Given the cogent objections Richard Katz raised to increasing the consumption tax, why is Noda still pushing the issue? John, Nobu and Paul have provided additional evidence for my original proposition that the alternatives are also unattractive, and that the political dynamics might not be as resistant to a tax increase as they appear at first glance. Yesterday's news that the major parties reached tentative agreement on a 7.8% wage cut for public servants further paves the way by showing that the government is sincere about cutting its own costs before asking the voters to pay more in taxes.
In addition, Japanese policymakers have good reasons to focus on increasing the consumption tax fairly soon rather than waiting, and putting primary emphasis on consumption rather than other taxes. I agree with Richard that ideally it would be preferable first to improve tax collection via strict implementation of a taxpayer ID number, and then raise taxes on real estate, personal income and estates before turning to an increase in the consumption tax, and I hope his efforts at persuading Japanese policymakers bear some fruit. And indeed, as in the US, there is broad support, at least in principle, for raising personal income tax rates. It is also important to recognize, however, that the focus on consumption taxes is not just happenstance, but is the outcome of extended policy debates. Policymakers finally have achieved a rough consensus on what to do. As late as Abe's time, it was at least somewhat plausible to argue that expenditure cuts should come before tax increases, but after several more years of restraint on expenditures and explosive growth in public debt, that period has passed. Policymakers now largely agree that consumption and personal income taxes must go up, while corporate taxes should stay the same or decrease. In contrast, even after more than three decades of effort, the government has consistently failed to implement taxpayer ID. Maybe the DPJ, less dependent on farmers and small business owners than the LDP, will fare better at passing taxpayer ID legislation-but then again, maybe not. Or maybe not in time. As a native of California, I can attest that it is also difficult to raise taxes on real estate.
Moreover, there are compelling reasons why governments around the world, including European social democracies, the liberal UK, and Japan's neighbors in East Asia, rely heavily on VAT and other consumption
taxes: taxes on consumption raise prodigious amounts of revenue relatively efficiently and with minimal distortion and corruption (introduction of mandatory invoicing in Japan would further improve transparency and honesty); they encourage savings, investment, and growth; they do not penalize exports; and they are relatively stable across the business cycle.
Consumption taxes are quite good at capturing revenue from groups that might otherwise escape the tax system altogether, such as farmers, small business owners, and the elderly, and in that sense they are quite fair.
Consumption taxes are regressive across income classes, but exempting food and other necessities or taxing them at a lower rate can ameliorate the effect; at any rate, regressivity is fairly limited when considered across consumers' life spans. Last but not least, the spending consumption taxes enable is relatively progressive.
Arthur Alexander and Richard Katz suggest that Japan's fiscal problems are still manageable and that increasing the consumption tax too soon could worsen the economic situation. There is some truth to this: as I suggested in my earlier post, while fiscal crisis has moved from the unthinkable to the thinkable, it is probably still several years from posing an immediate threat. But raising tax rates will take time, and in the meantime the financial situation at all levels of government grows steadily more perilous: in 2010, the debt to GDP ratio exceeded 220% and even net debt reached 117%, far over the Reinhart and Rogoff warning line of 90% (after which crises become more likely and growth slows; see their update at http://voxeu.org/index.php?q=node/5395), and nearly double the levels in the US (92%/65%) and UK (77%/69%).
Parsing the debt into levels of government and types of holders is useful, but events of the last few years have shown how dangerous it is for all levels of government (and banking systems) to indulge in over-leveraging. Whereas it took an interest rate of 7% to spark a crisis in Italy, an increase in interest rates even to the relatively normal rate of 3% would devastate the value of bank holdings in Japan.
Moreover, the "balance sheet recession" of the 1990s and early 2000s has largely passed, and with it the need for extraordinary government stimulation to overcome private sector weakness: the corporate sector has steadily decreased its financial leveraging, and surveys of businesses suggest that the backlog of labor is largely exhausted (though it reappeared briefly after the Lehman and Fukushima shocks).
The most interesting question revolves around timing and trust in government. Of course, trust in government has declined everywhere over the last few decades, and some scholars argue that that is not entirely a bad thing. Levels of trust also respond, however, to perceptions of how well the government is doing its job. Richard's proposal to wait until growth is firmly under way before embarking on fiscal consolidation makes sense for the US, with its relatively high potential growth rate and moderate levels of accumulated debt. Even in the US, though, that view is hotly contested. In Japan, waiting for the ideal time all too easily could become yet another excuse for inaction, and further fuel anxiety about Japan's future. Of course, the best way to restore a degree of confidence-and thus spur consumption and investment-would be for the economy to recover, and we all hope that happens soon. But letting Japan's alarming fiscal situation spiral further out of control is hardly a recipe for restoring confidence. Making serious efforts to restore fiscal balance, and not just vague promises about future sobriety, might help. In practice, the current proposal to implement increases in stages, beginning in two years, would probably coincide with Richard's proposal to wait for an upturn in the economy. But it would also provide a clearer, more definitive signal that political leaders are taking decisive action. In contrast, waiting for a full-scale upheaval of the party system to work itself out and produce a government capable of taking painful steps to rein in the deficit seems like a risky wager indeed. By that point, a full-scale debt crisis could well become not only thinkable but imminent.