Abstract
Selected Issues
The Impact of Consumption Tax Increases and Their Policy Implications for Japan1
Japan’s VAT rate is set to increase in October 2019 to 10 percent. Given past experiences of VAT rate increases, there are concerns regarding its impact on the economy.2 Carefully designing policy measures and communicating them clearly to the public are paramount to attenuate any negative outcomes in the short term. A simple, single-rate VAT would efficiently raise tax revenues and support the government’s objective of achieving fiscal consolidation in the medium term.
A. Introduction
1. Japan is gearing up for a two-percentage point increase in its value-added tax (VAT) rate in October 2019. With the world’s highest debt-to-GDP ratio (over 200 percent), raising the standard VAT rate to 10 percent is critical to achieving the government’s objective of a primary surplus and moving toward debt sustainability. However, concerns remain that the VAT rate increase targeted for October 2019 may trigger a sharp macroeconomic contraction, given previous experiences where quarterly GDP growth declined by 0.7 percentage points and 1.8 percentage points following the 1997 and 2014 VAT increases, respectively.
2. This chapter explores Japan’s experiences with past VAT rate increases and discusses potential policy options to mitigate the economic impact of a third rate increase. It assesses the impact on the Japanese economy and, where possible, provides some international context. Alongside possible mitigating policies, it also discusses the importance of policy commitment and credibility, and how they can influence the macroeconomic impact of tax rate changes.
B. Impact of VAT Rate Increases on the Japanese Economy
3. The 2014 Japan VAT rate increase appears to have been markedly different from previous experiences. Following a decade of debate, Japan successfully introduced a broad-based consumption tax at a rate of 3 percent in April 1989 (Table 1). The rate was subsequently increased on two further occasions, in April 1997 and April 2014, by 2 and 3 percentage points, respectively. However, the impact of the VAT rate changes on the economy differed for each episode (Figure 1). Last-minute consumption and investment demand by both households and corporates was particularly strong prior to the 2014 VAT rate increase—leading to swings in consumption and (residential and nonresidential) investment growth around its implementation.
Japan: Key VAT Announcement and Implementation Dates since 1979
Japan: Key VAT Announcement and Implementation Dates since 1979
| Date | Prime Minister | Announcement | Implementation |
|---|---|---|---|
| Jan-79 | Ohira, Masayoshi | The Cabinet approved introduction of the “general consumption tax” to improve public finance. However, PM Ohira abandoned the plan during the general election in Oct-79 given severe public backlash. | |
| Feb-87 | Nakasone, Yasuhiro | The administration submitted a draft “Sales Tax” bill to the Diet, but abandoned in May-87 in the face of widespread public opposition. | |
| Dec-88 | Takeshita, Noboru | Tax bill including the consumption tax was passed, following months of intense negotiation between politicians, bureaucrats, businesses and labor unions and a 26-hour parliamentary session. | |
| Apr-89 | Takeshita, Noboru | VAT introduced at 3 percent. | |
| Feb-94 | Hosokawa, Morihiro | The administration announced a plan to abolish VAT and introduce a 7 percent national welfare tax. However, the plan was withdrawn soon after its announcement with disarray of the coalition government. | |
| Nov-94 | Murayama, Tomiichi | The Diet passed a bill to increase VAT rate from 3 percent to 5 percent in 1997, including a regional VAT of 1 percent. | |
| Apr-97 | Hashimoto, Ryutaro | VAT increased to 5 percent (+2). | |
| Sep-09 | Hatoyama, Yukio | The Democratic Party of Japan (DPJ), led by PM Hatoyama, defeated the Liberal Democratic Party (LDP) ending its uninterrupted rule since 1955. Th DPJ pledged no VAT rate increases for four years. | |
| Jun-10 | Kan, Naoto | The DPJ, led by PM Kan, announced its intention to raise the VAT to 10 percent but went on to suffer a loss in the Upper House election in Jul-10. | |
| Jun-12 | Noda, Yoshihiko | The Noda administration introduced a bill to raise the VAT rate to 8 percent in Apr-14 and to 10 percent in Oct-15, which was approved by the Upper House in Aug-12. | |
| Apr-14 | Abe, Shinzo | VAT increased to 8 percent (+3). | |
| Nov-14 | Abe, Shinzo | The administration postponed the scheduled increase in VAT rate to 10 percent by 18 months, from Oct-15 to Apr-17. | |
