The consumption tax rate was raised from 8 percent to 10 percent on Oct. 1. The government introduced a variety of measures to minimize the economic impact of the tax hike. Those measures have made the consumption tax system complex -- some aspects of it are so complicated that taxpayers have to think hard to figure out how the relevant mechanisms work.
First, the tax rate was raised together with the introduction of a reduced tax rate system under which the levy remains at 8 percent for food -- excluding alcoholic drinks -- and certain other articles. To be specific, luxurious restaurant meals are excluded from this mitigating system as it would be odd to treat them favorably in taxation. Only food items defined as "necessities" are covered by the system.
The idea behind the mitigating system is understandable, but it is not easy to determine which meals count as luxurious. Any meals eaten in a restaurant are now subject to the new 10 percent levy as the government finally concluded that none of them are "necessities." As a result, the consumption tax rates applied at eateries are 8 percent for take-out and delivery meals but 10 percent for eating in at the same establishment. Likewise, the consumption tax rate for a hotel guest drinking juice is 8 percent if he stays in his room and drinks it from the minibar, but 10 percent if he goes out to drink it in the hotel restaurant.
Second, the reward points program that has been implemented together with the consumption tax rate increase is more confusing. Consumers can earn a tax rebate of 5 percentage points by using credit cards and electronic money cards as well as smartphones scanning QR codes, among other methods, for "cashless payments" at small and midsize businesses. The reward rate is lower, at 2 percentage points, for consumers going cashless at franchise convenience stores or similar franchise retailers of major chain store operators. And it is zero at stores directly run by convenience store chains, department stores and large-scale supermarkets, among others.
Consequently, although the consumption tax rate change had called for an increase of 2 percentage points, the effective consumption tax rates are now divided into multiple levels, varying from 3 percent to 10 percent. When consumers purchase take-out food at small and midsize retailers, they are charged 8 percent tax but get a 5 percentage point rebate, thus effectively paying a net 3 percent consumption tax rate. In such a case, consumers benefit from a de facto 5 percentage point tax reduction. In a contrasting example, the consumption tax rate is 10 percent in the case of buying goods other than food at supermarkets. However, the complicated reward points program is a limited-duration plan to be effective for just nine months, until the end of June 2020.
For what earthly purpose were those incomprehensible measures adopted? The government aims at just one thing -- to "prevent an economic downturn." The consumption tax rate hike to 10 percent was originally scheduled for October 2015, but the government, citing the need to avert negative economic consequences, decided in November 2014 and again in June 2016 to postpone the planned hike. So, the hike has got off the ground on the third attempt.
Economic consequences
We need to properly sort out issues in connection with the relationship between the consumption tax and the economy.
First, a tax rate hike plan tends to cause a rush or last-minute surge in demand, with consumers buying more goods than usual ahead of the raise, a development that tends to be followed by a "reactionary drop in demand" in the wake of the tax hike. This time, it is said that rush demand was relatively limited, although some people perhaps saw lines of commuters at railway stations in late September, waiting for their turn to buy seasonal passes. Nevertheless, such a phenomenon means a forward shift in the timing of consumer activity to days prior to the tax rate hike. In other words, when we look at the annual amount of consumption, there can be no overall change. As such, this is not a big issue.
Second, it should be noted, however, that the impact of a consumption tax rate increase would not be limited to a chain of rush demand growth and subsequent demand contraction. As this is a tax increase, it does mean that disposable household income shrinks as much as the increased tax burden, resulting in a decrease in consumption.
But this decrease just causes the present level of consumption to decline -- it has nothing to do with the state of consumption "growth." If consumer spending fails to recover for a long time following a tax rate increase, we should think not that the consumption tax rate hike is to blame, but that there must be some other reasons.
Would a higher consumption tax (also called a value-added tax, or VAT) really cause the economy to remain stagnant for a long time and therefore hinder growth? If so, European Union countries whose VAT rates are generally around 20 percent should have been economically ruined by now. But the EU countries, though having to tackle many challenges, continue to be among the world's leading "advanced countries."
