Don't overreact to the consumption tax debate

Japan Times

16-05-2025

As Japan prepares for an Upper House election this summer, a, if not the, key issue in the campaign will be the consumption tax.
Economic uncertainty in combination with rising prices are squeezing the budgets of households, businesses and the government. The focus of domestic debate to ease those pressures is the consumption tax.
A growing number of parties and politicians are pressing for relief, most typically in the form of a reduction in the current levy — 10% for most items and 8% for food products. Proposals include across the board cuts, fixed temporary reductions for particular items such as food or gas, or even suspension or cancellation of the tax. The ruling Liberal Democratic Party and the government of Prime Minister Shigeru Ishiba remain committed to the current plan, however, while debating aid for households in the form of subsidies.
The government's claim that it must be fiscally responsible is sound. Japan's government debt is substantial and cuts to the tax are more politically expedient than economic necessity. That does not mean that households do not need aid or assistance; rather, the case is for smart, targeted efforts that help those most in need without blowing a hole in the national budget.
The consumption tax has weighed heavily on Japanese politics. It was first proposed in the late 1970s to ease financial strains as the provision of social services outstripped government revenues. That suggestion alone was enough, argue political analysts, to cost the LDP its majority in the 1979 general election. A 3% levy was eventually introduced a decade later in 1989 — after one false start two years earlier — and it was raised to 5%, the first in what was anticipated to be a gradual but steady increase in the tax. That increase contributed to the loss of the LDP's majority in the Upper House in 1998 and the resignation of then Prime Minister Ryutaro Hashimoto.
The Democratic Party of Japan took power in 2009 on a platform that promised, among other things, a freeze on taxes. In 2010 then Prime Minister Naoto Kan proposed raising the tax rate to 10%, which yielded a crushing defeat for his party in the next election and the plans were abandoned. A 2012 agreement with the LDP, then in the opposition, to raise the consumption tax to 10% to help pay for burgeoning social services costs contributed to the DPJ's defeat in elections later that year.
That agreement endured however and the consumption tax went from 5% to 8% in 2014. Yet even formidable Prime Minister Shinzo Abe twice delayed the scheduled hike to 10% during his second term in office out of concern for the electoral consequences. Finally, in October 2019 the consumption tax increased to 10% for most items, with food (and a few others) remaining at 8%.
Meanwhile, financial demands on the government have mounted as society ages, prime ministers promise child care and defense budgets swell. Japan's government debt as a percentage of gross domestic product in 2023 was 195%, the highest share among major advanced economies. That is why government officials agree with Chief Cabinet Secretary Yoshimasa Hayashi, who warned last week that 'The government does not think it is appropriate to lower that tax rate,' noting that 'it's an important funding source for the social security system for all generations.'
That position is a striking contrast — some say political suicide — when opposition parties are all calling for some relief in taxes. The Constitutional Democratic Party of Japan, the main opposition party, has proposed lowering the consumption tax on foodstuffs to zero for one year. Ishin no Kai wants to reduce the tax on foodstuffs to zero for two years and the Democratic Party for the People calls for cutting the tax to 5% across the board. Even Komeito, the junior partner in the ruling coalition with the LDP, wants some relief, although it hasn't endorsed a specific proposal.
The LDP is divided, however. A substantial number of its members are worried about their political vulnerability. Sixty-nine LDP lawmakers signed a petition calling for eliminating the consumption tax on foodstuffs, and that combined with pressure from Komeito could yield a softening of the party's hard line.
While there may be some political logic to the call for accommodation, — and other governments have done so — the party should not bend. Once reduced, it will be extremely difficult to raise — or more properly, restore — the consumption tax to its previous level and Japan's fiscal difficulties will be compounded. In the fiscal 2025 budget, the tax accounted for nearly one-third (32%) of government tax revenue. According to one estimate, eliminating the tax on foodstuffs would boost nominal and real gross domestic product by approximately 0.43% a year — but yield a tax shortfall of about ¥5 trillion ($33.8 billion).
That does not mean that households don't need some form of help. Consumers are being squeezed. The Bank of Japan anticipates that prices will continue to rise, the product of labor shortages, disruptions to global trade resulting from the U.S. tariff policies and shortages of some products, like rice. But the virtuous cycle — in which rising prices lead to rising wages — that Japan has enjoyed in recent years is now threatened by that same uncertainty. The BOJ has lowered its forecast for the Japanese economy and has warned that the outlook could change further and some officials worry about the prospect of stagflation — a stagnant economy that suffers inflation nonetheless.
While providing a stable source of revenue — such taxes are largely unaffected by economic cycles — the consumption tax weighs most heavily on low-income earners. Prime Minister Ishiba has acknowledged fiscal and political reality by noting that 'It's important to take generous measures for those who are truly in need while taking responsibility for the next generation.'
Targeted measures are thus key, which rules out sweeping cuts in the consumption tax. Putting money in the pockets of those individuals and their families through subsidies, for example, may not provide economic stimulus — economists worry that payments would be saved, not spent — but they would ease the pain.
Having lost its majority in Lower House elections last year, the government, the LDP and its junior partner Komeito, fear a similar outcome in the summer Upper House vote (or a worse outcome if Ishiba decides to call a snap double election). Relief for besieged consumers is important but so too is avoiding the image of pandering to voters.
The public wants and needs a thoughtful government that rejects populism and focuses on the national interest — not just the need to win votes. A plan that balances the need to help households with attention to deficits will win that support.
The Japan Times Editorial Board