| Jun-16 | Abe, Shinzo | The administration postponed the scheduled increase in VAT rate to 10 percent by 30 months, from Apr-17 to Oct-19. |
Japan: Key VAT Announcement and Implementation Dates since 1979
| Date | Prime Minister | Announcement | Implementation |
|---|---|---|---|
| Jan-79 | Ohira, Masayoshi | The Cabinet approved introduction of the “general consumption tax” to improve public finance. However, PM Ohira abandoned the plan during the general election in Oct-79 given severe public backlash. | |
| Feb-87 | Nakasone, Yasuhiro | The administration submitted a draft “Sales Tax” bill to the Diet, but abandoned in May-87 in the face of widespread public opposition. | |
| Dec-88 | Takeshita, Noboru | Tax bill including the consumption tax was passed, following months of intense negotiation between politicians, bureaucrats, businesses and labor unions and a 26-hour parliamentary session. | |
| Apr-89 | Takeshita, Noboru | VAT introduced at 3 percent. | |
| Feb-94 | Hosokawa, Morihiro | The administration announced a plan to abolish VAT and introduce a 7 percent national welfare tax. However, the plan was withdrawn soon after its announcement with disarray of the coalition government. | |
| Nov-94 | Murayama, Tomiichi | The Diet passed a bill to increase VAT rate from 3 percent to 5 percent in 1997, including a regional VAT of 1 percent. | |
| Apr-97 | Hashimoto, Ryutaro | VAT increased to 5 percent (+2). | |
| Sep-09 | Hatoyama, Yukio | The Democratic Party of Japan (DPJ), led by PM Hatoyama, defeated the Liberal Democratic Party (LDP) ending its uninterrupted rule since 1955. Th DPJ pledged no VAT rate increases for four years. | |
| Jun-10 | Kan, Naoto | The DPJ, led by PM Kan, announced its intention to raise the VAT to 10 percent but went on to suffer a loss in the Upper House election in Jul-10. | |
| Jun-12 | Noda, Yoshihiko | The Noda administration introduced a bill to raise the VAT rate to 8 percent in Apr-14 and to 10 percent in Oct-15, which was approved by the Upper House in Aug-12. | |
| Apr-14 | Abe, Shinzo | VAT increased to 8 percent (+3). | |
| Nov-14 | Abe, Shinzo | The administration postponed the scheduled increase in VAT rate to 10 percent by 18 months, from Oct-15 to Apr-17. | |
| Jun-16 | Abe, Shinzo | The administration postponed the scheduled increase in VAT rate to 10 percent by 30 months, from Apr-17 to Oct-19. |
Episodes of VAT Rate Increases in Japan: Real GDP and Household Consumption
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Episodes of VAT Rate Increases in Japan: Real GDP and Household Consumption
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Episodes of VAT Rate Increases in Japan: Real GDP and Household Consumption
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
4. A record decline in household consumption in the second quarter of 2014 led to a sharp macroeconomic contraction. This was driven by a large downturn in durable and nondurable household consumption, which was far more pronounced than during the global financial crisis and previous VAT rate increases (Figure 1). Empirical evidence suggests that, in addition to the direct impact of the three-percentage point increase in April 2014, the negative reaction by households was exacerbated by anticipation of an additional two-percentage point increase in the VAT rate scheduled for 18 months later (Cashin and Unayama, 2016). That is, households potentially made “excessive” advance purchases of durables and storable non-durables prior to April 2014 in anticipation of a total five-percentage point increase in the VAT rate.3
5. VAT passthrough was larger in 2014 than in previous episodes, reducing real disposable incomes and exacerbating the economic downturn. Many retailers and wholesalers passed the VAT rate increase fully into prices of their goods and services in 2014. About 60 percent of the respondents to a survey of over 3,000 small- and medium-sized enterprises reported that they had fully passed the VAT rate increase through to their customers by May 2014, whereas about 30 percent had “only partially” done so (see Japan Chamber of Commerce and Industry, 2014). This was up from 40 and 22 percent, respectively, following the VAT rate increase in 1997. A higher fraction of wholesalers (75 percent), compared to retailers (56 percent), indicated the tax had been passed through fully. As a result, year-over-year monthly CPI inflation jumped in April 2014 to 3½ percent, compared to an average of 1 percent for the previous 12 months. At the same time, real wages also declined significantly in 2014.
