Japan Is Taxing Itself Into Trouble

(Originally published here.)

On April 1, Japan’s national sales tax will rise to 8 percent from 5 percent. Unless wages rise by an equal amount, the effect will be a drop in consumer spending. Japanese automakers anticipate a sales decline of as much as 16 percent during the next 12 months. Even if this isn’t enough to push the economy into recession, raising the sales tax is a bad move that will undermine Prime Minister Shinzo Abe’s agenda for the world’s third-largest economy.

Ever since its economic bubble burst almost a quarter-century ago, Japan has been stuck with timid businesses that won’t invest or raise wages, skittish households that won’t spend and zombie banks that prefer to roll over bad loans to insolvent companies rather than finance new enterprises. Abe wants to break this cycle. The evidence suggests that his efforts, while helpful, will be negated by such a large tax increase.

The chart below shows household consumption after accounting for inflation and changes in population. You can see the slowdown after the bubble burst in about 1990, but since then the improvement has been steady. 

From this vantage point, though, it’s impossible to see the positive impact of Abenomics. Growth stalled after the Tohoku earthquake in 2011 but has since recovered. But the rate of increase has been slowing.

There are a couple of useful indicators to check if the economy can handle the tax increase. They suggest it can’t. For instance, Japanese have been large net sellers of Japanese stocks ever since the big rally that began in the fall of 2012. Foreign investors have more faith in Abenomics than the people with the most at stake. 

One consequence is that regular Japanese have missed out on much of the gains they could have reaped had they not sold so many shares. Greater equity wealth might have helped offset the coming tax increase.

A more encouraging bit of news is the rise in consumer prices, excluding food and energy. This measure of inflation has accelerated to 0.7 percent annually — its fastest pace since 1998, although still slower than the official target of 2 percent. Wages have also started falling more slowly. 

Things look less rosy if you include food and energy prices, which have risen thanks to the decline in the value of the yen. Since Japan imports almost all of its energy and much of its food, this form of inflation functions as a tax on consumer spending. If anything, the government should be cutting taxes now, not raising them.

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

To contact the writer of this article: Matthew C. Klein at mklein62@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.

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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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