In April 1997, the Cabinet of Prime Minister Ryutaro Hashimoto raised the consumption tax rate from 3 percent to 5 percent. After that, Japan plunged into an economic slump until 1999. Although the primary reason was the outbreak of a financial crisis that led one major financial institution after another to collapse, some people still remember it as a lingering "traumatic event related to the consumption tax rate hike."
In April 2014, the administration of Prime Minister Shinzo Abe raised the consumption tax rate from 5 percent to 8 percent. After that, consumption stayed stagnant for a long time and the consumption tax rate hike was again fingered as the culprit for the economic outcome. This caused the government to devise the current set of measures mentioned earlier, which can be said to be excessive. However, the continuation of the lackluster state of consumption actually stems from insufficient wage increases and the public's anxiety about the future of the country's social security.
In fact, when we take a long-term look back at what has happened to the economy, it becomes clear that consumption has risen in real terms even with the increased consumption tax rates. In fiscal 2018, when the consumption tax rate was 8 percent, annual private consumption totaled 300 trillion yen, up 16 percent from 258 trillion yen in fiscal 1996 when the tax rate was 3 percent. Over the same period, the country's gross domestic product (GDP) grew by nearly 20 percent. In the long run, economic growth is instrumental in boosting overall private consumption in a country.
Why a tax hike?
By the way, let's consider why the consumption tax rate needs to be raised in the first place. This is an important point, but it has tended to be buried under the media's inclination to focus on the economic pulse immediately after the tax rate hike and the mitigating measures.
The latest tax rate increase of 2 percentage points is projected to increase the total annual tax burden on consumers by 5.7 trillion yen when both national and local taxation are considered. In reality, the reduced tax system also eases their burdens by 1.1 trillion yen, and the government has introduced measures supportive of families with children, including free early childhood education. On balance, the increase in households' tax burdens amounts to about 2 trillion yen in net terms. This means the effective consumption tax rate hike is a mere 0.7 percentage point. In the process of raising the consumption tax, this low figure does not justify giving significant weight to fears of a consumption slowdown affecting the economy.
What is important to note is the fact that it has become increasingly difficult to make ends meet in financing the country's social security as a bulwark against the widening income inequality that is happening in tandem with the super-aging of society. In Japan, society's "revenue" is destined to decrease as the working population declines on the one hand while its "expenditure" is set to increase as the elderly population keeps rising on the other hand. The state continues to constantly suffer from shortfalls in tax revenue, the basis that supports social security, with fiscal deficits snowballing at a nearly unsustainable pace. The mainstay fiscal resource to back social security is the consumption tax. It is indispensable for as many Japanese as possible to understand this difficult situation and reach a consensus on the country's policy for 21st-century nation-building at home.
As for the consumption tax, it is often pointed out that the system is regressive, compelling those who are poorer to bear heavier tax burdens. However, the income tax, which is a progressive tax system, is far from ideal in reality because of problems relating to the separate fixed-rate taxation of financial income, which accounts for the greater part of the wealthy's overall income, as well as because of the difficulty for tax authorities to accurately ascertain the wealthy's income. But all humans have a habit of eventually spending what they earn for consumption. Naturally, those who are richer spend more. In that sense, the consumption tax is a straightforward tax system like a "bill-splitting" taxation method.
The merit of the consumption tax is that people from primary school students to those aged 100 or older all pay taxes. Therefore, people are highly interested in the system -- and there are many opposed to it. But in a society where many people are of the opinion that tax burdens ought to be borne by either the rich and large-scale businesses or "everyone but me," democracy can hardly thrive.
When all people pay taxes commensurate with their consumption, they are likely to become inclined to seriously discuss how their taxes should be spent. As such, the consumption tax can be said to be a touchstone of our society's ability to create a sound democracy to cope with the fast aging of its population.
The government is responsible for giving a detailed explanation of the significance of the consumption tax, together with the future of the country's social security.
Yoshikawa is the president of Rissho University, a post he assumed in April this year after being a professor at the university for three years. Prior to that, he was a professor at the Graduate School of Economics of the University of Tokyo. He also serves as the chair of the Cabinet Office's study panel on diffusion indexes for business conditions. Previously, he chaired the National Council for Social Security and the Fiscal System Council, and served as a member of the Council on Economic and Fiscal Policy.
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