Significance of Showing Net Prices that Include Consumption Tax: With a View to Improving Business Productivity

TSURU Kotaro
Senior Fellow, RIETI

Matters pertaining to consumption tax in the tax system revisions for fiscal 2004 include (1) lowering the tax exemption threshold for businesses (from ¥30 million to ¥10 million), (2) lowering the limit for application of the simplified taxation system (from ¥200 million to ¥50 million), (3) reviewing the number of times tax is declared and paid, along with (4) the obligation to show net prices that include the consumption tax. These changes will take effect from April 1. Such revisions should be welcomed in the sense that they aim to reduce the "carrots" (a typical example of this is the tax which is collected but does not enter state coffers as a result of the tax exemption ceiling) that were necessary to reduce resistance by businesses when introducing consumption tax and to plug, albeit slightly, the loopholes that exist in the current system. Among these revisions, there has been much debate and criticism from both businesses and consumers surrounding the obligation for firms such as retailers to show the prices of their goods with the consumption tax included, and it seems there is some confusion over the issue. In this column, I would like to critically examine these arguments and consider once more the significance of showing prices in such a way.

Why is this change being implemented now?

When the consumption tax was first introduced, there were no restrictions regarding whether the levy should be excluded or included when displaying a product's price - the decision of which style to take was left up to businesses. While parties such as small firms which do not want to deal with small change and vending machines have adopted the tax-inclusive pricing method, many retailers such as supermarkets, convenience stores and department stores have chosen to show prices with the consumption tax excluded. Because of this, problems arose, including (1) the difficulty in comparing prices because the two systems were intermingled, and (2) the difficulty in grasping how much had to be paid before actually going to the cashier under the tax-exclusive style of price presentation.

Therefore, the obligation to show net prices aims to do away with such situations and make the total amount payable including consumption tax visible just by looking at price tags. This revision can be said to be out of consideration for consumer convenience, but why is such a change being undertaken now? It is said that what triggered the latest set of reforms was not any strategy on the part of tax authorities but rather a single order from a hugely influential member of the Liberal Democratic Party's Research Commission on the Tax System, requesting that past mistakes be corrected before it is too late.

In European countries that have introduced value-added taxes since the 1960s, displayed prices include tax, and there is an obligation to show net prices to the final consumer to ensure consumer protection (this is not stipulated under tax laws but under legislation covering competition policy and consumer protection policy). In the United States, where retail sales taxes have been introduced at state, county and city levels, although it does not appear to be mandatory to do so, net prices are generally shown. Given global trends, not least consumer convenience, Japan should have adopted the net price system (the inclusion of the consumption tax in the displayed price) from the outset. The reason this could not be done was because authorities, when making efforts to introduce the consumption tax, gave consideration to small and medium-sized firms which argued that they could not possibly shift the tax onto the prices of their goods. Although a bit late in the day, the backdrop for the introduction of this obligation to show net prices is a desire to use this opportunity of tax system revision to set matters straight.

Problems facing firms

The problems that this change will pose to businesses may be summed up in three points. First, there is the issue of the cost required for businesses that have hitherto been showing tax-exclusive prices to shift to the new system (broadly speaking, "menu cost"). While the cost of changing such things as price tags and advertisements may not be that great, huge costs may be expected in changing cash registers that are linked to point-of-sale systems and revising the prices displayed on products whose prices are already shown without tax, such as product catalogues and books (which had initially adopted the tax-inclusive price display system when the consumption tax was introduced, but shifted to the exclusive format when the levy was raised in 1997). Such costs incurred on businesses should be justified as serving to improve consumer convenience, but some form of public assistance is also needed to ensure that this transition goes smoothly. As for switching cash register systems, the tax breaks for information technology-related investments that were introduced in fiscal 2003 can be applied in cases that meet the conditions.

The second problem is how to deal with odd figures. At present, under tax-exclusive pricing, authorities have allowed consumption tax amounts less than ¥1 to be dropped when paying the tax. Once everything is unified under the net price system this rounding off will become meaningless and thus disallowed. While this may sound like a trivial issue, it signifies an increase in burden ranging from some tens of millions of yen to several billion yen for firms. However, the authorities have taken this into consideration and prepared policy measures, including a three-year grace period during which firms will be able to drop tax that amounts to less than ¥1 in transactions with consumers.

Third, there is the question of how to set prices. The retail strategy of fixing prices slightly below a key level so as to give the buyer a feeling that they are reasonable or cheap is one that is also familiar to consumers. Examples of this are prices set at ¥98, ¥198 and ¥980. Because these prices are the prices of the actual product, once the net price system is in place, they will carry price tags of ¥102, ¥207 and ¥1,029, respectively, and will exceed the key level, thus making it questionable whether consumers would still find them appealing. The same may be said for so-called 100 yen shops, whose selling point is the fact that the price of all their wares is ¥100. Retailers will be forced to drastically review their pricing strategies. If they seek to continue pricing policies that are attractive to consumers, they will have to negotiate with suppliers to cut costs or pass the burden on to suppliers, and concerns will be raised over possible abuse of retailers' superior position. To deal with this, the Fair Trade Commission is to actively check for any illegal activities by retailers.

