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.