Impact of 2019’s Japan Consumption Tax Hike on Domestic Consumption

By: Ace Chua, Hu Si Ying, Eugene Lee

Research Head: Tanvi Johri

Editor: Praharsh Mehrotra

Illustration by Ng Jia Ying

Abstract In October 2019, the Japanese Government (JG) announced that consumption tax (CT) will be increased from 8% to 10% on all items, with the exception of food and non-alcoholic drinks. Their aim is to reduce their high debt to GDP ratio (Fig 1, 238%) and fund social welfare (free childcare education and ageing population needs). The increase to 10% Consumption tax was previously postponed in 2015 due to the sharp decline in domestic consumption and economic contraction after the 2014 tax hike (Japan Times, 2019). This article will discuss the impact of the 2019 consumption tax hike on consumption in the economy.

1. Background Information

Japan’s High Debt

Since the 1980s, Japan’s asset value grew into a bubble due to high inflow of capital into stock and land. Beginning in 1990, the bubble burst and with it, Japan’s economic and financial systems. Soon, huge amounts of debt were created as institutions portfolio’s value fell due to dropping land value. In 1997, large banks were at risk of defaulting. The Japanese government’s fiscal stimulus into the banking sector with the aim of supporting the financial system in 1998 and 1999 at the cost of incurring high debt (Statistics Japan, 2019). (Fig 2). The 2011 earthquake also added to increasing Japan government debt beyond 200% of the government budget due to government spending on finance reconstruction (OECD, 2012). Japan thus, has been financing its national debt by issuing government bonds, and the Bank of Japan (BOJ) buys a large portion of it, nearly 45% as of 2018 (OECD, 2019). With the interest rate around ± 0% resulting in negligible cost of servicing (Trading Economics, 2019), the government. is able to finance its spending where terms of repayment are internalised. However, due to close to zero interest rates, Japan faces a liquidity trap, and any monetary policy stimulus is futile. With the aforementioned method of monetary stimulus, to BOJ, Japan is able to maintain current debt levels. However, Japan’s growing ageing population represents an exigency to expand social welfare capacity. Thus, the government has to engage in fiscal policy to raise revenue.

2014 Consumption Tax Hike

In March 2014, Japan increased the consumption tax rate from 5% to 8% causing consumption to decline by 3% from Q2 2014 to Q2 2015. This resulted in an economic contraction from Q2 2014 to Q1 2015 (Fig 3b), as domestic consumption makes up 59.75% of GDP (Fig 3c), when the tax was implemented in Q1 2014. 2. Analysis

With the 2014 tax increase, the Consumer Price Index (CPI) growth spiked from 0.3% to 2.8%. Since then, CPI experienced slowing growth and finally negative growth in 2016 at -0.1%. Subsequently, inflation is rather stable (Fig 4). Unlike 2014, the expected after-tax inflation in 2019 should not spike badly as 60% of commodity prices is expected to consist of food and non-alcoholic drinks, which are excluded from 2019 tax hike (Mizuho, 2018). This is further elaborated below. To mitigate the negative impact of the tax hike on consumption spending, a tax rebate of 5% was implemented on all cashless transactions. JG aims to increase the proportion of cashless transactions from 18.5% in 2015 to 40% in 2027 (CNA, 2019).

The change in price for food and non-alcoholics from the 2019 tax hike is -4.63% while other items is -2.78% through the tax rebate system. Even with a tax hike, the effective prices for consumers are lower. (Table 1). The upward trend in usage of cashless transaction methods (Fig 5) and a lower effective price suggests that consumers may benefit enormously from the cashless tax rebate system. However, small local businesses may incur higher costs to operate a cashless transaction system that may hurt profits. The point-of-sales are also well-equipped to handle cash transactions but ill-prepared for cashless transactions due to unfamiliarity (Takagi, 2019). Although the cashless tax rebate system may not be the immediate answer in the short term, the tax rebate system may bear fruit over time as the government pushes for a cashless economy (Fig 6).

As of today, the cashless rebate is effective in offsetting the tax hike as it caused 40% of consumers to frequently use cashless methods (Japan Times, 2020).

Implications to government spending and debt

As mentioned earlier, the tax will be used on improving social welfare, especially with a growing aging population (65 years and above) that is expected to increase from 28.1% to 38.1% in 2060 (Statistics Japan, 2019). This means that government spending will continue increasing and implies the government debt is not likely to decrease (Fig 7a and 7b). 3. Savings and Ageing Population

Savings rate took a dip in March 2014 (Fig 8), due to the surge in retail sales before the tax hike (BBC, 2014). After-tax savings rate remained mostly positive in light of decreasing consumption expenditure. A similar pattern in consumption and savings is observed following 2019’s tax hike (Fig 9a – 9b).

Seeing that CT hikes encourage an increase in household saving rates, a projected tax hike may ensure that saving rates remain positive in lieu of supporting Japan’s ageing population.

4. Conclusion

The impact of the 2019 tax hike Japan’s domestic consumption will be less detrimental than 2014 in the short run, due to the effectiveness of the cashless tax rebates in offsetting the tax hike. This also justifies that the tax-driven inflation will not be as worse than 2014. Japan currently has the highest debt-to GDP ratio in the world (OECD, 2019), and pressed with an ageing population and shrinking workforce, this poses a challenge to productivity growth and a burden on fiscal balance to support the ageing population. IMF has recommended that CT should be raised gradually to 20% by 2050 (Morita, 2019). While increasing tax is crucial for raising revenue, Japan should not just focus on increasing consumption tax but also include other tax reforms to make the tax system more efficient, for example, lowering personal income tax and raising environment-related taxes (Potosky, 2016). Social security reforms and a bigger working population is needed to sustain social welfare costs if raising consumption tax is not an option. JG should monitor closely the impacts of rising CT and be open to policy changes in the near future.

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