The case for a higher consumption tax

November 4th, 2014 by Philip Brasor & Masako Tsubuku

Big needs: Should daily necessities by exempt from the consumption tax?

Big needs: Should daily necessities by exempt from the consumption tax?

Right now the government is fretting over whether or not to raise the consumption tax to its planned level of 10 percent in October of next year. For a while it seemed like a sure thing, but the drop in demand that accompanied the most recent hike to 8 percent in April, coupled with less inflation than the administration and the Bank of Japan had hoped for, has put the plan into doubt. The fear is that another boost in the tax will send the economy into a recessionary tailspin.

Akira Sugawara, a high school teacher who has published an economics primer for businessmen, recently wrote a simple, easy-to-understand polemic in favor of raising the tax for the online version of the business magazine Toyo Keizai. In line with his mission to explain economic principles to people who don’t have a strong grasp of basics, Sugawara starts out by explaining what the consumption tax is supposed to do, rather than what it is actually doing.

Originally, the purpose of the tax was to bolster social security in the face of a rapidly aging society, and though so far revenues from the tax have been used to pay off Japan’s massive debt, Sugawara still thinks social security should be prioritized when discussing the consumption tax.

The cost of social security — medical services, caregiving and pensions — rises between ¥1 and ¥1.5 trillion every year. At present, these costs amount to about ¥100 trillion a year, so in 10 years’ time you can add another ¥10 to ¥15 trillion to that amount. Sixty percent of these costs are covered by the tax-like premiums that people pay into the various systems, with the remaining 40 percent coming from tax revenues, both local and national.

Many people say that before taxes are increased, the government should cut its budget first, but even if salaries of politicians were reduced by 30 percent, it would only save the government ¥70.2 billion, which will hardly make a dent in the debt. And if civil servants’ pay, for both local and central government workers, were cut by 20 percent, it would provide only 4 to 5 years’ worth of social security funds.

Despite what many people may think, Japan’s public sector isn’t that big compared to its population. In fact, it’s much smaller than it is in other developed countries, so there isn’t much room for budget cutting with a so-called smaller government.

What about boosting other taxes instead, as some people have advocated? Increasing the inheritance tax or doubling the cigarette tax would also have no discernible effect on the treasury. Other than income, corporate and consumption taxes, subsidiary tax levies only account for 20 percent of all public sector revenues.

Some people believe that the government was too quick to cut the corporate tax, but as it stands 70 percent of Japanese companies do not turn a profit, which means they don’t pay any taxes. (Even during the “bubble” era, only 50 percent paid any taxes.)

Ninety-nine percent of all Japanese firms are classified as “small or medium-sized,” and 90 percent (1.57 million) of all the companies operating in the red are capitalized at less than ¥10 million. It should be noted, however, that most of these companies are family businesses, meaning that profits are not a big deal because family members are the employees and thus receive salaries for which they pay income taxes.

Nevertheless, these companies don’t have to pay corporate tax, and since the absolute number of companies in Japan never seems to rise, there is no point in raising the corporate tax, since it is only borne by the largest of corporations. The most compelling reason for taxing corporations is that the private sector benefits from publicly provided infrastructure, but since a relatively small number of corporations pay taxes in the first place, a rise in rates would not provide the revenue necessary to pay for social security.

The same goes for the income tax. Progressive tax rates have been reduced in recent years, and as a result people who make more than ¥10 million a year — 9.8 percent of all workers — pays 76 percent of all the income taxes in Japan. Persons who earn the average salary of ¥4.2 million only account for 7.3 percent of income taxes.

Just as the vast majority of companies don’t pay corporate tax, a large portion of wage-earners don’t pay income tax due to all the deductions available to them. Starting in 2015, the top tax bracket will be increased from 40 to 45 percent, but that change will only result in an extra ¥60 billion in revenues.

And that leaves the consumption tax, which really is the fairest tax of all. It falls on everyone equally and is not influenced by the condition of the economy, since people have to consume to survive. Many people think the CT is an unequal burden on lower income households because they still have to buy necessities and have less money to do that with. Poorer people spend all the money they make on the things they need, while richer people have the luxury of being able to save some of their income after they buy what they need. How is that fair?

Sugawara’s argument is that the basic economic activity being taxed is consumption, and if you take into consideration the entire life of an individual, every one consumes on a relatively equal basis. The poor consume constantly, and while those with more money put some of it aside for their old age, during their twilight years they will theoretically spend it as well. Even in those situations where a person leaves money to his or her heirs, the heirs will spend it. So money will be spent and taxed equally over time. More importantly, exempting food and other daily necessities from CT (keigenzei) with the idea that it helps lower income people is wrong-headed.

