The Politics of the Tax Hike and Abenomics

The Right Time for a Tax Hike?

On October 1, the cabinet of Prime Minister Abe Shinzō decided that the government would raise the consumption tax rate from 5% to 8% as scheduled next April. Below I provide a political interpretation of why it reached this decision.

In recent months, Prime Minister Abe repeatedly acknowledged that he would carefully make the final judgment about the hike while taking into account its impact on the economy and deflation. At the end of August, he organized a series of panel meetings to examine the potential impact. His decision to hold these meetings caused concern to mushroom among the public that the prime minister might revise the schedule of raising the tax rate—a concern only reinforced as some of Abe’s policy advisors publicly showed reluctance to hike the tax.

So why has Prime Minister Abe finally decided to bring the tax rate to 8%? The major reason, of course, is the current state of the Japanese economy. The GDP growth rate announced on September 9 was a very strong 3.8% on an annualized basis. With economic recovery, concern has lessened that the tax hike might have a negative impact on the economy.

Not All About the Economy

It is possible, however, to point out several political reasons for his decision.

The first was the possible conflict among agendas in the upcoming session of the Diet. If the government were to revise the tax hike schedule, it would need to introduce a new bill in the session starting in mid-October. During this session the Abe cabinet plans to introduce a number of important bills to the Diet, including one to strengthen Japan’s industrial competitiveness, one to liberalize the electricity business, and one to establish a Japanese version of the National Security Council. Had the Abe cabinet introduced an additional bill to revise the tax hike schedule, it would have consumed a considerable amount of time, in turn making it difficult to pass some of the other legislation.

The second was preservation of consistency with past policies of the Liberal Democratic Party. The LDP committed to the tax hike in a series of past national elections: the 2009 general election, 2010 upper house election, and 2012 general election. It also supported the bill to raise the consumption tax in August 2012. If Prime Minister Abe revised the schedule, it could have raised questions about the LDP’s political integrity and the Abe cabinet and the party might have seen their credibility slip among the public.

Third, by raising the issue of negative impacts of the tax hike on the economy, it became easier to introduce new economic measures. On the same day as it determined to raise the consumption tax, the Abe cabinet decided that it would implement a series of policies to mitigate the negative impact of the tax hike on the economy.

There are three pillars. The first is economic measures amounting to ¥5 trillion, which the government will put together by December and implement in a newly formulated supplementary budget. The second is various tax credits, including those for making plant and equipment investment and for construction expenditures to reinforce buildings against earthquakes. The third is stipends for those with low incomes and for those who purchase new homes.

In addition to these policies, Prime Minister Abe affirmed that the government would consider eliminating the temporary corporate tax whose revenues are earmarked for reconstruction of the 3/11 disaster zone. It is highly likely that he will exercise leadership and abolish this tax, which will lower the effective corporate tax rate from 38.0% to 35.6%. (Note that the tax credits, the stipends, and elimination of the corporate tax will be all a part of the forthcoming ¥5 trillion in economic measures.)

These policies would certainly mitigate the impact of the higher consumption tax rate. In particular, the tax credits and construction spending that will surely be included in the December economic measures will also give LDP politicians something for which to claim credit among their individual constituencies. The tax hike is now a fait accompli. As I noted above, revising the schedule for this hike could have jeopardized support for the Abe cabinet and the LDP; adhering to the schedule while providing side payments was politically a better option.

Looking Ahead on the Legislative Agenda

Now that Prime Minister Abe has decided to stick to the tax hike schedule as well as to pave the way for lowering the corporate tax rate, the next item on his agenda is whether he can deliver other policies to stimulate the Japanese economy.

The first is further reduction of the effective corporate tax rate. Prime Minister Abe himself is eager to bring down the effective rate further, going beyond the elimination of the temporary corporate tax. He expressed this willingness in the press conference where he explained his decision to raise the consumption tax. The second is measures besides tax policies related to his so-called growth strategy. Also on October 1, the Headquarters for Japan’s Economic Revitalization announced a set of short-term target policies (link in Japanese). They include the aforementioned tax credits as well as the introduction of national strategic economic growth areas, strengthening of corporate governance, and enhanced competitiveness for Japanese agriculture. The question is whether Prime Minister Abe can exercise enough leadership to achieve the necessary deregulation. Another challenge is whether he can push all necessary legislation through the Diet in the upcoming session to make these policies effective. We have to bear in mind that it is very hard for the government to control the agenda and schedule of the Diet, as I have described elsewhere.

(Originally written in English on October 1, 2013.)