Why raising the consumption tax is a good idea AND good politics

The following is a lightly edited version of my e-mail reply to a friend who asked about the ongoing fight over passing a hike to the consumption tax. As of this writing the bill has passed the lower house but has still not become law. See Japan Real Time for a good breakdown of recent events:

The consumption tax was definitely too low for a country with such generous welfare benefits, so raising it only makes all the sense in the world. I almost wish they had put in a delay mechanism in case the economy is still in bad shape in 2 years, but hopefully that won’t be the case.

Fiscally, I think it is a drop in the bucket, and the short term economic impact is definitely not great. That is why there is such a strong knee-jerk negative reaction among the public. They either run or know people who run small businesses that will get hurt, but more importantly it’s one of the few policies that stares average people in the face every day and is easy to understand. Everything you pay for will get more expensive.

But at the same time it’s vital to get the house in order so to speak, or else Japan really is in for a hard landing. The social programs that Japan has are great and they need to be maintained. So they need to be funded in a way that’s not too onerous, and this seems like as good a way as any to me.

I have basically come to the conclusion that inflation is unlikely in Japan over the long term because there isn’t a fundamental basis for it. People are getting older fast and are just going to spend less. And productivity gains aren’t going to be fast enough to make up for that (economics isn’t my strong suit… but isn’t it the case that inflation is at least supposed to track economic cycles?) Japan isn’t going to necessarily have another growth boom, but what it can do is enjoy a comfortable and proud status as a rich nation. That is, they should be able to if people in their prime now can actually feel some security and expect a reasonable retirement not too different from what their parents had.

In terms of the political situation, there are a lot of people saying that Ozawa “won” but I don’t really see it that way. He didn’t stop Noda from doing what he wanted to do – there has effectively been a Grand Coalition in place since Noda came to power (note how close to unanimous the jail-for-download law was, or the postal reform bill, or take your pick) and for all the blustering among the parties they are pretty much united on a lot of policy measures because they are a) consensus among the Serious People muckimucks like the finance ministry and media opinion makers, and b) the subject of gaiatsu (I believe the IMF has been dogging Japan to raise the consumption tax).

And although Ozawa technically has the power to basically an early election through defecting, he is too afraid to do it because he knows that his clique is even more exposed to getting voted out than the others because it contains so many first-termers. It seems pretty shrewd for Noda to NOT punish the defectors in that case because it prevents the election from happening and lets the de facto grand coalition continue with him running the show.

If there is an election the DPJ will lose, the LDP will win (though maybe not get an outright lower house majority), Komeito will maintain, and Hashimoto’s party might make a serious splash, though Hashimoto himself has said he won’t run. So in that context I think all the established parties, especially the DPJ, have an incentive to delay an election as long as possible. Once Hashimoto has his foot in the door of national politics life won’t be the same. Every little thing will be a fight that can’t be worked out by getting drunk together at a ryotei.

Make no mistake, though, this is a big deal. This type of potential split in the DPJ was months in the making, maybe even years because Kan might have pushed for the tax hike had there been no earthquake (remember how he for whatever reason ran on that issue in the Upper House elections?).

And there is always the need to point out that this agenda of raising the tax was pushed by the finance ministry. Politicians in general are empty shells with voting power, and they need to get pushed in a certain direction by the people who they think will help them keep or increase that power. This time it was the ministry of finance because it is a permanent bureaucracy that has a political agenda that’s informed by its mission as the steward of the Japanese government’s finances.

That isn’t necessarily a bad thing because if there is one thing that the DPJ coming to power has taught me is that it’s dangerous to allow people with zero expertise being responsible for governing convince themselves that they know what’s best for the country. It feels like all they are good for is posturing and fundraising. The DPJ made the critical mistake of making enemies of the bureaucrats instead of cultivating them and influencing them in the subtle, glad-handing way the LDP mastered. Or at least they could have brought in people with talent and real ideas.

17 thoughts on “Why raising the consumption tax is a good idea AND good politics

  1. Raising revenue is fine and necessary, but I’ve never seen particularly good explanations of why they can’t try more progressive means such as increasing income taxes or savings taxes — or even closing all of those crazy loopholes that basically let small businesses write off every single expense. Consumption taxes are just by their nature going to disproportionately hurt lower income people more than higher income people, which is why the JCP was so against it. And I am not sure I ever read anything about consumption tax rebates to the very poor.