6. Within durables consumption, automobile purchases reacted most sharply to the 2014 VAT rate increase. Extracts from the Japanese Family Income and Expenditure Survey show how last-minute demand for automobiles and furniture boosted durable consumption in the month before the 2014 rate increase (Figure 2). This is consistent with survey findings by the Japan Automobile Manufacturers Association (2014), which indicate that households made several advance purchases prior to the rate increase. Although seasonality can partly explain fluctuations in automobile purchases, the annual fluctuation in the purchases at the 2014 tax increase was substantial. Underlying demographic change also drove demand. In particular, the share of licensed female drivers aged 50 years and above increased by over 20 percentage points during 2001–15. Demand for more fuel-efficient cars (including small cars) also increased as consumers looked to save on fuel expenditure both in the short and medium term. In the months following the 2014 rate increase, average monthly expenditure on transportation, communications, furniture, and home utensils contracted by more than one half. Overall demand for durables was slow to recover, and the contractionary impact lingered largely due to the long replacement cycle (Higashi and Kawata,2017).
Japan: VAT Impact on Durables Consumption in 2014
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Japan: VAT Impact on Durables Consumption in 2014
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Japan: VAT Impact on Durables Consumption in 2014
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
7. Firms’ investment decisions also helped amplify demand behavior in 2014. Investment demand—including purchases of machinery and equipment—increased at an annualized rate of 26 percent in the first quarter of 2014 vis-à-vis the previous quarter.4 This was followed by a 22 percent decline in the subsequent quarter, and declines in housing demand also contributed (Figure 3).5 This amplitude was the largest since the government started collecting such data on a consistent basis in 1994, and was partly driven by the VAT rate increase. The boom-bust pattern clearly added to fluctuations in overall fixed investment, and to a lesser extent in the overall economy. As with consumption, the behavior of fixed investment in 2014 differs from past episodes.
Japan: Episodes of VAT Rate Increases—Investment Growth and Housing Starts
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Japan: Episodes of VAT Rate Increases—Investment Growth and Housing Starts
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Japan: Episodes of VAT Rate Increases—Investment Growth and Housing Starts
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
8. Residential investment was also affected in 2014, but less so than in 1997. The average age of Japanese who purchase their first home has declined from 48 years in 2008 to 43 years in 2017 (MLIT, 2018). At the same time, the rate of home ownership among 20- and 30-year-olds has been gradually declining. An increasing number of young individuals move into metropolitan areas where house prices tend to be very high. At the same time, this cohort relies more on non-regular employment for a larger share of their income, at the cost of good wage dynamics over their working lives. These factors may explain the diminished impact of VAT rate increases on home purchases in the 2014 episode. In contrast, a financial crisis triggered by the failure of Hokkaido Takushoku Bank and Yamaichi Securities had a strong impact on the housing market in 1997 (Figure 3).
C. Japan: Policy Changes and Uncertainty
9. The prolonged uncertainty and lack of time to prepare for the rate increase may have amplified its macroeconomic impact in 2014. It was during the Noda administration (between 2011 and 2012) that the law to implement the 2014 and 2015 VAT rate increases was passed, as part of the Comprehensive Review of Social Security and Tax.6 However, following his election in December 2012, Prime Minister Abe could not commit to these policies for 10 months since the government had to carefully assess economic conditions before implementing the law. The Cabinet announcement supporting the VAT rate increase was finally made in October 2013, at which point the public had only six months until implementation.
