WAS the decision to raise a key tax this year a big mistake? For years, the political consensus has been that Japan’s consumption (ie, value-added) tax needs to go up in order to control a ballooning public debt. In April the government of Shinzo Abe carried out a decision made by the previous government and lifted the tax from 5% to 8%. That is still low by developed-country standards, but it seems to have inflicted more pain than most predicted. Reports from Tokyo’s brothel districts to the country’s rural regions suggest the move has hurt an already limp recovery.
The last time politicians dared raise the consumption tax was back in 1997. It helped push a recovering economy back into recession. Then, however, the move coincided with a financial storm in Asia and a bad-loans crisis at home. This time, politicians seemed surer that people would soon head back to the shops. Yet the fall in household demand has proven even sharper than in 1997 (see chart), and a recession is again on the cards. The economy shrank by an annualised 7.1% in the second quarter of the year. Economists are growing nervous about Japan’s third-quarter GDP, to be published on November 17th.
To add to concerns, the government intends to raise the consumption tax again, to 10% in October 2015. Towards the end of this year, Mr Abe must decide whether to go ahead with that plan or postpone it on the grounds of a weak economy. The dilemma has set off a battle inside his Liberal Democratic Party (LDP) and among his close advisers. On the one hand, opponents of tax rises say their dire predictions have come true. And many in the LDP worry that another unpopular increase could spell trouble in local elections in the spring. On the other hand, for a country with gross public borrowing at close to 240% of GDP, fiscal rectitude is paramount. The finance ministry has long advocated a higher consumption tax.
Probably, the prime minister will stop short of defying the powerful ministry. A loss of political nerve might raise doubts about Mr Abe’s commitment to his broader economic programme, which is intended to impress with its boldness. Further, says Robert Feldman of Morgan Stanley in Tokyo, it should be easier to take steps to guard against an economic slump than to counter the risk of a bond-market crisis.
Politicians arguing against a second tax rise will not be left empty-handed should the finance ministry get its way. In parallel with the April increase, the government spent an extra ¥5.5 trillion ($51.4 billion) in a bid to offset its effects. That spending, mostly on public works, was not wholly successful. A shortage of workers in the construction industry meant delays to projects and to money reaching people’s pockets. Next time, then, the government maybe obliged to spend more. The Bank of Japan may also come under pressure to embark on a second round of unconventional monetary policy in the form of quantitative easing.
Nearly seven-tenths of those surveyed oppose another rise in the consumption tax. Women, many of whom still hold the purse strings in Japan, are especially against. (Ordinary people also grumble that Mr Abe has promised businesses cuts in their taxation.) The government is now thinking about marking basic foodstuffs and other necessities for a lower rate of consumption tax. But the tax will continue to be the government’s big headache.
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