  2. Income taxes would disproportionately affect the working population, savings taxes would disproportionately affect the retired population, and closing corporate tax loopholes would accelerate the flight of international business out of Japan.

    Personally I would like to see some tightening of inheritance/gift tax loopholes, and perhaps a punitive tax on political fundraising.

  3. “Income taxes would disproportionately affect the working population”

    Income taxes and consumption taxes already affect everyone. Why pile on a tax that affects poor households more than rich ones?

  4. “I almost wish they had put in a delay mechanism in case the economy is still in bad shape in 2 years”

    Check out the 景気弾力条項 part on this NHK overview of the legislation. Earlier drafts tied the possibility of deferring the tax hike to specific growth targets, but that didn’t make it to the version that got voted on. There’s still some wiggle room in there for administrations in 2014 and 2015, though.

  5. Well written, and credit to you for putting in a lot of the important background points that you seldom see in English language coverage and discussion of this. However, I come down completely on the other side of the fence – but credit you for writing something I can disagree with but still see as balanced and fair.

    It really comes down to the last two paragraphs. There is a not insubstantial school of thought in Japan, which really has been the thinking behind governance for half a century that; – Politicians are not competent to actually exercise authority in important areas of policy and their influence should be minimized to supporting professional policy making bureaucrats – Ministries understand what budgets they need, and spending, like policy making should be left at their discretion to decide, and not put at the mercy of populist electoral politics – The primary solution to Japan’s increasingly dire revenue intake shortfall is to increase tax take, and the most logical area to raise tax is consumption tax, which has an element of fairness and uniformity, and is generally considered the most efficient (lowest cost to collect, producing the greatest intake) of taxes.

    The point is, if you support the running of Japan Inc as business as usual, the most pressing area for new lawmaking at the moment is increasing the consumption tax. This is something that the LDP - the eternal champion political party of bureacrats recognized and electioned on, and what Kan and Noda both became convinced of in their stints working as Finance Minister prior to becoming PM. Essentially, the Finance Ministry was able to persuade Kan and Noda both that the only way that they could allocate new budget to helping the DPJ fulfill its policy promises would be if the DPJ increased their revenues first. Like the LDP - play ball. You scratch my back, I’ll scratch yours.

    If you agree that this is the way government should ideally operate, then you support what Noda did. Although most likely, you wouldn’t vote for the DPJ - you would vote for the LDP. But you would be grateful for Noda doing what the LDP thinks is best.

    The betrayal here is that the DPJ represented an earth change in popular attitudes towards government in Japan. Whereas through the economic miracle, the bubble, and even the lost years after the bubble, the public continued to trust the LDP to trust the burocrasy to figure things out, people have come to the increasing realization that the ties of interests between vested business interests, the media, the bureaucracy, and how these interests converged to lock in the political process as a rubber stamp for those interests was not only broken down and not working. In some clear cases of outright corruption and wasteful public spending, it was actually causing and exaccerbating Japan’s decline. The ministries, regulated businesses, media and “controlled” politicians were taking public money and using it in their own interests, ahead of and counter to public interest.

    The DPJ was the party that would put administrative reform ahead of simply raising taxes and continuing to outsource governance to the bureaucracy. DPJ factions agreed on a manifesto, that implemented the policy program Ozawa has publicly had since the 1990s, of rearranging government to ensure it is led by democratically elected lawmakers who make laws and lead their ministries. Think of the steps taken when the DPJ came in – bureaucrats were banned from answering questions in Diet Q&A about laws politicians were sponsoring but didn’t understand. People were dragged into gymnasiums and forced item by item to reveal and justify wasteful spending.

    The point of cutting spending was not just to boost revenue, to allow for the DPJ to implement its programs. It represented an earth change where spending for the first time comes under democratic political control, rather than the discretion of the Finance Ministry. It was an attempt to make Japanese democracy actually democratic.

    It was also an open war on the ministry of finance, and corrupt interests in the bureaucracy that lived and survived by politicians playing ball. That is why Makiko Tanaka joined the DPJ (who was practically raped by MoFA bureaucrats and supporting mass media during her term as foreign minister). The point is that there was a critical mass of public awareness, and awareness among elected politicians that the bureaucracy in Japan is out of control, and proactively contributing to Japan’s problems.

