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Raising Japan sales tax is a matter of necessity

Publication Date : 09-10-2013

 

For Prime Minister Shinzo Abe, telling the Japanese that they must pay 3 per cent more for their purchases from next April must have been somewhat akin to jumping off a cliff.

The move, announced earlier this month, is fraught with risks. Raising the sales tax is the last thing a government would choose to do if economic recovery was a priority - which, of course, it is.

Unless he succeeds in raising the wages of Japanese workers to offset the burden of higher prices, the prime minister will not only be unable to defeat 15 years of deflation, but could also send the still far-from-robust Japanese economy into another tailspin.

By all accounts, Abe was not enthusiastic about raising the sales tax, which is slated to go up from the present 5 per cent to 8 per cent. He belongs to a faction of the ruling Liberal Democratic Party (LDP) that believes the country's fiscal health can be restored through a natural increase in tax revenue that comes from economic growth.

The first two "arrows" of Abe's "Abenomics" formula to get rid of deflation are hyper-easy monetary policy by the Bank of Japan and government spending on public works projects.

Together, they have sent Tokyo shares soaring. They have also weakened the yen by some 20 per cent since last December, helping Japanese exports.

Various growth strategies, many of them expected to be fleshed out later this year, make up the third arrow of Abenomics.

To raise wages, Abe wants to reduce Japan's effective corporate tax rate - currently at about 38 per cent. By doing so, he hopes to induce a virtuous cycle in which increased corporate earnings lead to higher wages, which in turn boost consumer demand.

Jacking up the sales tax, which would depress consumer demand for a few months at least, was naturally not something Abe favoured.
Economists predict that Japan's gross domestic product (GDP) will grow by 5.2 per cent in the January-to-March quarter next year, plummeting to -4.9 per cent for the following quarter after the 8 per cent sales tax kicks in.

But Abe had no choice but to raise the tax. Last year, his LDP made a pact with then Prime Minister Yoshihiko Noda, that it would support the passage of a Bill requiring Japan to raise its sales tax.

Noda wanted the tax in order to pay for future increases in social security expenditure. The tax rise was also aimed at reducing the national debt, which has since ballooned to just over 1,000 trillion yen (US$10 trillion), or about twice Japan's GDP.

In exchange for the LDP's backing, Noda agreed to call early general elections in December. Those elections saw his centre-left Democratic Party of Japan routed.

But if the sales tax law had not been passed, ratings agencies would very likely have further downgraded Japan's credit rating. Such a move would have caused interest rates to rise, thereby making it even more difficult for Japan to reduce its public debt.

In August 2011, Moody's downgraded Japan's long-term sovereign debt rating to Aa3. The ratings agency did this based on Tokyo's huge budget deficits and looming government debt, which were exacerbated by the March 2011 earthquake and tsunami.

To ensure that the economy does not backslide due to next April's sales tax hike, Abe has to ensure that wages will rise.

He has already started talks with business leaders representing major companies. One way is to persuade them to divert some of their combined estimated 240 trillion yen in corporate reserve funds towards wage increases.

Given that domestic demand is shrinking, Japanese corporations believe that to survive, they need huge funds to expand overseas through mergers and acquisitions as well as other means. So money to boost wages will have to come from elsewhere, such as Abe's proposed cut in corporate taxes.

While big companies may be happy to oblige Abe by boosting one-time bonuses (no doubt in the hope that he will push for further cuts in corporate taxes), few companies are likely to want to raise basic wages. The latter are hard to cut back on later when the business climate turns sour.

Another problem is that most Japanese workers are not employed by major firms and are therefore unlikely to see either bonuses or wages going up anytime soon.

What appears to hold back major corporations is that they are not sure if Abenomics will work.

Nearly 10 months after he took office, Abe has also still not set into motion reforms that would make it easier for companies to do business and to compete better globally.

Topping the list of reforms desired by corporations is the loosening of labour regulations. In Japan, labour laws currently stand on the side of employees, making it difficult for employers to dismiss a worker without very good reasons.

Abe is seeking to establish special economic zones where it will be easy for employers to sack workers if they violate conditions mutually agreed to beforehand.

A panel advising the government asserts that this will also make Japan more attractive to foreign investors. In the past, many foreign companies have run into legal problems when attempting to dismiss unproductive staff.

The proposals are due to be tabled in parliament later this month as part of a Bill to boost Japan's industrial competitiveness.

Several past administrations have attempted similar economic reforms using the concept of special zones, but have been stymied by opposition from ministries and interest groups.

To show he means business, the premier has decided to personally head a panel tasked with initating the reforms.

Abe need hardly be reminded that raising the sales tax is a politically risky business. Two previous premiers - one who introduced a sales tax in 1989 and another who raised it in 1997 - ended up losing their jobs when the ruling LDP was defeated in subsequent national elections.

Luckily for Abe, he does not face a national election until mid- 2016. But the law obliges him to raise the sales tax once more from 8 to 10 per cent by October 2015.

The tight timetable means he will probably have to make a final decision by April 2015, a decision that may have more serious economic consequences than next April's hike to 8 per cent.

A frustrated Abe reportedly told an aide recently that the sales tax hike was a "trap" laid for him by his predecessor Noda.

Trap or otherwise, having taken the plunge, Abe will need to do his utmost to achieve a soft landing.

 

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