In reply to Gregory Noble:

My view is that the consumption tax is the wrong tax at the wrong time.

It's the wrong time because Japan's recovery is so weak. After today's release, GDP is still 4% below below the peak reached almost four years earlier in Jan-March 2008. To raise taxes in the near term would be to repeat the mistake of 1997. Much of the huge surge in the deficit and total debt occurred in the last few years as a result of the global slump and then the March 2011 disaster, not from longterm trends. In fact, during the 2003-07, the ratio of NET government debt to GDP actually stabilized and then the global slump sent it skyward.

My view is that Japan should use fiscal and monetary stimulus to boost recovery now. To reassure markets, it should combine that with a law that will raise taxes, not in a specific year, but when the recovery reaches certain milestones, e.g. a narrowing of the "output gap." The latter is the gap between actual GDP and potential GDP, i.e. what GDP would be at full employment and full use of physical capacity. That gap was estimated at 5% of GDP for 2011 by the IMF. By the way, narrowing that gap has proved the best way to both counter deflation and limit or decrease the budget deficit.

A consumption tax might be a good tax for other countries, but not for Japan where anemic consumption is one of its chronic structural defects.
Weak spending is produced by weak income (including falling real wages) not by a refusal to spend due to anxiety or deflation or any other of the excuses. If the latter were the case, the savings rate would be rising. Instead, as Gregory notes, it has fallen drastically. How will taking away more of the consumers' money lead them to spend more?

Yes, eventually, Japan must raise taxes. When it does, there are far better alternatives. For example, a citizen ID system like the ones in virtually every other advanced industrial democracy. This would limit massive tax evastion in rural areas and among the self-employed. In the 1990s, the MOF estimated that a citizen ID would raise as much money as a 5% hike in the consumption tax, the hike that Noda is now seeking.

Another tax would be to end the tax breaks on urban and suburban land that is zoned and taxed and assessed as farmland but grows more votes than food. This should be combined with changes in land usage laws that would make it easier for agribusiness to get into farming and make it easier for farmers to sell their land for nonfarm uses, like malls, offices, residences, factories, etc. It would kill several birds with one stone (apologies to the Audobon Society): 1) it would immediately bring in lots of tax revenue; 2) The owners would make a big capital gain; and 3) it would immediately enlarge the amount of land available for development thereby lowering the cost of development; that, in turn, would help spur investment and GDP and thus the tax base. When I asked an official from the MOF's tax bureau about this, he said that the MOF had made both of these proposals to the LDP way back when, but the LDP turned them down because it would hurt their voter base in rural areas and their funding base from the real estate lobby. The consumption tax became the default option and the only tax people now talk about.

Japan is not Greece and won't be so for at least a decade or more. Every single Euro country that has gone into crisis has had twin deficits:
i.e. not only a big budget deficit and accumulated debt, but also big current account deficits (i.e. its borrowing from other countries). In the case of Greece, the latter was in double digits. Hence, these countries were vulnerable to capital flight. Moreover, while twin deficits seem to be necessary for capital flight and crisis, they are not sufficient. There are several coutnries with debts as big as the crisis countries and small current account deficits and accumulated net foriegn debt, but they did not get into crisis, e.g.
France. On the other hand, not a single country that was a big government debtor but ran current account surpluses has run into crisis. This includes not only Japan, but also Belgium, a country whose NET government debt to GDP has been around 100% for a couple decades, a level that Japan hit just recently. (NET debt, not gross debt, is the important factor because gross debt involves double-counting of the debt that the govenrment owes to itself.)

Some alarmists say that Japan could begin running a current account deficit as early as 2015-16. I disagree and so does Robert Feldman of Morgan Stanley who ran a scenario in which this took place in 2023. In my view, even 2023 may be too early. To run a current account deficit, Japan would have to run a goods and services trade deficit about 4-6 times the size of the deficit of 2011 in order to surpass is Y10-14 annual net income from its overseas investments. Even when it runs a current account deficit, it will still enjoy a huge stock of overseas assets, including foreign exchange reserves. Those could be be sold if necessary.

The fact that 10-year interest rates are lower today than at most points in the past dozen years suggests that the market does not perceive more than a tiny risk of crisis in the coming decade.

I recall the same logic that Greg Noble uses now being used to push the urgency of a tax hike in 1997 and then fear among bond traders in 2003.
It proved false on both occasions. So is talk of Japan becoming the next Greece. It's a scare story being used to try to sell an unpopular tax.

Now to the politics of the issue:

Why do we get a seeming contradiction: people who acknowledge that social security cannot be maintained without a tax hike, yet growing opposition to Noda's tax? Besides fear of a tax hike in a weak economy, I see a larger issue: a crisis of trust. The voters simply don't trust the govermment. When Noda announced that the Fukushima crisis was over because plants had achieved cold shutdown, only 12% of the people believed him. When Noda promises that the consumption tax will only be used for social security, people don't believe it and think the pols will find a way to shuffle the money to boondoggles. The more Noda talks about Greece, the more that opposition rises. The people believe that the government is crying wolf on the tax issue and crying sheep on the nuclear issue. They're against tax hikes for much the same reason that they oppose reopening of nuke plants that the government claims are safe.

Why, then, is Noda doing it despite the example of Kan in 2010 and Hashimoto in 1998? Either he doesn't believe a tax hike is electoral suicide for him and his party, or he doesn't care, or some combination of both.
It seems that Greg accepts the former, arguing that the LDP will eventually cave and let a tax hike pass the Upper House. I disagree. Yes, the LDP's obstructionism has hurt it, just as the Republicans' obstructionism in the US has hurt them. But as long as the LDP figures that it hurts the DPJ more than it hurts the LDP, they have no incentive to change. I think the LDP stragegy remains to make Japan ungovernable under the DPJ. Let's see what they do about passing the bills authorizing the bonds needed to pay for nearly half of this year's budget. And let's not forget that emotionalism can sometimes trump rationality in these things. BTW, it's not at all clear that Noda can win enough DPJ votes to pass the Lower House, let alone get the LDP and Komeito to let it pass the Upper House. Lots of DPJ Diet members are afraid of the coming election due to the tax hike and the TPP. One first-term Diet member (who personally supports both the tax hike and the TPP) told
me: "In 2009, I won because I was DPJ; this time, I'll have to win despite being DPJ." Ozawa has come out against it, and his power will depend in part on the outcome of his trial.

Paul Midford writes:

>Of course, if the LDP fails to win a majority in the
next election,
>which seems plausible to me, it might have to make a
coalition with
>Mina no tou, Genzei Nippon or Hashimoto's party.
Aligning with those
>parties would in and of itself preclude a tax
increase.
>
I agree that there is a good chance that neither the LDP nor the DPJ will win a majority in the next LH election. Your Party has opposed the consumption tax hike, but my understanding is that Hashimoto has been very careful not to come down clearly on either side of this issue. Did I miss something? Eventually, if Hashimoto wants to run a national LH election party, he'll have to take a stance. Easy to be popular when one is simply "not DPJ" and "not LDP." But, once the blanks begin to fill in on assorted controversies, keeping that popularity won't be as easy.

Richard Katz
The Oriental Economist Report