Will Japan’s consumption tax hike fix its fiscal woes?

Australia & Japan in the Region

Volume 7, No 10, October 2019

After two postponements resulting in a delay of four years, the Japanese government at last raised the consumption tax rate from 8 to 10 per cent as of 1 October 2019. The revenue from the consumption tax will be used exclusively to finance growing social security spending such as pensions, medical and old-age care and support for childbearing and childrearing.

The government introduced dual rates with the rate on take-home food items staying at 8 per cent to protect the poor. The rate increase also came with frills to appease consumers, such as special subsidies for purchases made by non-cash payments, to reduce a post-hike consumption slump. As expected, these complications have led to distortions as well as confusion among retailers and consumers. After the hike, Japanese Prime Minister Shinzo Abe said publicly that he believes no further hike will be needed for 10 years. But it is unclear on what basis he made this claim.

According to the government’s own projection published in July 2019, its goal of zero primary deficits (that is, balancing the budget excluding interest payments on its debt) can be achieved by 2026 only under a highly optimistic GDP growth scenario. Under a more realistic scenario, the primary deficits are expected to be 1 per cent of GDP even in 2028, down from the current level of 2.7 per cent. If this goal is worth achieving ― and it is difficult to argue otherwise given the gross public debt of more than 200 per cent and net debt of around 150 per cent of GDP ― there is not much solace in the government’s long-delayed tax hike. The government’s fiscal management should remain vigilant, with expenditure restraints and additional revenue measures where possible.

Yet, there is currently no sense of urgency in Japan. The risk of fiscal crisis is nowhere in sight. The government can finance its debt and deficits at zero or negative interest rates, thanks to the Bank of Japan’s (BoJ) qualitative and quantitative monetary easing (QQE). Inflation is still subdued and well below target. Favourable financing conditions are likely to last for the foreseeable future.

After the hike, Japanese Prime Minister Shinzo Abe said publicly that he believes no further hike will be needed for 10 years.

Influential pundits have argued that under the current situation there is no need for the government to worry about fiscal sustainability. They have found support in the proponents of so-called modern monetary theory, who have cited Japan as real-world proof of their heterodox doctrine. Even some mainstream economists, including Olivier Blanchard, have advocated for fiscal activism in Japan and argued against the consumption tax hike. An important basis of their argument is the absence of inflation and the resulting very low interest rates. Still, most mainstream academic economists in Japan are undaunted, sticking to their guns of prudent fiscal management.

Unfortunately, discussions of sustainability, including fiscal sustainability, are intrinsically vague because they involve the future. Since the ability to forecast economic conditions over the medium to long term is woefully weak, it is impossible to settle the debate one way or the other. Without taking sides, however, there remain proposals which should receive no objections from both sides.

The OECD has a webpage dedicated to ‘independent fiscal institutions’ (IFIs). IFIs are ‘public institutions with a mandate to critically assess, and in some cases provide non-partisan advice on, fiscal policy and performance’. Only six OECD members had IFIs by the 1990s, including the US Congressional Budget Office, but the number increased sharply in the 2000s and 2010s to 27 of 36 OECD member states. Japan is conspicuously missing from the list despite its distinctively bad public finance figures. Isn’t it time for Japan to have an IFI that has a strong mandate and research capabilities?

Isn’t it time for Japan to have an IFI (independent fiscal institution) that has a strong mandate and research capabilities?

At present, it is the Cabinet Office’s responsibility to produce fiscal projections, serving as secretariat for the government’s Council on Economic and Fiscal Policy. It has competent economists and there is no doubt that it can do the job well. Yet, being part of the government, there is a limit to its ability to be fully objective and candid, which justifies having a separate institution for checks and balances.

This institution’s mandate can be broader than fiscal sustainability, including assessments of the efficiency and effectiveness of policy proposals to be made into law. It should also include a transparent analysis of the fiscal consequences of an exit from the BoJ’s QQE, the topic BoJ Governor Haruhiko Kuroda has adamantly refused to discuss, because QQE is now closely intertwined with fiscal policy and is critical for its sustainability.

It was reported in 2015 that a group of parliamentarians across the aisle were planning to propose a law to establish an IFI in the Diet. There has been no follow-up report on this since. It may have fizzled out. This initiative should be revived so that all parliamentarians, and Japanese citizens in general, can have access to reliable and impartial information about where Japan’s public finances stand and where it is going.

About the author

Masahiko Takeda is a recently retired Professor of Economics who was based at the School of International and Public Policy, Hitotsubashi University, Tokyo.

Before he taught at Hitotsubashi, Takeda worked at the Bank of Japan (1981-2002), the Bank for International Settlements (1989-1992) and served as Alternate Executive Director for Japan at the IMF (1998-1999), and then as a seniormember of the IMF’s European Department and the Asia and Pacific Department (2000-13).

He received Ph.D. in Economics from Massachusetts Institute of Technology in 1988.

Image taken by Richard-G and sourced from Flickr.

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