Japan to Raise Sales Tax (Oct 2013)

Japan's Prime Minister Shinzo Abe attends a news conference at his official residence in Tokyo

Source: WSJ – Japan to Raise Sales Tax

Notable excerpts:

Japanese Prime Minister Shinzo Abe said Tuesday he will go ahead with a plan to raise the national sales tax in April and promised a stimulus package to cushion its impact, stressing that the country needs to achieve both fiscal consolidation and economic growth to exit 15 years of debilitating deflation.

Following the widely anticipated decision, the focus soon turned to whether Mr. Abe would proceed with more structural measures to ensure Japan’s recovery remains intact, such as deeper cuts to corporate taxes, and pressure on companies to raise wages.

Whether to proceed with the plan to raise the 5% sales tax to 8%, formulated under the previous government, was one of the most difficult decisions faced by Mr. Abe since taking office last December pledging to reverse years of falling prices. The extra burden is certain to weigh on economic activity, but forgoing it in the face of a ballooning debt risked losing investor confidence in Japan’s fiscal policy and a devastating jump in borrowing costs.

“Economic revitalization and fiscal rehabilitation. The only path for us is to achieve these two at the same time,” Mr. Abe told a news conference televised live by all major broadcasters. “I am convinced that the economic policy package we decided today is the best option for that purpose.

Mr. Abe said the package of stimulus measures totals around ¥5 trillion ($51 billion), including cash-handouts to low-income families. On top of that there will be tax breaks worth ¥1 trillion for firms making capital investment and wage increases.

Japan’s business community welcomed Mr. Abe’s decision. “Fiscal stability is something positive for the country as well as companies over the medium- to longer-terms,” said Kazuo Hirai, chief executive of Sony Corp.

But businesses and financial markets were already calling for more steps, particularly a further reduction in Japan’s 38% corporate tax, one of the highest in the industrial world.

Mr. Abe managed to convince opponents in the ruling coalition to agree to scrapping a temporary surcharge on the corporate tax, expected to lessen businesses’ burden by around ¥900 billion. A final decision will be made in December. And on Tuesday, the prime minister pledged to “seriously review” further cuts, but stopped short of offering an actual reduction.

Investors will also be watching to see whether the prime minister will follow through on his promises to deliver further structural reform measures aimed at promoting growth, such as designating special economic zones offering incentives to lure overseas investment.

Mr. Abe’s decision follows a debate that has raged among policy makers and economists since early summer, and it came only after a string of bright economic data left him with no choice but to raise the levy. Japan’s current tax law requires him to abide by the hike if the economy is in an “upturn.”

April’s increase will take an estimated ¥8 trillion out of consumers’ pockets annually, a step economists agree will weigh significantly on consumption, at least temporarily. Some of Mr. Abe’s close economic advisers have thus called for a delay or a slower implementation of the tax increase, saying he could otherwise jeopardize all the gains made by his “Abenomics” policy program.

Comprised of aggressive monetary easing, flexible government spending and structural reform, Abenomics is considered Japan’s most aggressive effort in many years to end its economic stagnation since the early 1990s. The program has raised hopes for better times ahead, prompting some signs of improvement in spending among Japan’s usually cautious consumers, despite lackluster wage growth, and pushing up Tokyo stock markets. Abenomics has also weakened the yen’s value against its major counterparts, making Japanese exports more competitive abroad.

The central bank’s tankan survey released Tuesday, considered one of a key benchmarks for corporate sentiment, offered fresh evidence that the economic recovery is gaining traction. Sentiment among Japan’s major manufacturers rose to plus-12 in September from plus-4 in the June survey, the highest reading since December 2007. The index represents the percentage of companies saying business conditions are good minus those that say conditions are bad.

Still, Mr. Abe doesn’t have the luxury of focusing solely on bolstering growth, with Japan’s public debt now approaching 250% of total annual output by some measures.

The nation’s debt market has been stable in part because bond investors believe the government can meet its debt obligation by raising the consumption tax if needed. Japan’s Finance Ministry, the Bank of Japan and the International Monetary Fund have warned Mr. Abe over recent months that if he dallied on the tax plan, the market might begin to doubt the government’s commitment to paying down its debt, pushing Japanese borrowing costs higher.

“We need to understand that my administration’s top priority of putting an end to 15 years of deflation is no easy task,” Mr. Abe said earlier in the day. “Furthermore, it is important to strike a balance between economic recovery and fiscal soundness.”

Mr. Abe also said he would take into account economic conditions when making a judgment on whether to proceed with the planned second-stage increase to 10% in October 2015.

How the tax decision affects Mr. Abe’s public approval rating—which has stayed well above 50% in polls thanks to his economic policies—is likely to be watched closely in the coming months. Charged on almost everything consumers buy, the sales tax has been highly unpopular in Japan. The lawmakers who introduced it at 3% in 1989, as well as those who raised it to 5% in 1997, saw their parties suffer significant losses in subsequent elections.

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