    However, starting with Kan, and continuing with Noda, that agenda was undone and replaced with a cooperative engagement agenda with bureaucrats. Give them their extra play money first, and hope they help you with restructuring later. Noda openly said the line you did – better to have them help you than make enemies of them. If you want to see what happens if you make enemies of the bureaucracy, check out the drummed up political trial, and surrounding media coverage around Ozawa.

    The public has ruled on the DPJ’s change of course in the last upper house election where they destroyed the DPJ under Kan, and they will do so again for Noda’s betrayal of the Japanese public in the next election. Hashimoto’s party will step in to fill the gap left by the LDP-ification of the DPJ as a pro-institutional party, where Hashimoto will advocate a similar war on bureaucrats agenda to Ozawa (indeed, he has backed Ozawa repeatedly on this battle), but with a more right wing nationalist, Ishihara backed slant that I don’t think will be as good for Japan as the kind of change the DPJ was supposed to represent.

    The consumption tax increase itself has a bunch of issues around it – the timing is bad, there is no offset of reductions of other less efficient taxes like income taxes, that could have a postive inflationary effect, etc, etc. But fundamentally, no one says there should be no consumption tax increase. The issue is what the consumption tax increase law represents. It is a capitulation of the DPJ’s reform agenda, and a blank cheque for the Finance Ministry to keep running Japan the unaccountable way it has for the last 60 years, often counter to the best interests of the Japanese people and the Japanese economy.

  6. “element of fairness and uniformity”

    Only if you don’t believe in the marginal utility of money. ¥1000 is a greater burden on a low income family than a high income family.

  7. Marxy – in most countries where consumption taxes are implemented or increased, they are accompanied by income tax relief for people on lower incomes, which often actually creates a slight inflationary effect where those people end up with more money in their pocket than before – that is the great thing about consumption tax when implemented properly. It’s simplicity makes it cheap to collect, which allows for reduction of more complicated less efficient taxes that impact the less well off.

    Of course in this case, there is no tax relief. It is all just more money, disproprotionately taken from the less well off, and put in the ministry of finance coffers to pour more concrete on dodgy public works projects where nobody needs them. So, yeah, it sucks.

  8. Hikosaemon makes excellent points: the consumption tax increase has the potential to be a distraction from some (more) painful decisions necessary in the coming years. Adamu, you say that Japan’s social programs are great, but from my point of view they seem unsustainable, and unfortunately a rise in the consumption tax will merely stem the tide. I haven’t seen much sign of reform of the spending side of the ledger, and demographics are a powerful enemy.

    There have been many doomsday sayers that suggest that Japan is near a fiscal cliff, and those that have shorted jgbs or JPY trying to take advantage of that have lost big. Doesn’t mean a collapse isn’t eventually going to happen. I was listening to someone speak last week who said that barely half of govt expenditure is covered by tax revenues currently. Raising taxes solves part of the problem, but if it entrenches current (unsustainable) service, then it’s as dangerous as it is helpful.

  9. Good discussion here. I’m curious as to how Japan’s social programs are “great.” The country has limited national health insurance, unemployment benefits, old-age care, etc. but Japan’s welfare state is thin compared to what exists in Western European nations. In fact for decades, Japanese companies providing lifetime employment and other benefits effectively substituted for the government in offering social welfare provisions. Only when compared to the USA does Japan’s welfare state look extensive.

    Also, while it’s clear now that the DPJ turned quickly into LDP-lite after being swept into office 3 years ago, it’s doubtful that the LDP’s return to power will be a good thing. Steven Reed of Chuo University has argued that major political parties are unlikely to “learn” and reform themselves unless they lose in at 2 straight general elections. The LDP has yet to do that, and so I suspect its leaders believe that what happened in 2009 was an aberration rather than an actual repudiation of LDP-led cronyism, factionalism, corruption, incompetence, and stasis.

  10. Maybe this has to be done, but why now?

    Japan pays very, very little in the way of interest on its debt (second lowest rate in the world after Switzerland averaged across the debt) so this is as close to free money as one can get. Why further depress domestic consumption – the retail and service industries are the last best chance at dignified jobs for many young people – when Japan has just seen 4 of the bottom 5 yearly GDP growth rates of the the entire postwar era? Japan may not be in for the fist-pumping high growth of the 1960s again, but with all of this talk about rising wages in China forcing production back to the US and Japan (and that will not likely be production of export products, but production to meet domestic demand) now does not seem like the time to throw a potential wrench into domestic demand. Japan will likely be reduced to a niche electronics exporter and even this is only possible if there is a domestic field to try new products (still expect industrial tech and precision exports to be strong).

