1. IHS Research Note:
IHS Economics and Country Risk Principal Economist Harumi Taguchi’s analysis
and commentary on Japan's consumption tax hike follows. Harumi may be
reached in Tokyo on 81.3.4530.9730 or at Harumi.Taguchi@ihs.com for additional
comment or if you have questions.
Japan: Consumption tax hike is a first step, but path toward
fiscal reconstruction still unclear
Prime Minister Shinzo Abe announced he will go ahead with plans to raise the
consumption tax from 5% to 8% in April 2014. The government also decided on a
JPY5 trillion (USD51 billion) stimulus package to counter the negative effects of
tax effects on the economy. Given that corporate sentiment has been leaning
toward increased fixed investment, the Japanese economy is likely to avoid
recession caused by a slump for consumer spending. However, the next step in
2015 will be more of a challenge for the government.
Japan’s government announced plans to raise the consumption tax from 5%
to 8% in April 2014 after the Tankan survey confirmed that current business
conditions are improving.
The economic stimulus package includes cash benefits for low income
households and tax breaks for homebuyers, as well as tax incentives to
encourage corporations to increase fixed investment and wages.
Our main scenario is for public works and stronger private investment to
partially offset the slowdown for consumer spending and prevent a recession.
IHS global insight forecasts economic growth of 2.0% for Japan in 2014.
While the government aims to equalize the primary balance by 2020, the next
step—raising the consumption tax from 8% to 10% together with cuts to the
corporate taxes—will be more of a challenge for the government. Pursuing
2. Abenomics’ goals of deregulation and structural reform will be the key to
improving potential economic growth and fiscal balance.
Prime Minister Shinzo Abe decided to take a step to raise the consumption tax to
8% in April 2014 after the September Tankan (released on October 1), confirming
that the business sentiment was strengthening and that sales and profit outlooks
were improving. The consumption tax hike―the most significant tax reform since
April 1997―was planned by the previous government under the agreement
between Democratic Party of Japan and the current ruling parties, the Liberal
Democratic Party and New Komeito Party. The agreement included an opt-out
clause allowing the tax hike to be postponed or cancelled if the economy was
Improving tax revenue is a critical issue, as the central government can cover only
46.5% of the expense by tax revenue and stamp duties, and the government’s
debt is over 200% of Nominal GDP. Japan’s consumption tax rate is still relatively
low compared with many developed countries. However, raising the consumption
tax was controversial under the deflationary conditions and residual trauma from
the last tax hike in 1997. The previous tax hike combined with Asia’s currency
crisis and yen strengthening weaken domestic demand, fueling an economic
recession in Japan.
3. Source: Ministry of Finance
Stimulus package to benefit corporations more than individuals
Tax revenue from the consumption tax increase was to be used for social welfare
spending. Social welfare spending currently accounts for 31.4% of the central
government’s expense in Fiscal Year (FY) 2013 budget, and is likely to increase in
tandem the higher weighting for older demographic groups. While Prime Minstar
confirmed that revenue from the tax hike, estimating at JPY6 trillion, will only be
used for social welfare, he plans to introduce a stimulus package to counter
“shock” from the tax hike. The economic stimulus package includes cash benefits
for low income households and tax breaks for home buyers, as well as tax
incentives to encourage corporations to boost fixed investment and increase
wages. A special corporate tax for earthquake reconstruction is going to end in
April, a year ahead of the originally scheduled. The effective corporate tax rate for
a big company in Tokyo would be lower to 35.6% from 38.0% by this tax cut.
Although the stimulus package is planed more benefit for corporations than
individuals, Abe believes the stimulus package is necessary to sustain the uptrend
for the economy and that the plan will encourage corporations to increase wages.
A detailed budget will be decided in December after a review of economic
4. conditions. The government plans to use extra tax revenue from the economic
recovery, funds leftover from the current year’s budget to avoid issuing new
bonds if possible. A decision to raise the consumption tax, from 8% to 10% in
October 2015, will depend on the economic conditions.
Major stimulus programs Breakdown of the JPY5 trillion package
Public works, such as infrastructure renovation
(including spending for the 2020 summer
To be decided in December
Acceleration of reconstruction from Great
Eastern Japan Earthquake
To be decided in December
Ending a special corporate tax for earthquake
reconstruction in April, ahead of the original
JPY 900 billion
Cash benefit for low income households JPY 300 billion
Tax breaks for new homebuyers JPY 110 billion
Tax breaks for companies that increase fixed
JPY 730 billion
Tax breaks for companies that increase wages JPY 160 billion
Source: Ministry of Finance
The Japanese economy is likely to avoid a recession
We see three main scenarios for the government’s plans to increase the
consumption tax and pursue a stimulus package.
1) The first scenario anticipates moderate growth after Q2. Consumer spending
grows at a slower pace in Q3 because only limited companies agree to raise
base salaries, but many of them adjust overtime wages and bonuses in 2014.
