Japan’s First Sales-Tax Increase Since ’97. What does this mean?

Japan saw its first national consumption tax hike since 1997, with the rate rising from 5 percent to 8 percent. For more than a decade, Japan’s relatively low consumer taxes have been seen as a likely target for raising rates to increase tax revenue and begin dealing with Japan’s high levels of national debt. But raising the tax rate has not entirely gone without controversy or criticism. Some have feared a drop in consumer spending and a heavier burden on Japan’s expanding aging population, pointing to how the 1997 tax hike contributed to the country’s return to recession.

 Japan's parliament enacted a budget for fiscal 2014, Japan raises taxes after a decade. The short-term effect is estimated to be about 6 trillion yen ($58 billion), or 1.2 percent of gross domestic product, according to Morgan Stanley. Tokyo hopes that stimulus measures designed to blunt the impact on select groups will help lessen the sting of the increase. Though Japanese Prime Minister Shinzo Abe feared the tax hike would harm his economic agenda, often referred to as Abenomics, Abe also feared that backing down on the long-planned increase would undermine confidence in the government’s commitment to addressing Japan’s ballooning debt and following through with other measures to improve the country’s economic position. Implementing the new tax, however, carries some risks, and if Japan’s economy begins slipping backward again, it could rapidly undermine Abe’s broader initiatives.

The Japanese economy is in relatively decent shape. The economic malaise of the past two decades has certainly taken the shine off of Japan, but its economy remains one of the three largest in the world, despite a slow decline in population and debt buildup. Japan’s debt, too, is perhaps not quite as significant as the numbers would appear, given that most of it is owed to domestic rather than international creditors. This doesn’t mean that Japan isn’t facing economic challenges. In particular, Japanese demographics and rising energy import costs are forcing the country to rethink its economic foundations, and trade spats with China have pushed Japan to revisit its economic relations in Southeast Asia and beyond.

These same demographics, several decades of slow growth and a quiet international role for Japan (even as the balance of power in its region has begun to change dramatically) have driven the country to reassess its overall position — not only in its economy, but also in its region. This is reflected most obviously in what is alternately referred to as Japan’s remilitarization or normalization, depending upon how one wants to view it. As a major global economic power, Japan has done little in the past two decades to match its economic role with a similarly significant political or security role. Japan’s large-scale economic diplomacy began to fade in the early 1990s as the country’s economic growth slowed, and Japan has not played a significant security role since the end of World War II.

But the region around Japan has been changing. China is moving past being an inwardly focused developing economy driven by cheap labor and even cheaper exports. The Cold War is long over, and the United States is expecting a much more active physical role from its partners in the region. Tokyo sees a more active and assertive China as a potential threat to Japanese economic power and national security. But reshaping Japan’s regional and international role is not something that is easily done, and Tokyo’s pattern of rapid leadership changes undermines the stability of leadership needed to redirect a state as large and entrenched as Japan.

And this brings us back to the new consumption tax. The tax issue alone is just one part of the overall political narrative. Abe has done more than any leader since former Prime Minister Junichiro Koizumi in the early 2000s to revive Japan’s standing as a powerful country. If the tax proves faulty and Japan slides back into economic malaise or recession, Abe’s government could be undermined and Japan could find itself back in the chaotic cycle of short-term prime ministers and failing governments. But if he manages to go through with it and maintain relatively strong economic performance — which will depend on spurring investment, reinvesting tax revenues effectively, boosting efficiency and restarting nuclear power — then he will be able to retain his current status of relative political strength, thus benefiting his other reform initiatives and international policies.

Japan Enacts a Long-Discussed Tax Hike is republished with permission of Stratfor. http://www.stratfor.com/search/site/japan%20tax%20hike
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