10. This atmosphere of uncertainty may arise again for the 2019 VAT rate increase—with the two earlier delays having a potentially negative impact on the credibility of policy implementation. Survey data suggests that spikes in fiscal policy uncertainty and dips in consumer confidence have coincided with VAT developments—most notably announcements (Figure 4). At the same time the sensitivity of household consumption and consumer confidence have also tracked VAT announcements before and after the 2014 VAT implementation (Figure 5). The initial delay (in late 2014) of the slated October 2015 rate increase to 2017, and the second postponement announced in 2016 pushing the VAT rate increase to 2019, have potentially undermined the credibility of future VAT increases. Following his win in the September 2018 LDP leadership election, at the Cabinet meeting of October 15, 2018, Prime Minister Abe confirmed that the VAT rate hike would proceed in October 2019. However, there remains the risk that uncertainty about actual implementation may rise during the period between announcement and implementation. This could imply that the timing of any reaction in consumption could once again be delayed even closer to the date of implementation.
Japan: Fiscal Policy Uncertainty and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+ = better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.Japan: Fiscal Policy Uncertainty and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+ = better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.Japan: Fiscal Policy Uncertainty and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+ = better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.
Japan: Real Expenditure, Disposable Income, and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+=better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.Japan: Real Expenditure, Disposable Income, and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+=better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.Japan: Real Expenditure, Disposable Income, and Consumer Confidence
(LHS: Index: April 2014=100; RHS: 50+=better)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: Arbatli et al. (2017) and IMF staff calculations.11. Uncertainty about the impact is also compounded by the different accompanying policies the government is now considering. Prior to the 1997 increase, labeling of prices inclusive or exclusive of VAT was not enforced. Anecdotal evidence indicates that retailers raised their prices above and beyond the two-percentage point VAT rate increase. To induce households to purchase goods, they labeled a discounted price inclusive of the correct VAT rate. In other instances, retailers—at their own discretion—applied lower VAT rates to their goods, forcing wholesalers to accept smaller profit margins. Given these 1997 experiences, temporary VAT rate reduction sales were banned prior to the 2014 VAT rate increase, given concerns over tax shifting. The 2018 Basic Policy on Economic and Fiscal Management and Reform aims to prevent such tax shifting again, thereby allowing business owners to freely set prices at their own discretion while monitoring the underlying demand conditions. However, wholesale SMEs face concerns of lost profit margins as a result. Implementation of the measure needs to be crystalized and clearly communicated ahead of the October 2019 deadline.7
12. Few mitigating measures were introduced to moderate the impact of the VAT rate increase in 2014. While it is possible that the behavior of consumption around the April 2014 VAT rate increase was exacerbated by the anticipation of the second VAT rate increase in October 2015, the government also did not introduce specific measures to attenuate it. Furthermore, the integrated reform of both social security and tax may have exacerbated the impact of the VAT rate increase in 2014. Ahead of the October 2019 VAT rate increase, the Japanese government will need to clearly communicate not only the details of the VAT increase to both consumers and businesses, but also all associated policies, including both the December 2017 policy package for childcare and education, and additional mitigating measures. This is essential to prevent confusion, reduce uncertainty, and dampen any (over)reactions in household consumption.
D. Cross-country Evidence on VAT Rate Increases
13. Japan’s past stepwise VAT rate increases are not unusual when compared with other advanced economies, but its consumption response was unusual. The average increase in the standard VAT rate across OECD advanced economies is just under three percent, and on average real household consumption growth fell by 0.6 of percentage points at implementation (Figure 6, panels 1 and 2).8 However, Japan’s fall in consumption growth averaged 4.4 percentage points across all three episodes—the 2014 episode alone saw real consumption growth fall by 5.8 percentage points. While on average real consumption growth gradually recovers for OECD advanced economies, real consumption growth in Japan not only turned negative after the 1997 and 2014 increases but remained so for the subsequent three quarters.