The "illusions" of the consumer and the obligation to show net prices

It is a fact that problems such as the increase in the cost burden for businesses are the demerits of obliging businesses to show net prices, and various policy measures have been put in place to ease them. However, it is very problematic for consumers to object to this obligation on the grounds that the difference in showing prices with the consumption tax included and excluded has a substantial effect on consumer behavior. Fundamentally, if the consumer is rational, no difficulties should be encountered with the net pricing system, which empowers the consumer to decide whether to purchase a product after proper calculation of the consumption tax burden. Generally speaking, consumers on the whole act rationally. Therefore, if businesses are certain that touting a product as costing ¥98 without tax will make it sell more than showing the same product as costing ¥102 including tax, this means that consumers are not making rational purchase decisions. If the way prices are shown are deluding consumers and preventing them from making appropriate decisions, then we should shift to the net pricing system, which will make it difficult for them to harbor such "illusions." In other words, the reason why businesses object to the net pricing method is the very reason why it is necessary to make it obligatory from a consumer perspective.

Meanwhile, one case in support of consumers' objections to the net pricing method, it has been said, is that it will weaken their sensitivity to the consumption tax burden, making it easier for authorities to raise the tax rate or introduce multiple rates (under which items such as food will fall under a lower tax rate). In other words, consumers oppose the introduction of the net pricing method because they see it as part of preparations for a future consumption tax hike. However, there is little evidence to support the view that the tax-exclusive pricing method ensures that people feel the pain of the consumption tax. For example, any consumer that does not buy a product when it costs ¥102 including tax, but purchases it when it bears a price tag of ¥98 excluding tax does not properly understand the consumption tax burden and can be said to be insensitive to it, even under the tax-exclusive pricing method. In addition, if we are to discuss the issue of the public's awareness on tax, it is more important to increase their awareness as taxpayers without having them feel the pain of tax burdens.

The tax burden for businesses and the motivation for increasing productivity

Finally, let us turn to the issue of the net pricing method and the shifting by firms of the consumption tax onus. Many businesses say that "it is easier to shift the consumption tax burden onto consumers under the tax-exclusive pricing method than by using the tax-inclusive method." This tacitly assumes that consumers make decisions regarding purchases based only on the product's price and that the consumption tax portion is an obligatory expenditure, in the sense that buyers will pay it regardless (ie price elasticity is zero). Yet, regardless of whether the consumer realizes it before a purchase or not, ex post consumer demand depends on how much was spent in total, including the consumption tax, and so long as the price elasticity of the goods and services purchased is not zero, it is not desirable for firms to shift all of the consumption tax burden onto consumers. This is because profits for businesses will be higher if they bear in mind the percentage of the consumption tax burden to be shifted in accordance with price elasticity and prevent a decline in sales volume, rather than shifting it 100% onto prices.

In other words, the consumption tax is not only a burden for consumers, but also for firms, and is desirable for them. What becomes the issue then is how to deal with the tax onus. For example, if the basis for a business model is the name "100 yen shop," then it would not be strange for some firms to carry out comprehensive cost-cutting through increased productivity and continue to call themselves "100 yen shops," even under the net pricing system. In this sense, if the obligation to show net prices becomes an opportunity for businesses to change their mindsets and boost productivity, it will be a welcome reform not only for consumers but for firms themselves.

Resolution of the nation's fiscal problems and improving the productivity of the general public as a whole

Considering Japan's current fiscal state and the level of value-added tax rates in Europe and other countries (around 20%), a hike in the consumption tax rate is unavoidable. At the same time, it appears that a consciousness is steadily increasing among the general public that "this is unavoidable." Despite this, the reality is that a consumption tax hike is a political taboo. It is already understood that any political party that mentions it first will come under attack from other parties and the mass media. Indeed, strong political leadership, including a nonpartisan agreement on the issue, is needed to push it forward.

On the other hand, we should also avoid raising the consumption tax with the simple notion of "getting tax revenue from where it is easiest gained." If there is to be a hike in the consumption tax rate, from the view of transparency and fairness, an invoicing method (making the presentation of bills with separate statements on tax amounts mandatory for receiving deductible consumption tax) should be introduced and further review of the tax exemption threshold and simplified taxation system is crucial. In addition, if other conditions remain the same, it is self-evident that the economy will contract because an increase in the consumption tax is certain to lead to a drop in demand. Therefore, from the macroeconomic viewpoint, efforts to boost overall economic productivity must be made simultaneously with the consumption tax hike. This will create a fundamentally strong economy that can withstand the increased tax burden and lead to the expanded equilibrium of it. The fiscal deficit problem often prompts debate over whether it should be solved by cutting expenditures or by raising taxes. However, in order for such fiscal reconsolidation measures to succeed, the country needs to go through a process under which overall economic productivity increases and potential growth is boosted. The fundamental principle of economics that "increasing the productivity of the overall economy is the only way for a country to become wealthy" is also useful when tacking issues related to fiscal policy. I hope that the obligation to show net prices with the consumption tax will become an opportunity for businesses to boost their productivity.

February 17, 2004

February 17, 2004