TOKYO - The Japanese government has decided at a Cabinet meeting to lower the consumption tax rate on food and beverages. It will be the first time since the tax was introduced in 1989 that the government has moved to cut it.
Japan's fiscal condition is among the worst in the world, and now is the time when the country must focus on securing fiscal room to prepare for future increases in spending. The tax rate should not be lowered, and I am surprised by the decision.
Prime Minister Sanae Takaichi is seeking to cut the consumption tax as a measure to deal with rising prices, but this departs from standard economic thinking because a tax reduction could stimulate demand and accelerate inflation. Given that wealthy people consume more and would benefit from the tax cut, it also cannot be described as support targeted at low- and middle-income earners.
The government plans to lower the consumption tax rate on food and beverages, currently at 8 percent, to 1 percent for two years from April 2027, and effectively reduce the rate to zero by providing cash benefits equivalent to the revenue from the remainder.
Cutting the rate to zero would create an annual revenue shortfall of about 5 trillion yen ($31 billion). In addition, the government has decided on a policy to invest more than 370 trillion yen in 17 priority strategic fields through the public and private sectors. It is also expected to raise defense spending needed to fundamentally strengthen Japan's defense capabilities. With spending increasing in this way, I feel there are many items for which the sources of funding are unclear.
Over the past roughly 30 years, interest rates remained extremely low, keeping interest payments on government bonds down. At present, inflation is pushing tax revenue above expectations, while the ratio of government debt to gross domestic product is declining, putting Japan in what could be called a "fiscal bonus period." Now is a good opportunity to improve the country's finances.
Yields on newly issued government bonds are on an upward trend, and interest payments will rise going forward. The prime minister is aiming to achieve high growth by using public- and private-sector investment as a lever, shore up tax revenue and thereby continue to keep the burden of interest payments down.
The economy, however, is a living thing. It is inappropriate to place excessive expectations on increased tax revenue, and the risk that doubts could arise over Japan's fiscal sustainability should also be taken into account.
The market is closely watching where the government will obtain funds for steps such as the consumption tax cut and higher defense spending. If the government fails to show reliable funding sources, the market may suspect deficit-covering debt will be issued as the source of funding, causing interest rates to surge and potentially leading to a downgrade of Japanese government bonds in the future.
Initially, the prime minister positioned the consumption tax cut as a "bridge" until the introduction of a new system to support low- and middle-income earners, a refundable tax credit. But she has apparently given up on the refundable tax credit and instead opted for a simple cash benefit scheme, trying to ease public dissatisfaction when the lowered consumption tax rate is returned to its original level in April 2029.
The details of the new benefit scheme, including the range of eligible recipients, have yet to be decided. I am concerned that unless eligibility is properly targeted, a sense of unfairness could remain. Unless the government maps out a benefit scheme that people find highly convincing, dissatisfaction could grow and make it difficult to restore the consumption tax rate to its original level.
During periods of inflation, it is the Bank of Japan's job to curb price hikes, and lifting its policy interest rate is the most effective way to respond.
It is only natural for prices to rise when the economy is expanding, as it is now. In such a phase, it cannot be justified for the government to repeatedly offer gasoline subsidies, tax cuts and other across-the-board support as steps to tackle higher prices.
Of course, measures for low- and middle-income earners are important. I believe the essential policy is to steadily raise Japan's growth potential through targeted cash benefits and public- and private-sector investment, thereby increasing incomes.
Mana Nakazora was born in Tokyo. She graduated from Keio University's Faculty of Economics. After working at Nomura Research Institute and BNP Paribas Securities, among other institutions, she assumed her current post as chief researcher at the Kampo Economic Research Institute. Her specialty is credit analysis.
