Minispike: The case for a consumption tax hike

Stuck in my stubborn ways, I’ve rarely changed my opinion about anything of importance since turning twenty, except perhaps to drift gently to the right on economic matters, a common enough trajectory. One of the last vestiges of a leftish youth, ever since first encountering the debate on tax and taxation structures as a teenager, was a visceral dislike of consumption taxes for their regressive, inequitable nature, a dislike that did not survive the half-hour I recently spent reading an impressively thought-through and impeccably presented IMF paper, Raising the Consumption Tax in Japan: Why, When, How?, which I thoroughly recommend to anyone interested in learning more about how Japan dug the fiscal hole it is in and how it might just get out again.

In passing the authors also take convincing potshots at two shibboleths widely held by observers of the malaise of the last two decades. The first is that the fiscal hole was dug by ardent Japanese disciples of Keynes who went on pump-priming binge after binge to jump-start a moribund economy back to life. This view is akin to gospel among those wild-eyed commentators who believe that FRB Chairman Ben Bernanke is the son of Satan and that Keynes liked nothing better than to quaff on the blood of freshly butchered babies for breakfast. It is also plain old-fashioned wrong. While there were a couple of whopper budgets along the way, what happened by and large was much more prosaic: after the Bubble burst, tax revenue flatlined, outlays on everything but social security stayed static, and social security spending nearly tripled, from Y11.6trn in 1990 to Y28.7trn in 2011. What stimuluses there were mostly cost fresh pennies on the budgetary dollar but garnered all the media attention because of the attendant political furor.

The second shibboleth is that the consumption tax hike, to 5% from 3% in April 1997, was the cause of the subsequent recession of 1997-1998. The authors point out that private consumption started to grow, post-hike, in the July-September quarter of 1997 (as did the economy as a whole) and that it is likely that other factors, such as the Asian financial crisis, coupled with a weak domestic banking sector that had still failed to deal with the poisonous legacy of soured Bubble loans, were more significant. Causes of recessions are open to almost endless debate, of course—no one has yet nailed the roots of the Great Depression, eighty years on—but the argument strikes this disinterested observer as plausible, given the paucity of evidence linking the dozens of consumption tax increases across the OECD in the last forty years with serious downturns.

These shibboleths are espoused by everyone from economists such as Richard Koo to columnists such as amiable if hyperopinionated Bloomberg scribe William Pesek, who repeats them both within the space of a couple of short paragraphs in a June 27 article:

Japan is a cautionary tale when it comes to rich nations getting incentives wrong. It issued mountains of debt, assuming for 20 years that it was just one stimulus plan away from 5% growth. That never happened.

Then, amid a ballooning budget deficit, it increased consumption taxes in 1997. That killed a nascent recovery.

The sooner these shibboleths are put to sleep or at least hedged with deep qualifiers, the better, as they obscure the causes of the problems and their solutions.

Returning to the consumption tax, even the IMF won’t deny that it is regressive:

A simple static analysis using micro-level household data suggests that tripling the uniform VAT rate to 15 percent in Japan will increase the tax burden for households in the bottom 20 percent of the income distribution by 9 percent of their current income, compared to only 4½ percent of current income for those in the top 20 percent.

Unfair, you cry—but hold on a minute. The bottom quintile of income earners in a modern economy does not constitute some forever enslaved lumpenproletariat: it includes recent graduates on low starting salaries but with good lifetime earnings prospects and—this is especially germane in Japan—hordes of retirees with low incomes but masses of assets, so consumption tax viewed over the lifetime of an individual is less regressive than a static analysis would suggest.

Moreover, it is surely equitable in an ageing society to place at least some of the tax burden on the generally asset-rich elderly beneficiaries of a no longer sustainable social security system in a way that income taxes cannot: “those over age 60 in 2005 are expected to receive Y100mn [about $1.25mn] more in net social benefits over their lifetimes than are those not yet born”.

