RIETI Report September 2013

Points of Discussion over the Planned Consumption Tax Increase: Tax hike would not necessarily lead to slower economic growth

Prime Minister Shinzo Abe is expected to formally announce on October 1, 2013 the implementation of the planned consumption tax rate hike from the current 5% to 8% in April 2014. The government has been studying the possible effects on the Japanese economy of the tax hike as well as of some other options and postponing the tax increase in response to potential concern that the planned tax increase will negatively affect the domestic economy. In the September issue of the RIETI Report, we present Consulting Fellow Kazumasa Oguro's column "Points of Discussion over the Planned Consumption Tax Increase: Tax hike would not necessarily lead to slower economic growth."

Tax increases are typically thought to dampen consumption and result in slower economic growth, but Oguro argues that singling out a consumption tax rate increase as something special and concerning is illogical. He points to several periods in Japan's history--the introduction of the consumption tax in 1989, the first hike of the consumption tax rate in 1997, and the scaling back and elimination of the fixed-rate tax cuts in 2006 and 2007--all of which provide evidence that tax hikes do not necessarily result in slower economic growth. Oguro also looks at overseas cases, many of which further supports his stance. Finally, he discusses what would happen if the consumption tax rate increase is postponed and its daunting implications.

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Points of Discussion over the Planned Consumption Tax Increase: Tax hike would not necessarily lead to slower economic growth

OGURO KazumasaConsulting Fellow, RIETI

Prime Minister Shinzo Abe is expected to decide by early October 2013 on whether or not to go ahead with the planned consumption tax rate hike from the current 5% to 8% in April 2014, by evaluating the country's economic outlook. The government has begun studying possible effects on the Japanese economy of the planned tax hike as well as of some other possible options such as reducing the margin of the April hike from the planned three percentage points and postponing the tax increase. The move is believed to come in response to concern that the planned tax increase will negatively affect the domestic economy. In fact, the consumption tax hike from 3% to 5% in 1997, which translates into an increase of five trillion yen in financial burden on consumers, was blamed for further aggravating the already slumping Japanese economy.

Typically, the economic impact of a tax increase can be evaluated in two dimensions, namely, in terms of its effects on a country's economic growth and tax revenue. Higher taxes will lower household disposable income, which in turn will dampen consumption thereby resulting in slower economic growth. This mechanism for tax changes to affect economic growth is called the "income effect."

To read the full text
http://www.rieti.go.jp/en/papers/contribution/oguro/04.html

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