Corporations increase capital expenditures cautiously but steadily, taking the
advantage of a tax break on the top of a recovery for exports and better profit
outlooks. Public works increase, but upside is partially offset by higher costs
for materials and a shortages of construction workers. Continuing economic
growth lets the government implement the next tax hike and pursue another
fiscal stimulus package, including broader benefits for low income households,
or lower tax rate for necessities. The Bank of Japan holds the current level of
monetary easing, barring increased downside risk for the economy or CPI
5. 2) The second is the upside scenario. Consumer spending dips after last-minute
demand before the tax hike in the second quarter (Q2) 2014, then rebounds
quickly on expectations for wage increases and improved employment, along
with upside from the expansion of corporate facilities and public works. In this
case, the economy recovers quickly and government revenue increases
because of the economic improvement and the higher consumption tax. The
better economic conditions make it easier for the government to implement
the next tax hike, from 8% to 10% from October 2015. This will also be paired
with another, smaller stimulus package to counter its impact.
3) The third is the downside scenario. Consumer spending continues to fall after
the tax hike with no or very limited wage increases, and cash benefits fail to
ease the impact of the tax increase on low income household. Under the
situation that people over 65 years old now make up 25% of Japan’s
population almost twice the 1997 level, pensioners curb spending not only
because of the consumption tax hike, but also because of lower pensions and
higher cost medical care for patients over 75 years old. Corporations do not
respond to tax breaks and decline to increase fixed investment because of
weak domestic demand. Growth for public works is limited because of labor
shortages in construction, higher costs for materials and government’s
inefficiency. This makes it difficult to proceed with the next tax hike, or it
requires a larger stimulus package. This increases concerns about the
government’s inability to control fiscal deficits, which in turn could trigger
higher bond yields. The Bank of Japan may also need to pursue further
aggressive monetary easing to avoid deflation.
Our main scenario is the first scenario (a 70% probability), anticipating moderate
growth from Q3. According to the September Tankan, large enterprises lowered
fixed investment plans in FY2013, but large manufacturing enterprises raised their
plans and medium-sized and small enterprises raised their outlooks for the
second half of FY2013. Companies will also need to consider increased fixed
investment with an eye on resolving problems with excess capacity. Public works
and improved private investment are likely to help ease a slowdown of consumer
spending and prevent a recession. IHS global insight forecasts economic growth of
2.0% for Japan in 2014.
6. Could the government reduce the corporate taxes ?
Although the stimulus package does not include cuts to the corporate tax, Prime
Minister Abe mentioned plans to begin a serious discussion of the issue. Japan’s
effective corporate tax rate is higher than neighboring Asian countries. A lower
corporate tax rate has been a topic of discussion recently, and Abe intended to
cut the effective corporate tax rate to 25-30% for improving competitiveness.
However, Ministry of Finance estimates that every 1 percentage point will reduce
tax revenue about JPY400 billon, and it is tough for the government to offset this.
Japan’s tax revenue as a percentage of GDP declined to 8.8% in FY2012 from
13.4% in FY1989. This is partially because of lowering revenue from income and
corporate taxes, reflecting wage reductions and a decline number of companies
subject to taxation, but the declines is also due from tax cuts. Japan has
lowered income tax rates for high income households, and cut the corporate tax
rate from 43.3% in FY1988 to 25.5% (excluding a special corporate tax) in FY2012.
It is obvious that those historical tax failed to increase domestic demand.
The main scenario (a 70%
2.0 1.3 2.8 2.1
The upside scenario (a 10%
2.2 1.5 3.0 2.3
The downside scenario (a
1.7 1.0 2.6 1.9
7. There is no simple link between cutting the corporate tax and increasing domestic
investment. Only 27.2% of companies pay corporate taxes, and over 50% of
revenue from the corporate tax is paid by 0.1% of the total. Many large
companies paying the corporate tax have substantial retained earnings and cash
flows. A high corporate tax rate used to be seen as one of the “six burden” for
companies operating in Japan. The six burden included yen appreciation,
environmental restrictions, electric power shortages, strict labor rules and other
regulations, delays with the Trans-Pacific Partnership (TPP) and other free trade
agreements (FTAs); and a need for lower corporate taxes and faster
administrative approvals. Some of these problems have been resolved or
addressed by the government, but the high corporate tax is not the most critical
obstacle to increase domestic investment and Japan’s competitiveness. .
Deregulation and structural reforms are the keys for improving potential growth
and fiscal balance
Japan is likely to avoid a critical economic downturn or recession in 2014 While
the government aims to equalize the primary balance by 2020, the next step—
raising the consumption tax from 8% to 10% and cutting the corporate tax— will
be more of challenge for the government. Improving Japan’s attractiveness for