TOKYO Jan 24 Japanese Prime Minister Naoto Kan
has put social security and tax reform at the top of his policy
agenda, seeking to increase the politically sensitive consumption
tax to fund welfare costs in a fast-ageing society.
Economists say raising the consumption tax, now 5 percent and
among the lowest in major economies, is vital for Japan, whose
public debt is about twice the size of its $5 trillion economy,
but if done immediately it could undermine a fragile recovery.
Following are some questions and answers on prospects for
Japan's sales tax hike and its potential impact on the economy.
HOW WILL KAN APPROACH SALES TAX HIKES?
Kan's cabinet aims to lay out a roadmap in June to fix
Japan's creaking social welfare system, which could include the
extent and timing of sales tax hikes. It also hopes to pass a tax
reform bill by the end of the fiscal year starting in April.
The bill would lay out reform plans but not necessarily raise
taxes immediately, Economics Minister Kaoru Yosano said, adding
that a tax hike should be timed to match the economy's ability to
Kan, facing a split parliament and doubts about his political
survival, has called for multiparty talks on welfare and tax
reforms, but the main opposition has turned a cold shoulder,
saying the ruling party must first show a concrete reform plan.
Kan is also likely to have a hard time gaining consensus on a
reform plan within his ruling Democratic Party of Japan (DPJ),
whose members are wary of alienating voters, making the outlook
on tax reform highly uncertain.
Having floated the idea of raising the sales tax when he took
office in June, Kan backed down after the DPJ badly lost an upper
house election the following month.
HOW WOULD TAX HIKES HURT THE ECONOMY?
It depends on how the economy is doing when a tax hike is
Economists warn that announcing plans for a tax increase
could trigger a rush or purchases before the tax hike is
implemented, followed by a subsequent slump in consumption to
levels that, during times of weak demand, could be less than what
prevailed before the announcement.
To avoid big fluctuations, analysts are calling for
incremental tax hikes, which some say could also boost inflation
expectations. But government officials are wary of taking such an
approach as it would involve complicated and time-consuming
procedures at government offices with each increase.
Nomura Securities says doubling the sales tax rate would cut
0.5 percentage point from Japan's real GDP growth in the year the
increase was implemented, and another 0.8 percentage point the
following year. Mitsubishi Research Institute estimates it would
knock as much as 2 percentage points off the real growth rate.
That could be a considerable blow to the economy given that
Japan's real growth averaged 1.3 percent over the decade up to
the financial crisis in 2008 and the government aims to achieve 2
percent expansion per year over the coming decade.
HOW DID PAST TAX HIKES AFFECT GROWTH?
Historic precedents suggest that an increase in the sales tax
would undermine growth initially, rather than boost it.
When Japan adopted a 3 percent consumption tax in 1989 the
economy was booming.
Growth slowed after the tax was introduced to 4.6 percent in
fiscal 1989/90 from 6.4 percent the previous year. Growth in
private consumption slid to 4.1 percent from 5.3 percent.
When the tax rate was raised to 5 percent in the year to
March 1998, the economy stalled after growth of 2.9 percent the
year before. A banking crisis also weighed on the economy, which
slipped into a recession the following year.
Analysts say the sales tax played a large part in the
economic slowdown in both cases, although the direct impact is
hard to calculate as the increase was accompanied by changes to
other tax rates.
HOW WOULD THE TAX IMPACT INFLATION?
The introduction of the tax in 1989 and its subsequent
increase a decade later raised prices, although such taxes
generally do not have a long-term inflationary impact.
Core consumer inflation excluding fresh food but including
oil product prices jumped to 2.8 percent in fiscal 1989/90 from
0.6 percent the year before.
It increased to 2.1 percent in fiscal 1997/98 from 0.3
percent a year earlier.
Nomura says increasing the sales tax to 10 percent would
raise core consumer inflation by 3 percentage points. Japan
Research Institute says such a rise would boost core inflation by
4.5 percentage points.
To offset the impact of a higher sales tax, Kan last year
proposed refunds for lower-income earners and applying different
rates to food and some other necessities as many other developed
countries do. That could complicate the impact a sales tax hike
would have on inflation.
WHAT SALES TAXES DO OTHER COUNTRIES APPLY?
Japan's 5 percent consumption tax rate is among the lowest in
major economies and compares with 20 percent in Britain and 23
percent in Portugal -- which raised the tax rate by 2.5 and 2
percentage points respectively this year to tackle debt issues.
The rate is 19 percent in Germany and 10 percent in South Korea.
The impact seems to have varied from country to country.
Germany raised its value-added tax, similar to a sales tax,
by 1 percentage point in 1993 to 15 percent, which came amid an
economic slowdown and led to a slide in personal consumption.
France increased its value-added tax by 2 percentage points
in 1995 to 20.6 percent. But it managed to avoid a sharp downturn
in consumption, partly because the tax hike came after the
economy's steady growth above 2 percent in the previous year.