WHY JAPAN’S 8% TAX DROVE ECONOMY TO RECESSION WHILE EUROPE WITHSTANDS 20%

 

Japanese Prime Minister Shinzo Abe is discovering that haste makes waste.


Trying to double his nation’s sales tax to 10 percent over an 18-month period has resulted in the fourth recession since 2008 and the need to postpone the increase’s second part planned for next October. With an election now pending, the levy may be on hold at 8 percent until 2017.

 
The lesson is that the increases proved too much, too soon, and baby steps may have been more prudent, with the initial 3 percentage-point boost equivalent to 60 percent of the original level. In contrast, the U.K.’s 2011 increase of 2.5 percentage points amounted to a much smaller 14 percent boost and didn’t generate a recession.

 
“Proportionally the increase is a lot bigger in Japan, where people are used to paying low consumption tax,” said Julian Jessop, chief international economist at research firm Capital Economics Ltd. in London. “Psychologically it’s a much bigger deal because it’s a meaningful amount of money.”

 
In fact the planned increase would be almost unprecedented among members of the Organization for Economic Cooperation and Development since sales taxes first began to be introduced in the late 1960s, as governments sought to expand their tax bases through hard-to-dodge revenue-raising measures.

 
Other countries’ recent sales-tax tweaks have been modest by comparison in relative terms. Since 2010, Spain increased its levy from 16 percent to 21 percent yet did so in two shifts spread over three years. Italy has raised its rate to 22 percent from 20 percent in 2011, also in two moves.

 
1979 Increase

 
The only shift that really rivals Japan’s is the U.K. government’s 1979 action to raise its value-added tax to 15 percent from 8 percent in one swoop. While that was aimed at containing inflation rather than restraining fiscal excesses, it still helped push the British economy into a recession.

 
Japan waited until 1989 to catch up with international counterparts and introduce a 3 percent tax. By 1997, in a lesson probably now understood by Abe, an increase to 5 percent cost then-Prime Minister Ryutaro Hashimoto his job after the economy slumped.

 
“Sales-tax increases are a rare event in Japan,” said Hidenori Suezawa, a financial-market and fiscal analyst at SMBC Nikko Securities Inc. in Tokyo who serves on an advisory panel to the Ministry of Finance. If the changes were “more regular and frequent, the impact on the economy would be much smaller.”

 
European Differences

 
Suezawa adds that the impact of a boost in Japan is bigger by international comparison because several European countries alleviate the burden for essential items such as food. European consumers also may anticipate that higher tax rates give their governments more funds to dole out pensions, meaning they can cut back more on saving than on spending, according to Suezawa.

 
As recently as last month, the International Monetary Fund said the second planned consumption-tax increase was “critical to establish a track record of fiscal discipline.”

 
The U.K. has shown more recently that it’s possible to raise the rate without causing a recession. While consumer spending contracted in the first quarter and flat-lined in the second after the value-added tax was elevated in January 2011 to 20 percent, buying has gained every period since.

 
Now Abe will have to wait to adjust his levy even as he seeks ways to control debt that advisers to his government forecast to rise to 264 percent of gross domestic product by 2030 from 227 percent in 2013.

 
Jessop at Capital Economics says Abe may find that voters still fear more increases, given that 10 percent is about half of the rates in the U.K., France and Germany.

 
“It’s worth stressing even 10 percent leaves it relatively low, so people may be worried of something further,” he said.

 
Source: Bloomberg / Nov. 19, 2014

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