look bizarre.
On Tuesday, barring what would be a surprise reversal of a policy decision that the prime minister’s advisers have been telegraphing for weeks, Shinzo Abe will formally announce that the tax is to rise from 5 to 8 per cent next April. The hike is the first of two that, if fully implemented over the next two years, will ultimately take the rate to 10 per cent – a shade higher than the sales tax in New York City, but still bargain territory for shoppers in Paris or Stockholm.
Japan, as is well known, has more public debt than any other developed country, relative to the size of its economy. Tax revenues cover barely half the government’s budget. The ballooning medical and pension costs that come with a rapidly ageing society make things worse every year: welfare-related payouts are expected to consume 31 per cent of the general account in fiscal year 2013, twice the proportion of 1990.
Given the ugly fiscal situation, bumping up what is one of the rich world’s lowest consumption tax rates might seem like a no-brainer. So why are many people worried? Partly, it is lingering trauma from the last time Japan raised the sales tax, in 1997. A recession followed – one deep enough that voters stripped the ruling party of its majority in parliament’s upper house, prompting the prime minister to resign.
This time, a rise would hit an economy that has been growing strongly. Fuelled by Mr Abe’s expansionary “Abenomics”, gross domestic product expanded at an annualised rate of 4 per cent in the first half, the fastest clip among Group of Seven countries. The tax hike would strike right at the heart of the revival: at consumer spending, which – unusually for Japan and in spite of the export-boosting effects of a weakened yen – has contributed more to recent growth than foreign demand or business investment.
Defenders of the tax hike say conditions are better than they were last time. The Asian currency meltdown and a now-resolved Japanese bank crisis made things worse in 1997, as did the government’s decision to cut spending at the same time. Today, Mr Abe is mulling a Y5tn ($51bn) stimulus package to cushion the tax hike’s impact on the economy, while the Bank of Japan is doing its bit with ultra-loose monetary policy. Haruhiko Kuroda, the central bank’s governor, has hinted that he might open the spigot wider if growth slows too much.
Politically, Mr Abe is winning more points for his apparent steeliness than for the tax policy itself. In an opinion survey published by the Nikkei newspaper at the weekend, 66 per cent of respondents said they supported his administration, yet only 47 per cent thought the hike was the right move, compared with 48 per cent who opposed it.
The premier is gearing up to test voters’ goodwill even further, by following the VAT increase with tax breaks for business. The idea is to bring the balance of Japanese personal and corporate taxes more into line with that of other countries, but to many it is likely to look like a raid on their pocketbooks for the sake of corporations.
Mr Abe is raising taxes while simultaneously creating inflation. Reversing a more than 15-year slide in consumer prices is a central goal of Abenomics, one that promises a number of economic side benefits. Yet ensuring that workers’ wages rise in tandem with their grocery and energy bills is a challenging enough task without higher taxes. Even if Mr Abe manages to avoid a 1997-style recession, the tax decision raises the bar for public satisfaction with Abenomics.