Given the current global fiscal instability, stimulating economic growth is a primary concern for most governments. In this environment, even global economic superpowers like Japan and the United States have been forced to increase national deficits, borrowing to keep their economies afloat while battling declining tax revenue. As debt-to-GDP ratios increase, interest rates follow closely, resulting in stagnated foreign investment and poor economic growth. Neither Japan nor the United States are immune to this vicious cycle.
Illustration by Phil Couzens
Japan’s current debt-to-GDP ratio is approaching 200 percent, the highest in the industrialized world, while the U.S. faces daunting Congressional Budget Office predictions that its debt-to-GDP ratio will increase from 53 percent to 90 percent over the next 10 years. Economists Kenneth Rogoff and Carmen Reinhart recently hypothesized that the critical debt-to-GDP ratio is 90 percent, at which point economies risk being destabilized and foreign investors take their money elsewhere. As discouraging as this vision is for the U.S., Japan’s deficit has already exceeded these frightening levels.
A consequence of Japan’s spiraling debt load is a continued struggle to attract foreign investors. Japan should take note of what nations like Great Britain, and even some economists in the United States, are beginning to recognize: Revenues from consumption tax will be critical to survive this recession. In Japan, former Keidanren Chairman Mitarai had called for the immediate implementation of a long-term plan to increase the consumption tax beginning in 2011 and reaching 15 percent by the mid-2020s. The significance of the Keidanren, the world’s largest and arguably most influential business lobby, calling for additional taxes that will reduce consumption should not be overlooked.
The European value-added tax (VAT) is similar to Japan’s own consumption tax and can provide guidance as the future of Japan’s consumption tax remains hotly debated. Great Britain recently announced plans to raise its VAT from 17.5 percent to 20 percent to stimulate its economy, a move the British Retail Consortium has predicted could reduce Britain’s deficit by $16.6 billion in just one year.
Economists in the U.S. have begun calling for a European-style VAT, mirroring the consumption tax in Japan. It has been suggested that even a 7 percent American VAT could raise additional revenues to equal the predicted $1 trillion deficit in 2020.
According to Paul Previtera, a Tokyo-based tax attorney, “Increasing the Japanese consumption tax will help reduce national debt, stabilize the economy, and attract foreign investment. Though this raises the price of consumer goods and therefore reduces consumption, the macroeconomic benefit could create a more promising Japanese marketplace.” Despite reduced consumption initially, the Keidanren recognizes and advocates the viability of this solution, and the Japanese government should not turn a deaf ear.
With Naoto Kan’s ascendency to the head of the Democratic Party of Japan, the likelihood of a hike in the consumption tax has become an imminent reality. While tax increases will always face opposition, Kan seems to understand that this increase is critical to stimulate the Japanese economy. On June 17th Kan reiterated his desire to reach a nonpartisan agreement and forge ahead with the consumption tax hike despite political liabilities. Kan’s aggressiveness on this issue could be the key to attracting foreign investment and in turn stabilizing and revitalizing the Japanese economy.
Dean Page is CEO of Accounting Asia. He is qualified as both an attorney and as a CPA and was formerly a partner with Ernst & Young. Dean.Page@Accounting.Asia
Adam Blair is a student at the University of Miami School of Law
