Japan's 2-year food tax cut risks becoming political football

Tax Cut Risks Becoming Political Football

Japan's Prime Minister Sanae Takaichi has decided to cut the consumption tax on food and beverages for two years starting next April. The move aims to help households cope with inflation, but experts are skeptical about the government's ability to restore the tax rate to 8 percent after two years.

The cabinet on Wednesday approved cutting the consumption tax on food and beverages to 1 percent from the current 8 percent to help households cope with inflation, following the ruling parties' campaign pledge in the House of Representatives election they won decisively. Despite Takaichi's pledge to restore the tax rate to 8 percent after two years, political science experts are skeptical, noting that such a move would effectively amount to a 7-percentage-point tax hike and that history shows prime ministers can lose their jobs over unpopular tax increases.

The envisaged tax reduction until the spring of 2029 is due to end when elections loom for both parliamentary houses, making political calculations by the prime minister at the time even more difficult, experts said. "It is unclear whether the government could undo the rate as planned," said Masaki Taniguchi, dean and professor at the University of Tokyo's Graduate Schools of Public Policy, noting that the tax reduction ends before the approaching end in February 2030 of the current four-year terms for lower house members.

If the tax cut continues without alternative funding sources, it could do more harm than good to the heavily indebted nation by pushing up long-term interest rates, weakening the yen and fueling inflation. The ruling Liberal Democratic Party and the Japan Innovation Party, along with major opposition parties, pledged during the February general election campaign to reduce the tax rate, a convergence Taniguchi said may have been intended to prevent the issue from becoming a major campaign battleground.

Despite that, Takaichi faced an uphill battle before deciding to go ahead with the tax cut, as cross-party talks aimed at paving the way for the first reduction since the levy was introduced in 1989 failed to produce an agreement. Takaichi, regarded as a fiscal dove who had advocated cutting the consumption tax, temporarily backed away from that position during the LDP presidential race last October, saying such a measure would not "immediately work" to curb inflation.

Under an LDP-JIP coalition agreement, the bloc initially sought to cut the tax rate to zero before shifting to the current 1 percent plan because reducing it to 1 percent would require less time to modify retailers' cash register systems. The government plans cash handouts worth roughly 600 billion yen ($3.8 billion), equivalent to the revenue from the remaining 1 percentage point of the consumption tax that it decided not to cut.

At a press briefing Thursday announcing the consumption tax cut, Takaichi stressed it is a "transitional" measure until the government introduces a refundable tax credit system for mainly low- and middle-income workers in April 2029. She said she would "take full responsibility" for restoring the tax rate to its original level after two years, while seeking to reassure financial markets concerned about her fiscal stance by pledging not to rely on deficit-covering bonds to finance the measure.

The announcement came as approval ratings for Takaichi's cabinet began to slip in media polls following a Diet stalemate between the ruling and opposition blocs and the passage of controversial bills last month. During the planned tax-cut period, a House of Councillors election is also scheduled for the summer of 2028, when half the seats in the less powerful chamber will be contested.

Hitoshi Komiya, a professor at Aoyama Gakuin University, said past administrations had fallen after raising the consumption tax and that Takaichi must be "well aware of how politically difficult" restoring the tax rate could be. The introduction of Japan's 3 percent consumption tax in 1989 and its increase to 5 percent in 1997 contributed to the resignations of LDP Prime Ministers Noboru Takeshita and Ryutaro Hashimoto, respectively.

In the December 2012 lower house election, Prime Minister Yoshihiko Noda's then ruling Democratic Party of Japan suffered a crushing defeat and lost power after parliament enacted legislation to raise the consumption tax to 8 percent from April 2014. In November 2014, then Prime Minister Shinzo Abe, Takaichi's political mentor, dissolved the lower house to seek voter support for postponing by 18 months a scheduled increase in the consumption tax on nonfood items to 10 percent from October 2015.

Regarding the latest tax-cut plan, Komiya, a political history expert, said the prime minister might follow the "precedent" set by Abe by dissolving the lower house and calling a snap election to seek a public mandate to extend the tax reduction before it expires. Japan has gradually raised the consumption tax to help finance ballooning social security costs. However, there has been little discussion of alternative revenue sources to offset the latest tax cut.

Komiya warned that if the tax cut remains in place longer than planned, further erosion of confidence in Japan's fiscal health, the weakest among the Group of Seven economies, could push up government bond yields and keep the yen under pressure. "In the end, the pledge to cut the consumption tax was successful as an election strategy," Komiya said. "But the bill for that success will eventually come due."