    Also agree with Marxy (although they are indeed introducing a rebate for low income people) and will add – why no exemption for food purchases, books, diapers, children’s clothing, and so on? Japan has 1,500,000 “millionaires” (wealth not counting primary residence). China is just topping 1,000,000 with 10x Japan’s population. People talk as if half of China’s population is driving BMWs, but the reality is that lots and lots of Japanese are still quite cash rich. The growth potential might not be there, but the dough sure is, enough to last until whatever we see in the next century (robots do every job and we either get a techno-anarcho-communism or we simply become jobless consumer serfs in mega-corporate fiefs, The Coming Anarchy, two 70 year old Chinese for every child born, or whatever). Japan has almost twice the per capita rate of millionaires as Germany! I like Joe’s idea of an inheritance and gift smack-down to capture some of this as long as it goes to the very needy and young families.

  11. Japan pays very little interest because current investors demand very little interest. However there is a general expectation among financial people that this can only go on for a few more years before the demand dries up such that the interest rates have to start coming up—the growing population of retirees will be cashing out their savings over time, while the population of working stiffs will gradually go down and erode the government’s income tax take.

    The rating agencies are already factoring this risk into Japan’s sovereign rating. In fact Fitch recently hinted that it might have downgraded Japan further if the consumption tax hike didn’t happen. Sovereign ratings pass through to businesses in the country, so a downgrade of Japan would also raise the borrowing costs for the biggest Japanese companies, eat away at their profit margins, put stress on the stock market, put stress on the domestic banks, etc.

    Anyway, Japan had to make a tough choice of some kind and this was the tough choice they came up with.

    Unrelated, but one little known (or little discussed) fact about consumption tax is that very small businesses are exempt—a company or sole proprietor with sales of less than 10 million yen per year is not subject to consumption tax on its sales, and new companies with less than 1 million yen of capital get their first two fiscal years consumption tax-free regardless of how much they sell. So the consumption tax hike will potentially give freelancers and other micro-enterprises a pricing advantage over larger businesses.

  12. Related to that little nugget of trivia, businesses that deal with small consumption tax-exempt operators are legally allowed to deduct the transactions from their overall consumption tax bill (it’s apparently a little more complicated than that but that is the basic idea). I don’t know if they’re going to change that but it’s a weird little quirk of the system (called 益税問題 for people who wish to google it)

  13. Actually, as I understand it, a business can reduce their consumption tax bill by the amount of consumption tax they spent on incoming goods/materials, regardless of who sold it to them. So if you’re a computer store, and you buy a laptop wholesale for 90,000 yen and sell it for 100,000 yen, you only have to give the government the consumption tax on the 10,000 yen gross profit, since the tax on the other 90,000 yen was already collected when you bought the laptop.

    The 益税問題 arises because you can do this even if you sourced from a small business that doesn’t pay consumption tax. Say a translation agency bills a client 100,000 yen for a project, and they paid a freelancer 90,000 yen for said project. The client pays consumption tax on 100,000 yen but the government only gets the consumption tax on the 10,000 yen margin, with the difference being pocketed by the freelancer. The rationale is that the agency wouldn’t necessarily know whether or not the freelancer is paying consumption tax out of the total.

    This is how I understand it, anyway; I don’t profess to be a tax expert…

  14. “this can only go on for a few more years before the demand dries up”

    So raise the consumption tax after that. Demand might not dry up so quickly if Japan were actually growing. Japan has run a budget deficit of 10% of GDP for three years. It was 3-5% during the not so sucky years between 2005 and 2008 (basically the same that it was between 1975 and 1985). Borrowing can’t go on forever, but I don’t see how doubling the consumption tax will lead us back to 2005.

  15. A side issue, but important. I haven’t paid much attention to this news (I should) but is there any plan for exemptions on the consumption tax, such as on food, or maybe medicine? A hike to 10% would go down a lot easier with the public if essentials like food were not included.

  16. The big measure they are considering is a tax break for low income earners on their consumption tax bills, with refunds possible

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