Japan vs. OECD Advanced Economies: VAT Event Studies
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: National Sources; OECD Tax Database (Table 2.A2.1); IMF, Fiscal Affairs Department Rates Database, and IMF staff calculations.Notes: Time t=0 is the implementation date of the VAT increase.Japan vs. OECD Advanced Economies: VAT Event Studies
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: National Sources; OECD Tax Database (Table 2.A2.1); IMF, Fiscal Affairs Department Rates Database, and IMF staff calculations.Notes: Time t=0 is the implementation date of the VAT increase.Japan vs. OECD Advanced Economies: VAT Event Studies
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Sources: National Sources; OECD Tax Database (Table 2.A2.1); IMF, Fiscal Affairs Department Rates Database, and IMF staff calculations.Notes: Time t=0 is the implementation date of the VAT increase.14. Japan’s outsize effect of past consumption tax increases is also related to its relatively large impact on the housing market, compared with other sectors of the economy. In 1997, the consumption tax increase was blamed for a long-term slump in home sales, and the corresponding wealth effects are believed to have triggered a recession. In 1989, real house prices continued to increase, uninterrupted by the VAT introduction. In 2014, real house prices once again reacted differently (Figure 6, panels 3 and 4). There was a sharp correction in both the level and growth of real house prices before they eventually recovered. If housing market conditions in Japan are similar now to those in 2014, it is possible that there could be a similar correction—with associated macroeconomic implications. Real house prices in other advanced economies have (on average) displayed much more muted responses—though this could be influenced by differences in the tax treatment of housing.9
15. VAT rate increases in advanced economies are associated with a fall in consumption at their point of implementation, but typically by more than rate cuts increase consumption. Many factors can determine the impact of VAT rate increases on consumption.10 To better gauge magnitudes, available macroeconomic data is used to estimate the response of household consumption to increases in the standard VAT rate using local projection methods.11 Figure 7 plots the response of real household consumption to: (i) a VAT rate “shock”, using a dummy variable to capture rate changes; and (ii) a one percentage point change in the VAT rate.12 What we find is that the response of household consumption to increases and decreases in VAT rates is asymmetric. On average, across advanced economies, real household consumption falls on impact—by almost one percentage point—following an increase in the VAT rate before slowly recovering. By contrast, the response of consumption to a rate decrease, while positive, is not statistically different from zero (Figure 7, panels 1 and 2).
Response of Household Consumption to Changes in the Standard VAT Rate Across OECD Advanced Economies
(Percent; quarters on x-axis)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Source: IMF staff calculations.Response of Household Consumption to Changes in the Standard VAT Rate Across OECD Advanced Economies
(Percent; quarters on x-axis)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Source: IMF staff calculations.Response of Household Consumption to Changes in the Standard VAT Rate Across OECD Advanced Economies
(Percent; quarters on x-axis)
Citation: IMF Staff Country Reports 2018, 334; 10.5089/9781484386804.002.A001
Source: IMF staff calculations.16. Advanced economies have, on average, experienced only small changes in consumption following changes in VAT rates. In terms of magnitudes, our sample of advanced economies (including Japan) on average see real household consumption fall by almost 0.25 of a percentage point following a one percentage point increase in the VAT rate (Figure 7, panel 3). Again, while the effect appears persistent in the years following the VAT rate change, the response is not statistically significant. We also look at the consumption response for those episodes where VAT rate changes took place outside of a recession (Figure 7, panel 3): in this case, the effect on real household consumption is not only negligible but also not statistically different from zero. While the impact of a one percentage point increase in the standard VAT rate (in a non-recession period) is still negative, it tends not to persist as long.
17. In many countries, VAT rate changes have typically not been introduced in isolation— they have formed part of larger fiscal and monetary policy packages. However, it is difficult to identify countries in which tax and spending policies have been specifically used to offset the impact of VAT rate increases on incomes and consumption. Newhouse and Zakharova (2007) explored the impact of specific fiscal measures when the Philippines increased its VAT rate from 10 to 12 percent and broadened the base between November 2005 and February 2006. Measures chosen to alleviate the impact on the poor included reductions in fuel excises and tariffs, and the earmarking of a share of the additional VAT revenues to increased education and health spending. Although these spending measures offset the household income reductions from the VAT rate increase for about 25 percent of all households, the authors found that high-income households also benefit substantially given their larger consumption shares of goods that saw tax rates reduced. As an alternative, targeted transfer schemes instead have the potential to deliver a much higher percentage of benefits to the poor.
