UPDATE 1-Japan sales tax plan may hurt at first, timing in doubt

* Tax proposal eyes gradual increases to 10 pct by 2015

* Sales tax hike could stimulate consumption if done in steps

* Doubts about implementation as government faces no confidence montion

* Many say higher taxes unavoidable given rising welfare costs, debt burden (Updates with sources, economists' comments)

By Stanley White and Yuko Yoshikawa

TOKYO, June 1 (Reuters) - Japan's government is laying the groundwork for an increase in the sales tax twice over the next four years, which could temporarily hurt consumption and profit margins but secure much-needed funds for social security provided the government is stable enough to enact the policy.

A Japanese government panel will propose raising the 5 percent sales tax in stages by 2 to 3 percentage points at a time to 10 percent by 2015, government sources told Reuters. The Nikkei business daily said on Wednesday the first rise could come in 2013.

The panel is scheduled to complete its proposal on Thursday.

Consumer spending would likely spike before each tax increase and then slump, but over the long term there would be little impact on consumption assuming the economy can steadily grow, economists say. A bigger obstacle is a no-confidence motion facing Prime Minister Naoto Kan, which could lead to a drawn-out policy logjam.

"A sales tax hike should have a negative impact at the beginning," said Masamichi Adachi, senior economist at JPMorgan in Tokyo.

"Given Japan's fiscal burden, it's better than doing nothing. It should be neutral over the long run because the tax revenue is going to social security, and that means it stays in the economy."

The plan estimates that Japan will need to secure funds to cover a net cost increase of about 2.7 trillion yen ($33 billion) for social security programs in the fiscal year to March 2016 , according to government sources.

Earlier this week academic experts recommended to the government that it should consider lowering welfare benefits for the wealthy, increasing the retirement age and unifying several pension systems into one to try to contain costs.

In a sign of a broad policy consensus, recommendations drafted by lawmakers from the main opposition Liberal Democratic Party and obtained by Reuters said Japan must consider tax hikes and review welfare spending to avoid a steep rise in bond yields.[ID:nL3E7H10DW]

Public debt is already about twice the size of Japan's $5 trillion economy and ratings agencies are threatening to downgrade Japan, so containing rising costs social security in a fast-ageing society and finding new sources of funding is needed to repair public finances.

Social security spending accounts for almost a third of the state budget, which totals 92.4 trillion yen for the fiscal year that started in April. As Japanese society grows older that spending rises about 1 trillion yen each year.

Opinion polls have shown for some time that the Japanese public is willing to accept a higher sales tax to pay for social security, but economists doubt the government has the political capital needed to change the tax code.

If the government did raise the sales tax, it would be the first increase since 1997 when the rate went to 5 percent from 3 percent. That tax hike coincided with the Asian financial crisis and is often blamed for pushing Japan into a recession and for making many politicians wary of raising taxes further.

"Spreading tax hikes out would lessen the negative impact to consumption," said Kiichi Murashima, economist at Citigroup Global Markets Japan.

"As long as the economy has momentum and household incomes are firm, things should be ok. However, there's no guarantee that the government can pull this off."

Kan could survive a vote on a no-confidence motion expected to be held Thursday in the lower house, but his position is likely to be weakened severely as criticism of his handling of an earthquake, tsunami and nuclear crisis in March is strong within the opposition. Members of Kan's own party are also showing increasing signs of revolt.

Industrial production has shown signs of bottoming out, raising hopes that Japan's economy will bounce back from the natural disaster on March 11 stronger than originally anticipated, which bodes well for the economy's ability to withstand higher taxes in the future.

If the government raises taxes when the economy is weak, that would put the squeeze on corporate margins as companies would absorb much of the rise rather than lift prices, according to Satoru Ogasawara, economist at Credit Suisse in Tokyo. (Additional reporting by Kaori Kaneko and Tetsushi Kajimoto; Editing by Tomasz Janowski)