Ahead of the House of Councilors election in Japan, ruling and opposition parties are discussing a consumption tax cut as an economic measure to counter high prices and U.S. tariffs. The Constitutional Democratic Party of Japan and the Japan Innovation Party have pledged to temporarily reduce the consumption tax rate on food from the current 8% to 0%. The National Democratic Party of Japan has advocated the reduction of consumption tax rates to a uniform 5%. The period for the tax cut is to be set at one year or is planned to vary depending on economic conditions.
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A temporary consumption tax cut to stimulate the economy can be viewed as an unconventional fiscal policy measure. If a temporary tax cut and a future tax increase (a return to the current tax rate) make current prices cheaper than future prices, they will stimulate current consumption through intertemporal substitution.
Although such a policy measure has been tried in Europe, views are divided over whether the measure actually reduced consumer prices in line with the theory. A consumption tax (value-added tax) cut in Germany during the COVID-19 pandemic reportedly had a particularly significant effect on durable goods consumption, meaning that most of the tax cut was passed on to consumers, expanding consumption.
In the United Kingdom, however, where the standard value-added tax rate was lowered in response to the global financial crisis, the effect of the tax cut on prices disappeared within a few months. France later reduced the value-added tax on consumption at restaurants, but most of the cut reportedly benefited restaurant owners.
In general, the effects of tax cuts depend on various factors, such as potential production increases responding to demand growth and the competitiveness of the market. Economists are generally skeptical of tax cuts. Japan’s economy has been on an inflationary trend for a long time. Under inflation, supply capacity factors, such as labor shortages, rather than demand factors, constrain consumption. Any tax cut to stimulate consumption could further exacerbate price hikes unless it is accompanied by an increase in production.
Tax cuts are not guaranteed to end within any limited period of time. If a tax cut is short-lived, it may be covered with a tax revenue increase or by dipping into government funds. Some may argue that deficit-covering government bonds may be used to cover a tax cut. Given that consumption tax hikes have been postponed twice in the past, it will take considerable political energy to reverse any tax cut.
If the reduced tax rate on food products is cut to 0%, national and local government tax revenue is estimated to decrease by about 5 trillion yen. As the consumption tax is a source of funding for social security, such as pensions and medical care, if a consumption tax cut is to be prolonged or become permanent, alternative revenue sources will be required.
It would be too optimistic to say that tax cuts will boost the economy and increase tax revenue naturally. Even if wise spending is thoroughly implemented through a reform of fiscal spending, measures such as social security benefit cuts may have to be undertaken to cover the trillions of yen in resulting tax revenue decreases.
Japan’s fiscal situation is difficult. Outstanding government bonds have continued to accumulate, topping 1quadrillion yen. Prime Minister Shigeru Ishiba has stated that Japan’s fiscal situation is worse than that of Greece. Although he has been criticized for comparing Japan’s fiscal situation to Greece, Japan should not regard the Greek fiscal crisis as “just a fire on the other side of the river (a Japanese saying).”
Although Japan’s government bonds have been stably absorbed (purchased) in the domestic market thanks to a money glut in households and companies under a deflationary economy, the situation is changing. While the Bank of Japan has changed its monetary policy to reduce government bond purchases, domestic financial institutions have little room to purchase government bonds. Against this backdrop, foreign ownership of Japanese government bonds has increased to 12% (as of December 2024).
However, Japan’s government bond rating is the second lowest after Italy among the Group of Seven major countries. There is a risk that if market confidence in Japanese government bonds is impaired, government bond yields could increase sharply. Such an increase could have a negative impact not only on public finances but also on companies and households by boosting market interest rates as a whole.
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Potential economic measures are not limited to the consumption tax cut. The government should propose effective measures while being aware of fiscal constraints. In this paper, I would like to propose the enhancement of production capacity for sustainable economic growth and the development of a safety net for working people. These measures will address not only short-term economic difficulties, but also Japan’s structural issues, such as sluggish growth rates and widening inequality.
In Japan, where the deflationary economy has continued, fiscal stimulus has been biased toward stimulating demand to eliminate a deflationary gap, or an excess of supply over demand. Japan should reform fiscal stimulus to focus on the supply side.
If we aim to raise real wages by even about 1%, improving labor productivity is indispensable. According to the Cabinet Office, the supply-demand gap for the January-March quarter of 2025 is estimated at minus 0.2%, indicating that concerns about deflation have not been completely dispelled. However, sustainable economic growth requires more than demand creation alone; increased investment to increase supply capacity is also needed.
Potential measures include investment in growth-oriented social infrastructure, investment in expanding semiconductor and storage battery production, support for research and development to lead to new innovation, and the promotion digitalization of the economy overall.
The Industrial Structure Vision of the Ministry of Economy, Trade and Industry envisions a scenario in which Japan’s domestic private sector investment will increase to 200 trillion yen by 2040. This would increase the nominal gross domestic product to 975 trillion yen and the average nominal wage to 5,366 yen per hour. Fiscal policy will be combined with regulatory reform to promote labor mobility and to improve economic metabolism under the scenario.
There are concerns that Trump tariffs will reduce Japan’s exports. Some hope to offset this by increasing domestic consumption. In 2024, automotive products accounted for about 30% (about 6 trillion yen) of Japan’s exports to the United States. Exports to the United States of agricultural, forestry, and fishery products, which are subject to domestic consumption tax cut proposals, have been increasing in recent years, but are limited to 200 billion yen. Rather than relying on domestic consumption, it would be more appropriate to provide emergency support for exporters and promote structural transformation, including the exploration of new markets and new business plans within industry, under the assumption that U.S. tariffs will remain high in the foreseeable future.
Behind the so-called “tax-cut populism” is the dissatisfaction of citizens, especially among working population. The ruling Liberal Democratic Party has pledged a cash handout of 20,000 yen per person, but during inflationary periods, fiscal policy should focus on expanding supply capacity and providing targeted support for daily living.
The figure shows a generational comparison of consumption tax and social insurance premium contributions, with the baseline of 1 set at those aged 34 or younger, and the ratio of social insurance premium contributions to consumption tax contributions for each generation. For the working population, social insurance premium contributions represent a heavier burden than consumption tax. Furthermore, the ratio of social insurance premium contributions to consumption tax contributions is disproportionately higher for workers. While low-income elderly pensioners (aged 70 or older) have low incomes due to being on pensions, their average savings is 24 million yen compared to 11.4 million yen for householders under 50 (according to the Family Income and Expenditure Survey for 2024). Burdens are not shared equally across generations.
Source: “Family Income and Expenditure Survey” by the Ministry of Internal Affairs and Communications (2024)
In principle, social insurance premiums are considered compensation for benefits received. In reality, however, they function more like redistributive taxes. For example, 40% of health insurance premiums paid by workers are spent on medical care for the elderly (both early-stage and late-stage elderly people). Financial resources for raising basic pension benefits under a pension reform include employee pension reserves. If the goal is to support the livelihood of working people, then reducing their social insurance premium contributions would be appropriate.
A conceivable approach would be to refund a fixed or capped percentage of employee and national pension premiums through the Japan Pension Service. The premiums would still be considered paid, so future pension benefits would not be affected. However, to avoid worsening pension finances, public funds in the general account would be used to cover the refund.
Potential funding sources include increases in inheritance and other asset taxes and taxes on financial income, and fundamentally reforming personal income tax through revision of income deductions. In the future, this refund system could evolve into a new safety net for workers, like a tax credit with benefits.
>> Original text in Japanese
* Translated by RIETI.
July 1, 2025 Nihon Keizai Shimbun
