After 15 years, Japan’s fiscal hawks appear to be getting what they want

“THE consumption tax doesn't have a snowball's chance in hell of being passed.” So wrote one (usually astute) American economist in December, banking on what has been one of the canons of Japanese politics for the past decade and a half—that few politicians are either brave or reckless enough to risk raising Japan's most contentious tax.

Surprisingly, to the relief of some and chagrin of others, on June 15th prime minister Yoshihiko Noda's Democratic Party of Japan (DPJ), though at war with itself, agreed with the main opposition parties to raise the sales tax from 5% to 8% in April 2014, and to 10% in October 2015. The only (ill-defined) proviso is that the economy is strong enough to withstand the increase.

A fiscal-reform bill was expected to clear the lower house of the Diet (parliament) after The Economist went to press, paving the way for its passage in the upper house this summer. If it is enacted, not only will it break a taboo of Japanese politics. It will also deepen the debate in Japan, as elsewhere, about the merits of austerity versus growth.

Politically, the tax rise is certainly daring. When the consumption tax was introduced in 1989 at 3%, and raised in 1997 to 5%, the moves undermined the popularity of the governments of the day. So contentious is the issue still that Mr Noda may feel he has to dissolve the Diet soon after passing the consumption-tax legislation. Either way, he may also face a leadership challenge from within the DPJ in September.

What makes the tax especially contentious are its disputed economic consequences. As far as ordinary people are concerned, history provides ample reason to shudder at the prospect of a higher consumption tax. Its introduction in 1989 coincided with the peak of Japan's stockmarket and property bubbles. The tax increase in 1997 seemed to mark a peak in the economy. Since then Japan's nominal GDP has shrunk by a tenth. Such a fall (exacerbated by deflation) has hit tax receipts, which have fallen by 22% since 1997, leading to a doubling of the government's debt.

At a time of stagnant wage growth, few consumers will relish the prospect of paying up to 5% more for everything they buy. However, at its current 5%, the consumption tax is the lowest in the rich world's sizeable economies, which has bred a sense in Japan that raising the tax was inevitable sooner or later. Even at 10%, it will be at half Europe's levels—and getting there may boost growth in the short term, by bringing spending forward.

Most people need little reminding that a surge of retiring baby-boomers over the next few years will add to the strains on the pension and health-care systems even as the numbers of working-age Japanese are falling fast. The question is whether a tax rise will increase people's economic anxieties and further dampen consumption, or reassure them that difficult decisions are being made to shore up their future, so bolstering confidence.

Economists are divided. For a start, they dispute the economic impact of the 1997 tax increase. Opponents of the new tax hike say it plunged Japan into recession. Supporters say the pain was brief. They believe that the 1997-98 Asian financial crisis, and deepening bad-loan woes at Japan's banks, caused the real harm.

Regarding the future, opponents of raising the tax contend that Mr Noda has been brainwashed by the hawkish finance ministry into believing Japan could be the next Greece or Spain—its ratio of debt to GDP, after all, stands at over 200%. Yet despite that, Japan is awash in private-sector and household savings, which enables the government to finance over nine-tenths of its borrowing domestically. That assurance explains why foreign money is pouring, in record amounts, into Japanese government bonds and why interest rates are at their lowest-ever levels. Some argue that the government could comfortably issue far more debt and remain secure.

Nonsense, retort the fiscal hawks. They reckon that unless Japan trims its public-sector debt, the huge stock of savings held by companies and households could vanish as quickly as you can say “capital flight”. In their view, the bond market is a bubble waiting to burst and, if anything, a doubling of the rate is not enough. The tax rise, says Takatoshi Ito of the University of Tokyo, “is the minimum they should be doing, but the maximum they can probably get away with.” He notes that as the population ages, Japan's economic growth rate will weaken. So the sooner public finances are shored up, the better.

Economists do, however, appear to agree on two things. First, the new tax legislation looks likely to give politicians plenty of room to stall in 2014 should growth not appear robust enough. Second, if the consumption tax is raised, then all the more reason for Japan to redouble efforts to promote economic growth, mostly through productivity-enhancing measures such as spurring foreign investment and entrepreneurship. Takuji Aida, an economist at UBS, a Swiss bank, believes that the government, if it is to ensure that the consumption tax is not viewed as damaging, is under pressure to do more to promote growth.

Indeed, Mr Noda's government is drawing up a new growth strategy that will promote renewable energy, as well as some reforms in health care and education. Regrettably, there is probably not a snowball's chance in hell that it will be ambitious enough.

Comprehension question

1. What are the economic consequences of VAT?

2. What is Japan’s new growth strategy?

Vocabulary