Consumption Tax Increase 消費税

Now that passage of Noda’s tax increase appears certain, it’s time to think about the implications. I will post a more complete analysis later at my regular blog site but want to try WordPress for ease of entry (and to see whether it generates more hits!).

First, I’m puzzled that the hike of a cumulative 5 percentage points (from 5% to 10%) is being done in two hikes rather than five or ten (my preference would be a boost of 0.5 pct points every six months). In the days of bar code scanners and computerized cash registers, surely this would not be hard from the retail side. It might also make it easier to extend the hikes, since it’s unrealistic to think that a 10% rate will be enough in the face of an aging population and an already small government —  expenditure cuts won’t go far.

Second, there’s the timing. To be honest, we’ll only know after the fact. Ideally, taxes should be increased in a period of robust growth, when otherwise (<i>ceteris paribus</i>) the BOJ might want to raise interest rates to slow things down. I’m sympathetic, however, to passing legislation now. There had been a broad consensus to raise the consumption tax over a decade ago. The timing just never was right — and that’s ignoring politics, which are more favorable than in the US because under Japan’s cabinet system there can be up to four years between elections.

History cemented it in political (and popular) memory. There was a consumption tax increase effective 01 April 1997, just when the Asian financial crisis was about to break — and the increase coincided with the expiration of a temporary tax cut and a stimulus package. The fiscal hit was large, the economy plunged into recession.

Third, there’s the argument that initial hike should be of other taxes, and above all that the government should introduce a tax ID system to stem tax evasion. Now with a long period of low interest rates and low returns on equities, and far fewer mom-and-pop stores and family farms, this will not produce the bonanza it would have a quarter century ago. In other words close loopholes first, raise rates later. That risks another round of “now is not the time” — and rates will have to be raised, and sooner rather than later.

Now I expect higher taxes to slow growth; I’m not convinced by the new macro of DSGE models in which expectations mute fiscal policy. (Not that proponents of such models are consistent in applying them: in the context of such models, if stimulative policy is ineffective in boosting the economy, then so are tax hikes in slowing it. That’s not the message I hear in the U.S., so my conclusion is that it’s ideology hiding behind mathematical formalism.) At some point, however, Japan’s deficits need to not only be trimmed but turned into surpluses. Since its government is already minimalistic, that must entail revenue enhancements.

Let’s cheer Prime Minister Noda’s gutsy leadership, and hope that he prevails.

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