When a Tax Increase Is Bad Policy

(Originally published here.)

Haruhiko Kuroda, the Bank of Japan’s boss, today warned the government that it needed to raise the national consumption tax to 8 percent from its current 5 percent.

Just why he favors a tax increase, to go into effect in April 2014, is a bit puzzling in light of the health of Japan’s economy. It’s almost as if he doesn’t recognize that, so far, monetary and fiscal activism hasn’t done much to boost growth. A quick check of recent data suggests that this isn’t the time to talk about taking money out of consumers’ pockets.Let’s start with the best piece of recent news — gross domestic product data. After accounting for deflation, the Japanese economy grew at an annual pace of almost 4 percent in the first half of this year — faster than any other rich country. It isn’t yet clear whether this growth is sustainable or simply a partial rebound from the damage caused by the 2008 financial crisis and 2011 earthquake.

The latest forecasts from the Organization for Economic Cooperation and Development are also encouraging. According to them, Japanese wages will rise significantly during the next 18 months, the first such pay increase in years:

Graph of OECD wage estimates, Japan

Graph of OECD wage estimates, Japan

However, the actual data on wages shows little improvement so far. According to the International Monetary Fund, Japanese monthly earnings have been little changed since the end of 2008:

Graph of IMF forecast of Japanese wages

Graph of IMF forecast of Japanese wages

The Tankan Survey of business conditions has also been looking up somewhat, but the improvement has been quite modest within the context of recent history and may just be a blip:

Graph of Tankan Business Index

Graph of Tankan Business Index

Business caution can be at least partially explained by the industrial production numbers, which seem immune to any of the stimulus measures so far:

Graph of Japan's Industrial Production

Graph of Japan’s Industrial Production

Perhaps the biggest indictment of the BOJ’s policies is that it still hasn’t managed to create inflation. Standard theory says that this is the single variable over which the central bank has the most influence. Yet for all of its efforts and confident talk, the BOJ has failed to raise the price level.

Analysts like to look at the consumer price index for Tokyo because it comes out a month earlier than the national CPI. The chart below shows the monthly changes in the Tokyo price level, excluding volatile commodities such as food and energy:

Graph of Tokyo's CPI excluding food and energy

Graph of Tokyo’s CPI excluding food and energy

I can’t spot the pivotal moment when the BOJ determined that it would end deflation and do whatever was necessary to generate inflation of 2 percent annually. So far, the price level seems to have been wiggling up and down just as it has been for the last 10 years.

I prefer household asset allocation preferences to surveys when it comes to indicators of how people really feel. This is why, a few months ago, I took the time to analyze the dataprovided by the Tokyo Stock Exchange on the buyers and sellers of Japanese equities. What I found then was that Japanese savers were selling shares to foreigners even as the value of those shares was soaring.

This suggests that Prime Minister Shinzo Abe’s economic program to alter the expectations of Japanese households and businesses has yet to take hold. Otherwise, why sell the asset most likely to benefit from a revitalization of the Japanese economy?

The idea behind “Abenomics” is that the economy has been held back by excessive caution. Ending that caution could, in theory, start a virtuous circle of greater consumption and higher investment, permanently increasing the Japanese standard of living.

Unfortunately, actual Japanese people haven’t been buying this feel-good story. This was true three months ago and it is still true, despite all of the fun market action since then:

Net equity purchases in Japan

Net equity purchases in Japan

These data don’t mean that Japan is doomed or that “Abenomics” has failed. However, they do corroborate the other data we have on wages, business expectations, industrial production and prices. There is little evidence — so far — that the Japanese economy can handle a big increase in the consumption tax. Kuroda should spend less time pressuring elected officials and more time getting the Japanese economy on more solid footing.

(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)


About Matthew C. Klein

I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist on a fellowship provided by the Marjorie Deane Financial Journalism Foundation. I have worked at the world's largest hedge fund and read every FOMC transcript since May, 1987.
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