Japan is about to walk the plank again when it follows through on a previous government decision to increase the consumption tax by a further 2 per cent on October 1, 2019. That means it rises from 8 per cent to 10 per cent. The latest fiscal documents suggest the government is hyper-sensitive to the historical experience, which tells us that each time they have fallen prey to the deficit terrorists who have bullied them into believing that their fiscal position is about to collapse, consumption expenditure falls sharply and the government has to respond by increasing the deficit even further to compensate. But, notwithstanding their caution (as evidenced by some permanent and temporary spending measures to offset the significant loss of non-government purchasing power that will follow the consumption tax hike, the fact remains that the policy shift will be undermine non-government spending and growth and is totally unnecessary. Moreover, the main problem in Japan at present is the lack of spending overall – non-government consumption expenditure has not yet recovered from the last consumption tax hike in April 2014. So far from raising taxes, the data on the ground is telling us that they should be increasing the fiscal deficit. This is another example of a few conservative politicians, being told by unaccountable mainstream economists to introduce policies that will damage the material prosperity of the ordinary Japanese worker and their families. And when we consider that the time is approaching when the debt-servicing burden for the government is approaching negative territory, then the consumption tax hike looks even more ridiculous.
The Government has twice delayed this increase because of the push back – which came from within its own ranks as well as more broadly.
Recall, that the tax was first introduced in April 1989 – the rate was 3 per cent. They claimed at the time that the tax was necessary to fund welfare spending – in relation to its ageing society.
So from the outset, the justification for the tax was flawed.
In April 1997, in the face of mounting criticism from conservatives that the rising fiscal deficit, which kept the economy growing after the massive property collapse, the Government pushed the rate up to 5 per cent.
Economic growth fell sharply and the Government was forced to renew its fiscal (deficit) support for the economy. This dislocation sealed the political fate of the Prime Minister at the time.
The same flawed justification (ageing society) was used to propose pushing the rate up to 8 per cent in April 2014 and then 10 per cent in October 2015.
The second proposed rate rise was delayed because of the fear that further retrenchment in the fiscal stimulus would promote recessionary forces.
I have written about that several times – Japan is different, right? Wrong! Fiscal policy works (August 15, 2017).
The following graphs show two different perspectives on consumption expenditure in Japan over the period 1994 to the June-quarter 2019. The first indexes the time series at the March-quarter 2014, the quarter before the most recent tax hike was introduced.
The two sharp declines in consumption expenditure followed the tax hikes in 1997 and 2014. There is clear causality here – cut purchasing power and demand for goods and services drops.
The second graph shows the quarterly rate of change in consumption expenditure. The two largest negative spikes (in red) are the quarters after the tax hikes in 1997 and 2014.
If you look at the current period, consumption expenditure has not yet recovered from the last tax hike in April 2014. It is still 1.6 per cent below that previous peak (March-quarter 2014).
The problem is not that the Japanese government has a fiscal crisis on its hands but that overall spending remains weak. A consumption tax rise will exacerbate that problem.
But the pressure for further rate hikes is clear – the conservative forces are continually pushing the Japanese government to cut its fiscal deficit to store up capacity to deal with the future ageing society.
In the annual – OECD Economic Surveys Japan 2019 (released April 2019) – the OECD said that:
Achieving a sufficient primary surplus through the consumption tax alone would require raising the rate to between 20% and 26%, above the 19% OECD average.
To create a primary fiscal surplus.
To pay for the welfare demands of the ageing society.
So, once again, a poor economic policy choice is being motivated by an incorrect construction of a problem.
Please read my blog post – Australia – the Fourth Intergenerational Myth Report (March 5, 2015) and the linked blog posts cited therein – for more discussion on this point.
A primary fiscal surplus is an excess of tax revenue over spending net of interest payments. I will return to the question of whether a scale of tax hike of this order is realistic.
But the Japanese government is clearly sensitive to the past sales tax history as it approaches the October 1 deadline.
In the most recent – Highlights of the Draft FY2019 Budget – the Government notes that:
Based on the previous experience with the past consumption tax hike by 3%, mobilize a range of measures and make every effort to ensure that the tax hike will not affect the trend of economic recovery.
So they are cognisant that the last two sales tax hikes caused significant declines in household consumption spending,
The Government provides the following estimates:
1. The consumption tax hike will increase revenue by approximately ¥5.2 trillion. That is, it will reduce current purchasing power in the non-government sector significantly.
