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Catch 3.0% - Japan’s Consumption Tax, GDP Growth Projections and Interest Rates Coming to a Head

October 18, 2007
By Ken Worsley


In an interview with the Nikkei on Wednesday, Kaoru Yosano, the Chairman of the ruling Liberal Democratic Party’s Fiscal Reform Panel, stated his belief that the government should lower its projection of 3% economic growth for fiscal 2007 through 2011. What’s so important about 3%?

At that level, the government believes it would secure enough funds through current tax structures to allow it to balance the national budget and not raise the consumption tax. Over the past few years, with pension obligations growing, it has become obvious that a raise in the consumption tax would have to be discussed at some point. Currently, one third of Japan’s pension fund obligations are derived from the consumption tax.

Nonetheless, we have seen successive prime ministers twist themselves into pretzels in order to avoid discussion of a tax hike. Koizumi had the least trouble; he was able to focus public attention on postal privatization and make it such a pivotal, polarizing issue that the consumption tax issue fell briefly by the wayside. Abe fared less well, instead blatantly ignoring discussion of the issue in the leadup to the Upper House election in July of this year: “We won’t not discuss the issue of consumption taxes at the appropriate time.”

The appropriate time was then.

Ignoring the issue did not help Abe in the Upper House election, in which his LDP looked like a solid high school football team going up against the New England Patriots, except the DPJ was actually the Miami Dolphins in stolen uniforms and should never have looked so good. Given how badly a consumption tax could hurt the LDP at the polls (not to mention the - ahem - economy), would it not make sense for Prime Minister Yasuo Fukuda to call a Lower House election this Fall, before a tax hike kicks in?

It gets better. Earlier today, in an interview published by the Mainichi Shimbun, Yosano called for a 2-3% hike in the consumption tax, saying:

It’d be absurd to raise the tax by 1 percent a few times and lose an election each time. We should raise the tax to a required level once

In other words, this is a heavily political issue.

At the same time, we learned that Credit Suisse lowered its projection for Japan’s fiscal 2008 GDP growth from 2.9% to 1.7%. Macquarie Bank lowered its forecast from 2.5% to 1.9%. Hell, I lowered my own projection from 1.6% to 1.5%. Why not?

In the face of all these negative revised projections (not counting mine), seven consecutive months of decrease in the consumer price index, GDP at -0.3% in the April-June quarter, shrinking industrial output in that same quarter, ten year nominal GDP growth at 0.0%, and low consumer confidence levels, what did the Bank of Japan have to say?

I’ll let David Pilling of the Financial Times do the talking:

Miyako Suda, one of the more hawkish members of the Bank of Japan’s policy board, recently warned that the central bank must not delay too long before raising interest rates from their current 0.5 per cent. If it did, she fretted, the chances that the economy might overheat would build.

Pilling published a must-read today for anyone watching the Japanese economy and feeling confused by what passes for comments made at press conferences by BOJ members. He quotes Paul Sheard, the chief global economist at Lehman Brothers as saying:

The Japanese economy has never fully recovered from the bubble and its aftermath in the important sense that the economy went into deflation, and a liquidity trap, and has yet to come out.

Then, at a seminar in Tokyo today, Koji Yamamoto, chairman of the LDP subcommittee on monetary policy, announced that he plans to challenge BOJ plans to hike the interest rate. Yamamoto put it bluntly: “We will promote discussions in order to prove that the BOJ’s monetary policy is wrong.”

Yamamoto is not joking. He has been planning and holding seminars at universities across the country, and plans to go up against BOJ Governor Toshihiko Fukui in a Diet session. Fukui, of course, has about five more months in his current job, and his successor…

…well, that’s another mess altogether, and a story for another time.

Filed Under Fiscal Policy, Politics, Taxes 

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Comments

2 Responses to “Catch 3.0% - Japan’s Consumption Tax, GDP Growth Projections and Interest Rates Coming to a Head”

  1. billy shears on October 18th, 2007 12:20 pm

    Fall is too early for Fukuda to call an election as he still has to prove himself to the Japanese public and the LDP may still be suffering from the Abe effect.
    In other words, in spite of the fact that the DPJ has nothing to offer, they could still make strong gains in a general election.
    Personally, I don’t think the Japanese economy will be truly thriving until most homeowners get out of negative equity, especially people who have bought homes or property since 1988. Homeowners having a substantial equity in their property seems to be a necessary ingredient of any healthy economy.

  2. Ken Worsley on October 18th, 2007 4:50 pm

    Fall is too early for Fukuda to call an election as he still has to prove himself to the Japanese public and the LDP may still be suffering from the Abe effect.

    Thus the “Catch 3.0%” in the title. Not being able to hold the election now means he has to hold it after raising the consumption tax. I don’t want his job.

    We’re a long way away from homeowners having substantial equity, or even the possibility thereof. I agree with you that it will be difficult for the economy to thrive without it.

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