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Abenomics seems to me like a straightforward and modern plan of economic reflation through monetary easing and some attempt at structural reform.

While it's still early, it looks like many of the predicted effects of this approach have begun to materialize: unemployment is lower, earnings are higher, currency has deflated resulting in a rise in exports and improvements to corporate earnings. Capital has, unfortunately, accumulated on corporate balance sheets rather than re-entered the economy, but even this is a known effect of easing.

One thing I don't understand (aka my question) is: why did the Japanese government seek to raise consumption tax (VAT) during this process?

It would seem that the whole point of easing is to stimulate productive money circulation, and implementing a consumption tax when consumers are likely to suffer in the initial stages from currency devaluation seems very counterproductive to the cause. If the government actually needed the funds then surely there were other approaches available (borrowing or deferred taxation) which would have had less negative impact on the overall easing programme?

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Everybody seems to be worried about the raise in the consumption tax, and how it has thus far crippled the efforts to bring the Japanese economy out of stagnation. But Japan has 200% of DGP in public debt, and it cannot leave its public finances go south, not even temporarily.

My impression is that it was the choice to lower corporate tax and "in exchange" increase V.A.T. (perhaps under the impression that it was low, if they looked at European Union levels). Demand was supposed to strengthen through direct transfers, while lowering corporate tax is to boost business initiatives, towards investment but also give some added room to increase wages (to help demand).

We' ll see. Up to now, it doesn't go very well.

ADDENDUM

That the increase in the Sales Tax had as its target to take care of the public finance side of the equation is clearly stated in the IMF-report on the matter, in which we read

"The consumption tax rate increase in April to 8 percent was a major achievement, but is only a first step towards fiscal sustainability...The second consumption tax rate increase in 2015 to 10 percent with a uniform rate should be confirmed. Raising the tax rate further at a moderate pace would help establish fiscal policy credibility. Staff estimates that fiscal consolidation in 2015 would slow growth by ½ percent, leaving growth in 2015/16 still above potential under the baseline."

A quick journalistic take can be found here.

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  • $\begingroup$ Thanks. However Japan's debt is mostly Yen denominated so reflation actually makes that debt cheaper. So I don't quite understand why one would seek to depress consumer spending when consumers are the most likely to get hurt by reflation in the short run via negative wealth effect. $\endgroup$ – tohster Feb 20 '15 at 0:05
  • $\begingroup$ Well, perhaps you should ask IMF to explain -they know better don't they?... I added their report and an excerpt. $\endgroup$ – Alecos Papadopoulos Feb 20 '15 at 1:58
  • $\begingroup$ Thanks for the addendum. You're right about the IMF, the quotation in the report is "Plans to lower the corporate tax rate have growth benefits, but should proceed in combination with measures to offset revenue losses and be consistent with plans to restore fiscal sustainability". It does seem to have backfired a bit though, because lower corporate tax has improved profits but not reinvestment, whereas VAT seems to have depressed consumer spending. I'm accepting your answer nonetheless because it is thoughtful, relevant and well informed. $\endgroup$ – tohster Feb 21 '15 at 4:50
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    $\begingroup$ @tohster Thanks. Let me clarify that my answer was descriptive/analytic. The general principle that "we have a debt to manage, and consumption taxes are comparatively less harmful to economic activity" is a classic supply-side dictum, hence possibly correct in the long-run, but probably mistaken in the short-run and especially when your focus is in stimulating demand. I hope to be alive to see this "supply side/demand side" dichotomy in economic theory and applied advice turning into a synthesis. $\endgroup$ – Alecos Papadopoulos Feb 21 '15 at 4:57
  • $\begingroup$ I agree with you...a syncretic approach seems better, particularly with the benefit of hindsight from the QE experiences in the US and Western Europe. Japan may be concerned over its creditworthiness and want to protect it with fiscal probity (which the IMF is almost duty-bound to affirm), but I think that bridge was crossed already when they embarked on reflation to begin with. $\endgroup$ – tohster Feb 21 '15 at 5:33

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