Japanese tax hikes loom large for Abenomics

After a promising start to an ambitious economic turn-around program, Prime Minister Shinzo Abe will have more difficulty with tax changes scheduled to come in over the next few years. EPA/Harish Tyagi

Another record trade deficit for Japan is raising doubts about Prime Minister Shinzo Abe’s “Abenomics” strategy for economic revival. The new figures follow poor manufacturing sentiment numbers earlier this month.

Abe had promised it would be a good year for the Japanese economy. His government made some progress last year in turning around the slow decline of the economy, and he told Davos that this was the year Japan would break free from chronic deflation.

But the mood is worsening. Japan’s consumption tax is scheduled to rise from 5% to 8% in April, and Abe will need to decide then whether to go ahead with a further increase to 10%, scheduled for 2015.

The April increase will be tied to a 10,000 yen handout for low-income earners, and if a stimulus and tax hike sounds controversial, consider an increase in consumption tax tied to a decrease, as foreshadowed by Abe, in corporate tax rates.

Japan’s corporate tax rate is high even among OECD countries at 37%, second only to the US. Abe succeeded in depreciating the yen last year, which saw the Tokyo Stock Exchange’s Nikkei Index rise more than 50%.

But these new trade figures show the growth in exports bought on by a weak yen has been easily outstripped by surging import costs.

To continue this trend and achieve sustainable growth, the government will eventually need to decrease the cost of doing business and lower corporate tax. However, it’s important that other reforms – in agriculture, labour markets and market regulations – aren’t ignored.

More problems

The real problem for Abe is not just a trade deficit or weak manufacturers’ sentiment. Japan’s public debt to GDP ratio, which at more than 200% in 2013, is the highest among developed countries.

Japan’s government needs to act rapidly to reduce this huge debt. More tax revenues are sorely needed to avoid a financial crisis.

According to the data, consumption tax revenue counted for approximately 24% of tax in 2012, while corporation tax revenue counted for 21%.

The government is trying to increase tax revenues from a broad base to mitigate the negative effects on consumption and some corporation tax reduction is being discussed.

This was meant to be the year of economic growth, with the government planning to unveil strategies aimed at encouraging investors and promoting private investment.

But to increase private investment and boost salaries, the government should undertake ambitious structural reforms to the economy, not just decrease corporate tax.

There is plenty of room for reform in the agricultural sector, in labour markets and in market regulation. Encouragingly, Abe has already started to act.

Limits to rice production that have for decades protected inefficient rice farmers will soon end. Relaxation of various regulations will see intense competition in many new sectors.

Older, not younger

Abe now needs to look at labour market reform.

Japanese society is growing older faster than any other OECD countries. The government introduced a new system in 2012 to promote the entry of highly-skilled foreign professionals.

This is a start, but more needs to be done. The share of foreign labour in Japan is still a very low 0.3% (Australia’s, by comparison, is 13.4%).

The number of women in the Japanese workforce is also low compared to other developed countries. The female labour participation rate is 48%, Australia’s is 58%.

Moreover, women in Japan who are employed tend to be either working part-time or are overqualified for the job they hold.

According to 2011 data, 34.8% of employed women worked part-time, compared to the OECD average of 26.0%. In Japan, 91% of women aged 25 to 64 have successfully completed high school, while the average of the OECD is 73%.

Changes in corporate labour practices can play an important role in increasing female labor participation. The government needs to take concrete measures, like increasing more child care facilities, and extending the duration and broadening the coverage of maternity leaves.

Abe will be pondering whether to increase consumption taxes and sap further momentum from the economy, or whether to cut corporate taxes and see Japan’s debt position further. He shouldn’t forget the other reforms that could help right Japan’s economic ship.

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