Residual equity concerns could be addressed by levying lower rates on essentials such as food, but as the proud and unbowed torch-bearer for the Washington Consensus, the IMF is having no truck with such lily-livered concessions, arguing that the higher standard rate that would have to be charged to generate the same tax revenue would cancel out any benefits accruing to lower income groups from a lower rate on food. My jury remains out on this, but it’s worth noting that the handful of OECD countries besides Japan that allow no or very few reduced VAT rates or exemptions include New Zealand, Denmark, and South Korea, none of which is known for its passionate embrace of inequality.

The familiar arguments in favor of a consumption tax are easily rehearsed: it’s less distortionary on saving and investment decisions than many other taxes, it’s relatively cheap and easy to administer, it’s less subject to business cycle fluctuations than income taxes are, it probably has a less detrimental impact on growth, and is likely to be more robust in a graying nation—“private consumption [in Japan] has grown by about ½ percentage point per year faster on average over the past 10 years than labor income”.

Above all, aside from the consumption tax, the consolidation policy cupboard is as bare as Old Mother Hubbard’s was. The power of the old in Japan’s already elderly electorate is amplified by the greater propensity of those over 50 to cast their ballots and further skewed in their favor by the disgraceful passive gerrymandering that favors wizened rural constituencies. Only a government intent on committing political seppuku would dream of tampering meaningfully with social security entitlements, which voters routinely cite in opinion polls as their overwhelming concern.

That leaves precious little fat to cut—defense, at 1% of GDP? Education? Implausible, as anyone who has set foot in a Spartan and crumbling state school of late will attest, and inadvisable too—a nation that spends so much on its senior citizens ought to ring-fence the little it spends on its youth. Infrastructure? Public works spending has been slashed by two-thirds in the last decade, the “construction state” of yore is no more. Healthcare? Already lean—at 8.5% of GDP, about as low as a high-income OECD economy gets.

For Japan, tax increases, however painful, must for practical political reasons as much as any be the main means of closing in on fiscal sustainability, and the consumption tax is the best, indeed the last, game left in town. High time for everyone to get playing—and paying.

14 responses to “Minispike: The case for a consumption tax hike

  1. Agree totally. Where else can they find this cash? A massive one-off on electric power utilities! But 10% or more? One could argue that the rate is now too high in the UK at 20%. 10% seems easy to administer and would not be too too great a shock. 7.5% would probably be the usual J cop-out compromise. Where is the spunk in this land? Purely rhetorical…

  2. Kyushu Ranger

    I’d agree so long as they excluded food and other necessities like the UK-just to take the sting out for the ‘lumpenproletariat’ many of whom cannot afford luxury items ..or good food as it is. Japan’s polarisation will continue.
    Perhaps they should raise death/inheritance taxes-a good source of revenue for the years ahead.
    Ah feck it, just (hyper) inflate.

  3. At least one study of taxation has concluded that each of the three principal taxes (wealth, income, and consumption) is highly inequitable, but in combination and over the lifetime of an individual they make up a highly equitable taxation regimen, for just the reasons you put forward in favor of an increased consumption tax in Japan.

    Regrettably, I can’t give you a reference. It may have been in some study out of the Brookings Institution, possibly by Hank Aaron.

    One way of ameliorating the impact of a no-exemptions consumption tax is to give a tax rebate to low income earners. That’s the system used here in Canada.

    Keep going, Spike, m’boy; I used to work in the property taxation field and reading what you have to say about taxation is something of a busman’s holiday.

  4. ” . . . coupled with a weak domestic banking sector that had still failed to deal with the poisonous legacy of soured Bubble loans, . . . ”

    Wasn’t this the case because a substantial portion of the defaults were held by gentlemen who favor full body tattoos, meaning that even the government was reluctant (read: made no effort whatsoever) to follow up on these?

  5. Hiding wealth and reducing consumption (or at least pretending to do so) is a Japanese tradition.

    Japanese governments were always poor, and they tried to raise taxes all the time for any excuse available to man.

