Economic Growth May Save Japan From Large Tax Hikes

by Mary Swire, Tax-News.com, Hong Kong

12 January 2006

Economists have suggested that a dramatic increase in Japan's consumption tax to help fund the country's growing social security bill will not be necessary if the government concentrates on measures to promote economic growth.

The government's fiscal advisors have consistently argued that consumption tax, currently 5%, must be increased to levels similar to those seen in Europe, where sales and value added taxes typically range between 15% and 20%, if future administrations are to meet the challenges of an ageing society whilst servicing Japan's public debt, which at 150% of GDP is the highest in the developed world.

The consumption tax issue is politically sensitive, and such a drastic increase in the tax rate is unlikely to be supported by government. The last time consumption tax was increased, from 3% to 5% in 1997, Japan fell into a recession which ultimately cost then-Prime Minister Ryutaro Hashimoto his job. No doubt aware of this, the present incumbent Junichiro Koizumi has stated that he will not increase the tax whilst in power - although his time as head of the ruling Liberal Democratic Party is set to come to an end in September.

However, one member of Koizumi's cabinet, Interior Minister Heizo Takenaka, has been particularly vocal in arguing against a policy of tax hikes to solve Japan's fiscal problems, and has suggested that a rise in consumption tax can be limited if the government focuses on economic growth.

Takenaka's views are supported by economists, such as Koichi Haji, chief economist at NLI Research Institute, who, according to Reuters, calculates that if the nominal economic growth rate averages 2.3% over the next ten years, the government will be able to limit a hike in consumption tax to 10% and still balance its books by 2014/15.

Makoto Ishikawa, an economist at the Japan Research Institute believes that the government can achieve a balanced budget by increasing consumption tax by 1% per year for four years from 2008/2009, assuming that the economy grows at an average annual rate of 2%, Reuters reported.

The Economy, Trade and Industry Ministry (METI) is due to present a "new growth strategy" in May which will propose a number of measure to improve the competitiveness of the Japanese economy. METI is also expected to present proposals on the future rate of consumption tax based upon its economic growth forecasts.

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