The Threat of ‘Abegeddon’ From Taxes in Japan; Abe Orders Japan’s First Sales-Tax Increase Since ’97

The Threat of ‘Abegeddon’ From Taxes in Japan

Posterity is watching carefully as Shinzo Abe goes ahead with a sales-tax increase aimed at getting a handle on Japan’s huge debt burden, the world’s largest. Unfortunately history may judge him no better than Ryutaro Hashimoto, the last Japanese prime minister to kill an economic recovery with ill-timed fiscal tightening. That’s not the conventional wisdom of the moment. Markets are euphoric over surging confidence among large Japanese manufacturers. September’s jump in the quarterly Tankan (JNTSMFG) index — to the highest levels since before the Lehman Brothers Holdings Inc. collapse in 2008 — gave Abe just the tail wind he needed to raise the consumption tax to 8 percent from 5 percent starting in April 2014, with a further 2 percent increase in the cards for 2015.Yet Abe is ignoring two things that could end his revival program, dubbed Abenomics: the precedent set by Hashimoto, Japan’s 53rd prime minister, and the specter of inflation.

Hashimoto’s 1997 sales-tax increase scuttled Japan’s best chance at strong growth in a decade. By the time Hashimoto left office in 1998, business leaders were deriding him as Japan’s Herbert Hoover, the 31st president who botched the U.S. exit from the Great Depression with badly timed austerity measures.

Inflation heightens the risk Abe is making the same mistake. The government hailed news last week that consumer prices are rising at the fastest pace since 2008 as a vindication of Abenomics. Yet the 0.8 percent jump in prices excluding fresh food in August was purely an energy story, driving by a surge in costs for fuel imports.

‘Heavy Burden’

The yen’s 20 percent slide against the dollar in the year through August comes just as Japan’s demand for fuel imports is skyrocketing. Safety concerns have shut down all of the country’s nuclear reactors since a March 2011 earthquake and tsunami wrecked the Fukushima power plant. Japan desperately needs gas, oil and coal to reactivate conventional power stations. And Japan is a price taker in global markets, not a price maker.

“Increases in fuel procurement costs impose a heavy burden on the Japanese economy,” Trade Minister Toshimitsu Motegi said in Tokyo recently.

That burden could lead to something even more ominous: stagflation. Alexander Friedman, chief investment officer at UBS AG, calls the prospect “Abegeddon.”

“We’ve had something like 13 stimulus programs in Japan since 1999, so we do have to see if there is a sustainable handoff to growth,” Friedman told Bloomberg Television’s Francine Lacqua on Sept. 27. “Months ago, I said the big risk on Japan might be what I would call ‘Abegeddon,’ instead of Abenomics, which would be a scenario where there is no growth, but there is inflation, so call it stagflation. Given Japan’s debt to GDP, that would be a tragedy. So I think it is too early to declare victory here and too early to say we have a sustainable path forward for Japan.”

What if raising taxes actually increases Japan’s debt load instead of cutting it? Abe is being goaded into it to avoid credit downgrades. International Monetary Fund officials are among those urging Tokyo to fix an ugly national balance sheet, which has been made worse by a shrinking population. The risk, though, is that a tax increase will dissuade Japanese from spending, while higher energy costs squeeze companies.

Lawmakers are already clamoring for stimulus to offset the new tax levies, which would deaden the fiscal benefit anyway. Why bother raising taxes in the first place — especially now, just as Abenomics is trying to gain traction? Besides, as University of Tokyo economist Takatoshi Ito argues, making a dent in a debt more than double the size of the economy would require a 20 percent sales tax — something no economist is seriously advocating.

Sweeping Deregulation

A better strategy would be to push through the sweeping deregulation Japan has avoided since 1990 in order to catalyze growth. Why not use the next six months to enact crucial elements of Abenomics? The government could cut the red tape that prevents entrepreneurs from starting new companies, negotiate entry into the Trans-Pacific Partnership, unveil new energy policies and announce quotas on female board members.

If Japan had done any of these things a decade ago, it wouldn’t have to burden consumers now. Sadly, lawmakers squandered the last two years debating how to raise taxes rather than how to improve the country’s competitiveness. Abe may not be courting a depression, but a Hashimoto-like recession can’t be ruled out. If he wants to give Japanese a brighter future, he should start by avoiding the mistakes of the past.

(William Pesek is a Bloomberg View columnist.)

To contact the writer of this article: William Pesek in Tokyo at wpesek@bloomberg.net.

Abe Proceeds With Japan’s First Sales-Tax Increase Since 1997

Japanese Prime Minister Shinzo Abe proceeded with an April sales-tax increase and will implement an stimulus program as he tries to rein in the world’s biggest debt burden without jeopardizing efforts to end deflation.

The levy will rise to 8 percent from 5 percent now, Abe, 59, said in Tokyo today, the first increase since 1997. Abe will unveil the size of a package of stimulus measures later today, the ruling party chief told reporters. Economists have projected a 5 trillion yen ($51 billion) plan that will include public works spending and tax breaks encouraging companies to boost capital spending and wages.

With households already hit by a rising cost of living and declines in pay, proceeding with the higher levy enacted by the previous government poses the biggest risk yet to Abe’s efforts to end two decades of Japanese stagnation. His next challenge in coming weeks is following through on pledges for domestic economic reforms that persuade companies to invest at home.