    So, those who had things to lose found elaborate ways to hide their wealth and consume in some ways to avoid government eyes.

    That’s why Japan became masters at making tea porcelains; they were not taxed, so wealthy people made a sport of acquiring the best teapots, tea cups, etc.

  6. @Adrianme Where else can they find this cash?

    How about selling some if not all of the $912.4 billion dollars worth of US treasury bonds?

    • Sounds like a lot of money, doesn’t it? But at Y71trn, it’s only about three-quarters of a single year’s worth of Japan central government spending. And attempting to liquidate it all (ore even a large chunk of it) at once would cause such turmoil on the US government debt market that the current pandemonium over the US debt ceiling would look like a village fete.

      • Not to mention the outsize impact such a liquidation would have on the value of the Yen. The Keidanren would soon have the politicians’ heads.

  7. >”Where else can they find this cash?”

    “So the question is, which are the least bad taxes? In my opinion the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago.” — Milton Friedman

    >”Hiding wealth and reducing consumption”

    The beauty of the land value tax is that land titles are impossible to hide.

    Land in Tokyo is selling Y500,000 to Y3,000,000+ per meter2.

    A 4% LVT would yield $300B or so for the 23-ku alone. Of course, this regime would also slaughter existing land values, so getting to there from here is a non-starter, alas.

    Sorry Granny, 10% for you.

    • By next year, when people all over in Kanto begin to develop cancer and other strange diseases en masse, the land price on tokyo will rival that of Timbuktu’s.

    • Oh, noes! Not Henry George!

      It somehow doesn’t surprise me that Milton Friedman, of all people, would think the Georgist single land tax “the best” (or at least, the least bad).

      For all the hoopdedoo about the wonderful effects of instituting the Georgist scheme, in fact no polity anywhere has ever implemented it per spec. Some municipalities in British Columbia tried it, but there were still non-Georgist provincial and federal taxes – and at least one that tried it, Burnaby, went bankrupt during the depression because they were not taxing all that lovely wealth in the form of buildings and structures.

      I believe it’s been tried in Australia at the state level, but again that’s not actually George’s “single tax” as taxation by other levels of government weren’t based on vacant land values.

      One of the hidden killers in George’s proposal (which, btw, predates Marx and has about the same level of validity, or even less) is that land valuation is close to impossible in built up urban areas because the base statistics, sale prices, are for the entire package of land plus buildings. It’s very close to a fool’s errand to try to split those prices into separate land and building components.

      Readers of Spike Japan, being sensible people one and all, are urged to pack heat in the form of small pearl handled revolvers, the better to plug squarely between the eyes any advocates of the Georgist single tax they may chance across.

  8. Read the review of a book that may interest you about Olde Blighty.

    http://www.ft.com/intl/cms/s/2/abe33d44-a972-11e0-bcc2-00144feabdc0.html#axzz1TR2Ru6w6

  9. I’ve always been curious as to why its been so hard to raise VAT in Japan – in most countries its risen simply because its probably the easiest tax to raise – long ago Finance Ministers realised that a percent or two on VAT can raise a huge amount of money with only a fraction of the resistance of equivalent raises in direct income tax or property taxes. Especially as the Japanese seem less price sensitive than other countries, especially with food.

    Mind you, its an interesting contrast to here in Ireland, where the government has cut VAT in a vain attempt to help tourism and to stimulate some spending (other taxes have gone up).

    I’m not a huge fan of VAT because of its regressive nature, but I think its clear that it does have a major role to play in an overall tax system. But I would have thought the most progressive taxes in Japan would be those which encourage more spending and less speculation – i.e. taxes on savings and property taxes.

  10. Even at low rates, consumption tax is very effective at producing government income. With a falling workforce, it is pointless focusing on income tax and disincentivizing work.

    I also agree with the point that asset-wealthy older Japanese must pay.

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