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IMF Recommends Raising Japan's Consumption Tax

by Mary Swire,, Hong Kong

21 June 2011

In an International Monetary Fund (IMF) staff discussion note, entitled ‘Raising the Consumption Tax in Japan: Why, When, How?’, it has been suggested that the Japanese government should begin a gradual increase in consumption tax from 5% to 15% over several years.

In the note, the IMF staff point out that, over the past two decades, Japan’s gross public debt has more than tripled, to well over 200% of gross domestic product (GDP). However, with persistently weak economic growth associated with a fall in tax revenue (relative to GDP), and with limited room to reduce non–social security expenditure allied to spending pressures from an aging society, they consider that new revenue measures must play a central role in a medium-term strategy to reduce that debt.

Among various revenue measures, they have decided that raising consumption tax is the “most appealing”. At just 5%, they say that the rate of consumption tax “is among the lowest in the world and because it is broad based, by international standards, there is ample scope for raising additional revenue by raising the rate.”

IMF analysis has shown that a gradual increase in consumption tax from 5% to 15% over several years – “a level that is still modest by OECD standards” - could provide roughly half of the fiscal adjustment needed to put the public debt ratio on a downward path over that period.

While the IMF staff feel that other taxes may also have a role (including personal income tax) and caps on spending growth could provide the remaining adjustment, “without a fuller exploitation of the potential of consumption tax, it is hard to see how fiscal sustainability can be restored”.

They also maintain that, compared to other taxes, consumption tax is also “less distortionary, relatively easy to administer, and a stable source of revenue in an aging society. Moreover, raising the consumption tax may be fairer than other taxes in helping offset the imbalance in the distribution of lifetime pension benefits across generations.”

It is concluded that the strategy for raising consumption tax should be started as soon as possible, to take advantage of the cyclical recovery expected in 2012 and to strengthen credibility of the fiscal adjustment, and should be in a series of pre-announced modest rate increases that may stimulate consumption and limit the initial adverse impact on growth.

In addition, the IMF staff believe that the tax rate increases should be sustained, so as to advance consolidation in a meaningful manner, and should be simple to limit distortions and ease implementation. The IMF staff therefore propose that the single rate structure should be maintained, as “well-targeted spending measures” to relieve the higher burden for low-income households would be “more efficient” than any rate differentiation, such as a lower rate on food.

Their suggestion for staged increases in the rate of consumption tax supports the recommendation of the official panel, established by Prime Minister Naoto Kan, to work on proposals to finance increasing social security outlays in Japan. The panel’s recent recommendation to the government was that the tax should be raised to 10% in two stages by 2015, with the first hike in the next fiscal year from April 2012.

It should be noted, however, that the government remains nervous of any proposal to increase consumption tax as a similar suggestion for doubling the tax became a major cause of its losing its majority in the parliamentary upper house last year. The outlook for reform has also been clouded further as Kan, in order to survive a recent parliamentary vote of no confidence, has said that he is prepared to resign in the near future.

TAGS: tax | sales tax | International Monetary Fund (IMF) | tax rates | social security | tax reform | Japan

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