2. To offset this negative effect, they propose to implement some compensatory policy changes in the areas of “Free Early Childhood Education” and “Enhancement of Social Security System”.
The social security changes will target “low-income pensioners” and provide “compensation to medical fees” arising from the sales tax rises.
These offsets are estimated to benefit households by around ¥3.2 trillion and will be on-going fiscal changes.
3. So taken together the estimated contraction in spending will be ¥2 trillion, which is around 0.4 per cent of 2018 nominal GDP.
In scale terms, this is significant.
4. They also propose a range of temporary measures which will inject approximately ¥2.3 trillion in the short-run.
So taken together, the Government claims that it will provide ¥5.5 trillion in benefits or offsets to more than compensation for the ¥5.2 trillion in lost purchasing power.
The expectation is that in the short-run, the impact on economic growth will be small. In effect, the proposal just delays the negative impact of the tax rise.
When the temporary measures terminate then the tax hike will bite – as it did in the past.
So the question is whether it is sensible for the Japanese government to entertain the claims that it needs to ‘consolidate’ its fiscal position.
The answer is clearly that it is not sensible.
Japan issues its own currency and does not face a fiscal crisis. There will never be a situation where the Japanese government is unable to meet any financial liabilities issued in its own currency.
What about the OECD claim?
It is here that we see the absurdity of the claims that Japan has to move towards a primary fiscal surplus.
Consider the reality.
The following two graphs show the sectoral balances for Japan from 1980 to 2018 from two perspectives. The first graph shows the actual balances.
You can see a detailed explanation of the sectoral balances in this blog post – The Weekend Quiz – September 7-8, 2019 – answers and discussion (September 7, 2019).
The second graph shows the balances based on the average external balance (a surplus of 2.51 per cent of GDP) – the yellow line – to give a clearer depiction of the way the private domestic balance (grey) and the fiscal balance (blue) relate to each other.
These graphs don’t tell you about causality but we know that shifts in national income bring the balances into the accounting equality that underpins the relationships between the balances.
The following facts help frame the following conclusions:
1. Japan has run an average external surplus of 2.5 per cent of GDP since 1980.
2. On average, the private domestic sector has had an overall saving rate of 6.9 per cent of GDP since 1980.
3. The debt-servicing ‘burden’ in Japan is very low now.
It is also becoming clear that the debt-servicing ‘burden’ is likely to turn negative in coming years.
This is because as older debt issues mature, the negative yield issues will become more dominant in the overall debt servicing calculation, such that, at some point, the burden will become negative.
Think about that in relation to the Project Fear claims that it has to cut its fiscal deficit and hike its consumption tax.
Think about that in relation to the fact that Japan has the largest gross public debt to GDP ratio among advanced nations.
Which mainstream macroeconomics textbook could explain this?
Further, what do you expect will happen if the Japanese government followed the advice of the OECD and tried to run a primary fiscal surplus, given that the most recent fiscal deficit was around 3.2 per cent of GDP (in 2018) and is now slightly lower again?
1. The higher consumption tax will damage growth – that is undoubted. At a time where growth is being constrained by inadequate spending, a policy that exacerbated that problem doesn’t make any sense.
2. With a debt servicing heading into negative territory that will represent a further contractionary force (lost interest income).
3. With the non-government sector saving around 6.9 per cent of GDP and an external surplus of around 2.5 per cent the government has to run a fiscal deficit of around 3 per cent to 3.5 per cent for the current GDP level to be sustained.
There is actually a need for an increased fiscal deficit given the stagnating private consumption expenditure.
4. Pushing towards a primary fiscal surplus would be catastrophic given the related historical parameters.
Where anyone would think that would be a reasonable idea?
It demonstrates the way in which mainstream macroeconomics just blindly applies its dogma without regard for institutional reality.
The major problem in Japan is stagnating non-government spending.
There is no government funding problem. It issues its own currency.
And the non-government sector is now facing an overall loss of income coming from the public debt.
The Government should learn that its stop-go stimulus behaviour – where the ‘stop’ is generated by these repeating sales tax hikes – is not conducive to stable growth or the advancement of prosperity in Japan
I will be in Japan at the end of October and will be keen to discuss these issues further with government officials and activists.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.