Taxing times

Japan's surprise recession clouds fiscal future

Japan’s surprise recession has clouded its fiscal future.

Data released on November 17 showed the country’s output has fallen for a second straight quarter. Once again, the modest three percentage point increase in Japan’s sales tax rate in April was the culprit. The fragility of private demand not only rules out a planned second increase in the levy next year, but also reduces the chances that future politicians will bite the fiscal bullet. Taxing consumers to shrink the government’s huge debt load is a fast-receding dream.

Economists had hoped for a 2.1 per cent rebound in gross domestic product (GDP) in the third quarter following the 7.3-per cent contraction between April and June. Yet this failed to materialise despite the government boosting public investment. GDP shrank by an annualised 1.6 per cent.
 

The disappointing report means Prime Minister Shinzo Abe is almost certain to delay plans to raise the sales tax to 10 per cent next October, from the current eight per cent. He may also call a snap election in an effort to pre-empt any challenges to his leadership of Japan’s ruling Liberal Democratic Party.

It’s unclear what other plans for fiscal correction Abe may propose. A lack of any revenue-raising measures could be troubling for a country whose ratio of government debt to GDP is approaching 245 per cent, the highest among rich nations.

For now, the government can issue any amount of fresh IOUs because the Bank of Japan (BoJ) is buying assets by the truckload. But the BoJ’s bond-buying won’t continue forever. Once it ends, the government won’t have too many levers to quickly boost revenue and reduce its reliance on deficit financing. Japanese labour taxes are already high by OECD standards, while the Abe administration wants to cut corporate taxes to revive private investment. That leaves higher duties on consumption as the only way for an ageing society to fulfil its massive social-security commitments.

However, this is the second time that a modest sales tax increase has tipped Japan into recession. If Abe leaves the task unfinished, future Japanese politicians will be even more reluctant to risk their political capital chasing the chimera of fiscal correction.