If anything, such exemptions benefit the rich, because they will be able to save more of their income by not spending it on necessities. If you want to help lower income people, you should do it through direct grants, either handouts or welfare payments, not consumption tax exemptions, which, in the end, defeat the purpose of collecting tax revenues evenly. In any case, if you give money to the poor, they will definitely spend it. If you give money to the rich through yet another exemption, they probably won’t.

What Sugawara stresses is that the consumption tax is the easiest and most effective means of raising public revenues. What’s difficult is spending those revenues wisely, on public infrastructure that actually benefits the most number of people rather than a select group of companies and public workers; and on social security that everyone is entitled to but which has been compromised by an outdated system of collection and distribution.

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11 Responses

  1. Great article, interesting read.

  2. Yes, but now who is going to explain all this to the lawmakers?

  3. If you had to design a rocket, would you take the opinion of a high-school teacher as seriously as that of a specialist in, say, a university or a major research institution? If no, why would you trust this high-school teacher to understand a system (our economy) that is orders of magnitude more complex than a rocket?

    simpliflying things, and giving blanket moral arguments does not work. Some of these arguments are ridiculous. What about the fact that rich people get to invest what’s left of their revenue, and get out of such investments a much higher rate than workers? Please read Piketty and let’s start quoting from serious researchers in economics, not people that make it look simpler than what it really is for some hidden political agenda. If you did not understand yet that the benefits of abenomics and a tax hike have been mainly directed to companies and their shareholders via inflated Nikkei prices, and that those of us that live out of a salary have been massively screwed up, then I do not think you are living in Japan.

  4. “And that leaves the consumption tax, which really is the fairest tax of all. It falls on everyone equally and is not influenced by the condition of the economy, since people have to consume to survive. Many people think the CT is an unequal burden on lower income households because they still have to buy necessities and have less money to do that with. Poorer people spend all the money they make on the things they need, while richer people have the luxury of being able to save some of their income after they buy what they need. How is that fair?”

    Is this your reasoning, or Sugawara’s? Because it’s a terrible paragraph. The first sentence makes a value judgement that is contradicted by the second-last sentence. The third and fourth sentences describe reality while the beginning of the third sentence implies that reality is wrong.

    I’ll reserve my further comments until my question is answered, because I don’t want to rant at the wrong party.

  5. mc, high-school teacher Sugawara-sensei does not design the economy, nor does he design the tax-system. He explains it. That’s his job as teacher. In general, I think that school-teachers can explain complex things much better than specialists, who know very much about their subject, but fail to explain the bigger picture.
    Of course that is his own opinion, which can and should be debated, but first of all thanks to Philip and Masako for publishing it here.

  6. Cash-based transactions tend to elude consumption tax….and this is still a place where credit card payments aren’t fully embraced so…

  7. “The poor consume constantly, and while those with more money put some of it aside for their old age, during their twilight years they will theoretically spend it as well. Even in those situations where a person leaves money to his or her heirs, the heirs will spend it. So money will be spent and taxed equally over time.”
    This is very simplified view of economy by a school teacher. Maybe such view could be true during medieval self-isolation of Japan from the rest of the world. But to say such things in modern world of global finances where money freely passes over any borders? Rich people have more choices on how to spend their money without paying consumption taxes in Japan. They can invest in financial instruments or they can spent them abroad, without any effect for real economy and wellness of Japan.
    But what the teacher (as well as prime-minister Abe)failed to understand completely is that increasing consumption tax have immediate social effect. It dramatically changes for the worse the life of people who are just above being classified as poor. Very big portion of population in Japan falls in the category of being just above poor. If they all start sliding into poor category, we can say bye-bye to good old Japan, as poverty usually goes with crime and social unrest.
    Japan has to rely on inheritance tax. Wealthy bubble generation is going to pass away during next 2 decades. There are massive wealth and assets that can and should be taxed during the process of inheritance.

  8. Oliver, he does not explain the economy, he takes a stand on a very thorny debate. Economic policy is an extremely politicized debate, so “explaining” the economy in simple terms is always akin to taking a political stand. To take a stand on that debate requires an advanced understanding of the economy that he does not seem to have, nor seem to have credentials for.

    Saying that raising taxes is fair because all income is meant to be taxed anyway when it is eventually consumed at some point in the future is ludicrous. An analysis that does not seem, according to Philip and Masako’s explanation, to include interest rates and the benefits of holding capital and benefiting from its returns in this society (as opposed to having to consume it immediately in daily necessities) is not credible.

  9. Ct is fair to all? So that would imply marginal tax rates is unfair as the rich are being taxed more…

  10. still think the consumption tax is such a bright idea after these past 24 hours?

  11. We need more babies; make weddings tax exempt.

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