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【Watch Japan Now vol. 32/FPCJ】

August 15, 2012

 

By Masahiko Ishizuka

 

 

Japan’s consumption tax (the equivalent of value-added tax or sales tax in other countries), now at 5 percent, will be raised to 8 percent in April of 2014 and to 10 percent in October of 2015, as the Diet’s upper house approved the bills for the tax hike and related measures for social security reform on August 10. This will be the first increase in the consumption tax in 17 years since 1997 when it was raised to 5 percent from 3, the initial rate at which it was introduced in 1989.

 

In view of the troubled history of the consumption tax in Japan, with attempts to introduce it in the first place and subsequent efforts to raise it having cost governments elections or office, the parliamentary approval of its raise this time is praised by major media outlets as a “historic event” toward correcting the nation’s gargantuan public debt. Regarded significantly noteworthy is the fact that an unprecedented agreement between the ruling and major opposition parties has made the tax hike possible.

 

Although the agreement between the Democratic Party of Japan and the opposition Liberal Democratic Party and New Komeito Party looks highly precarious, the hard underlying reality that has driven politicians to agree on a higher consumption tax is huge budget deficits being generated year after year that have accumulated to public debts more than twice the size of the nation’s GDP, far worse than in any other major countries. Some economists express the fear that within years Japan might be pushed to a fiscal catastrophe, like the one in Greece or Spain, unless appropriate countermeasures are taken.

 

Despite the debt of a dangerous scale and a lackluster economic performance, Japan’s debt is carrying surprisingly low interest rates—well below 1 percent for 10-year bonds—for a variety of reasons. Among them is the underlying notion that Japan, given the current low consumption tax rate, which compares with those nearly 20 percent or higher in Europe, possesses a potentially wide room for tax increases to tackle the outstanding debts. Another fact often cited is that as much as 90 percent of the national debts are being financed with domestic funds—the source being people’s personal financial assets, worth an estimated 1,400 trillion yen, which is a definite advantage that the European countries in financial crisis lack.

 

It is not that the market is entirely insensitive to Japan’s fiscal conditions. When political wheeling and dealing deepened to make the parliament’s vote on the consumption tax uncertain, the 10-year bond yield surged beyond 0.8 percent, by 0.06 percentage points in two days. Although it dropped to below 0.8 percent when the tax hike was approved by the parliament, any political imbroglio in the future that could threaten the road to fiscal rehabilitation is considered likely to stir up the market sentiment.

 

While it is true that the forthcoming consumption hikes are of historic significance as a first step toward fiscal rehabilitation, it still is a very small step before the formidable tasks that lie ahead. When the consumption tax rate goes up to 10 percent, it is calculated to generate 13.5 trillion yen in extra revenues, of which 2.7 trillion will be spent on improvement of pensions and replenishment of medical, nursing and child care, while 10.8 trillion yen will be used to sustain the present social security and pension expenditures.

 

Of the 90.3 trillion yen revenue in the fiscal 2012 general account budget, tax and other incomes account for only 46 trillion yen, leaving the government to depend on new bond issues for 44 trillion yen. On the expenditure side, 21.9 trillion yen (24.3 percent of the total) goes to debt servicing, while social security programs consume 26.3 trillion yen (29.2 per cent). Under the impact of the aging and shrinking population, social security costs almost automatically swell by 1 trillion yen each year, a juggernaut-like factor in the ballooning budget deficits.

 

During the 1990s, in the wake of the bursting of the economic bubble, the government infused well over 100 trillion yen in public works investments in an attempt to turn the economy around―but in vain. This was the beginning of a marked deterioration in fiscal deficits, on top of which come expanding social security costs.

 

Under the circumstances, doubling the consumption tax to 10 percent is believed to be hardly enough to address the huge outstanding public debts. It must be accompanied by austerity and restructuring of social security programs and other expenditures, and, more importantly, by economic growth which will boost tax revenues. But what to do about these measures is largely left to haggling between political parties in the future.

 

In contrast with the media’s favorable assessment, the proposed consumption tax hike is unpopular with the public, as any tax increase inevitably is. Prime Minister Yoshihiko Noda has already paid the big price of having his Democratic Party split, as nearly 50 Diet members who are opposed to the consumption tax hike deserted the party to form a new party under the leadership of Ichiro Ozawa. In a talk with Liberal Democratic Party president Sadakazu Tanigaki to secure agreement from the LDP to vote for the tax hike, he also had to promise, albeit in a vague way as regards timing, dissolution of the House of Representatives (lower house) and general elections “in the near future.”

 

(Masahiko Ishizuka is a former managing director of the Foreign Press Center/Japan)

 

(Copyright 2012 Foreign Press Center/Japan)