“The next focus is solely on the growth strategy,” Naohiko Baba, chief Japan economist at Goldman Sachs Group Inc., said before the announcement. The planned stimulus package will help safeguard the economy “from the risk of faltering under the weight of the sales tax,” he said.

The economy will contract an annualized 4.5 percent in the three months after the sales tax is increased in April before returning to growth, according to the median calculation of economists surveyed by Bloomberg News. For the 2014 calendar year, the expansion is seen slowing to 1.6 percent from 1.9 percent this year, the median estimates show.

Economy’s Tailwinds

Tailwinds for the world’s third-largest economy heading toward the April increase in duties reduce the danger of Abe following in the footsteps of Prime Minister Ryutaro Hashimoto, who in 1997 oversaw a 2 percentage point boost in the levy. The move cost him his job as Japan sank into a recession with consumption swooning against a backdrop of weakening demand abroad due to the Asian financial crisis.

Japan’s large businesses now are the most confident they’ve been since before the collapse of Lehman Brothers Holdings Inc. The Bank of Japan’s quarterly Tankan index for big manufacturers rose to 12 in September from 4 in June, exceeding the median estimate of 7 in a Bloomberg survey.

The Topix index of stocks was up 0.8 percent as of the 11:30 a.m. break in Tokyo ahead of Abe’s announcement, bringing its gains to 64 percent over the past year amid optimism that Abe’s policies will end the economy’s malaise. The yen’s 21 percent slide against the dollar over the past year, propelled in part by monetary stimulus enacted by Abe’s pick for central bank chief, has helped stoke profits for the exporters.

Growth Rate

Abe is under pressure to keep a recovery going after the economy grew an annualized 3.8 percent in the second quarter, a third straight advance for gross domestic product. While consumer prices rose in August the most since 2008, the gains stemmed from higher energy costs that have squeezed households in the absence of wage increases.

A government report today showed that salaries in August extended the longest slide since 2010, with regular wages excluding overtime and bonuses falling 0.4 percent from a year earlier, a 15th straight drop. The figures underscore that companies have yet to grow confident enough about the outlook to start boosting compensation, even as they sit on what the BOJ calculated was 220 trillion yen in cash at the end of June.

Three Arrows

To help unlock that money, Abe has aimed his third arrow of economic policy at growth-inducing reforms from trade liberalization to steps elevating the participation of women in the workforce. Abenomics has so far relied on the first two arrows — of government spending and BOJ Governor Haruhiko Kuroda’s unprecedented commitment to achieve 2 percent inflation by increasing the supply of money.

Kuroda said last month that the central bank could take further action if its goal of engineering 2 percent inflation within about two years were imperiled.

With household spending compressed by falling pay, “the BOJ may be forced to lower its fiscal-year 2014 inflation forecast,” Credit Suisse AG economists in Tokyo led by Hiromichi Shirakawa wrote in a note last week. “The central bank may have little option but to announce additional easing measures in an attempt to fulfill its commitment to 2 percent inflation by fiscal-year 2015.”

Second Increase

Legislation passed by Abe’s predecessor called for the sales tax to rise to 8 percent in April and then to 10 percent in October 2015, pending a final decision by the prime minister. If the first step doesn’t go well, the next one would be scrapped, Economy Minister Akira Amari said over the weekend on Fuji Television.

“There is no next step but to wait for these policies to bring results,” said Hideo Kumano, chief economist at Dai-ichi Life Research Institute, before the announcement on the sales tax and the stimulus Abe will unveil later today. “Aggressive monetary easing has been implemented, public works will boost employment and tax incentives will be offered. We can only wait and see the outcome of these measures. Stimulus measures for the time being are sufficient.”

Abe, who took office in December after his Liberal Democratic Party resumed its nearly unbroken dominance of Japan’s politics in the postwar period, is trying to spur growth while putting the country’s finances on a sustainable footing. Public debt reached a record 1,008.6 trillion yen as of June 30, more than the economies of Germany, France and the U.K. combined.

Bond Yields

Deflation has helped contain Japan’s borrowing costs even as public debt expanded. Yields on benchmark 10-year notes are about 0.68 percent, compared with 2.635 percent for U.S. Treasuries and 1.78 percent for German bunds.

“Backtracking now would really put in question the ability of the government, the ability politically of the government to move ahead with fiscal adjustment,” Jerry Schiff, the International Monetary Fund’s mission chief for Japan, told reporters in August, commenting on the sales tax increase.

The Washington-based IMF has urged Japan to go beyond the scheduled increases in the consumption levy, lifting it to “at least 15 percent” to bring down its public debt over the medium term.

Others advocate even stronger steps to prevent an eventual collapse in confidence in Japanese government bonds.

“It is our responsibility as politicians to raise it,” Takeshi Fujimaki, a former adviser to billionaire George Soros who is now a member of Japan’s upper house of parliament, said in an interview last month in Tokyo.

His prescription: a rate of 35 percent to 40 percent.

To contact the reporters on this story: Isabel Reynolds in Tokyo at ireynolds1@bloomberg.net; Chikako Mogi in Tokyo at cmogi@bloomberg.net