18. Many countries have opted to offset the negative impact of VATs on poorer households by introducing reduced rates for necessity goods. Japan has also opted to take this route.13 However, the two-percentage point differential between the standard and reduced rate is less likely to help poorer households, given that existing price dispersion across the same goods is likely to be larger. Reducing rates on essential items hampers the efficiency of the VAT, increases compliance and administrative costs, and undermines the primary revenue-raising function of the VAT (Ebrill et al., 2001).
E. Conclusion and Policy Implications
19. Assuming underlying macroeconomic conditions are favorable, the October 2019 VAT rate increase could potentially have a smaller impact on the economy relative to that of 2014 for a number of reasons. Firstly, the VAT rate increase is 1 percentage point less than in 2014, while the VAT rate for food and beverages will remain at 8 percent. According to household surveys, expenditure on these latter items accounts for about one quarter of total expenditure. Therefore, it is possible that the impact on the economy and pass-through to inflation will be lower than in previous episodes.14 Secondly, replacement demand for longer-lived durable goods—which reacted strongly in 2014—could be marginal, given that many households purchased them prior to the 2014 episode of the VAT rate increase.
20. To reduce policy uncertainty and alleviate any adverse impacts from the 2019 VAT rate increase, the authorities should clearly communicate the timing and content of associated mitigating measures. To finance growing aging costs, this will require a gradual and credible increase in the consumption tax rate beyond 10 percent, to help dampen long-term stability risks and open more fiscal space as part of a credible medium-term fiscal framework. From an efficiency perspective, there should be a single VAT standard rate of 10 percent, rather than the proposed reduced rate for food and beverages. As discussed, equity concerns over VAT rate increases would instead be better addressed through mitigating measures, including through expenditure policy that uses targeted transfers.
21. Given concerns over durables consumption and investment, the government should carefully design mitigating measures to attenuate the impact of the VAT rate increase. For example, abolishing the automobile acquisition tax will help partly offset the VAT rate increase, likely moderating the impact on an important component of durables consumption.15 The authorities could also consider a time-bound and well-targeted tax rebate or transfers program, which would be more effective at reducing the burden of the VAT increase on households at the lower end of the income distribution. Implementing such a program could be appropriately timed to be most cost effective for the policy’s objectives.
22. Bearing in the mind the impact of the increase in the consumption tax rate on the housing market in 2014, the government could also consider measures to insulate housing from the pending rate increase. While the government should continue to apply VAT on only new home sales, the transactions-based real estate acquisition tax could be abolished with any lost revenue made up using higher recurrent (and less distortionary) property taxes. Such a measure will help assuage volatility in the housing market.
References
Arbatli, E. C., S.J. Davis, A. Ito, N. Miake, and I. Saito, 2017, “Policy Uncertainty in Japan,” NBER Working Paper No. 23411.
Bank of Japan, 2013, “Outlook for Economic Activity and Prices,” Secretariat of the Policy Board, Bank of Japan: Tokyo.
Bank of Japan, 2018, “Outlook for Economic Activity and Prices,” Secretariat of the Policy Board, Bank of Japan: Tokyo.
Cashin, D. and T. Unayama, 2016, “The Impact of a Permanent Income Shock on Consumption: Evidence from Japan’s 2014 VAT Increase,” RIETI Discussion Paper Series No. 16-E-052.
Ebrill, L., M. Keen, J.-P. Bodin, and V. Summers, 2001. The Modern VAT. Washington, D.C.: International Monetary Fund.
Higashi, M. and H. Kawata, 2017, “Recent Developments in Durable Goods Consumption: A Perspective from Spectrum Analysis,” Research and Statistics Department, Bank of Japan.
Ishi, H., 1992, “Japan’s VAT and its Aftermath.” Hitotsubashi Journal of Economics, Vol. 33, pp. 19–48.
Japan Automobile Manufacturers Association, 2014, “Passenger Cars: 2013 Survey of Market Development.”
Japan Automobile Manufacturers Association, 2018, “Passenger Cars: 2017 Survey of Market Development,” Japan Automobile Manufacturers Association.
Japan Chamber of Commerce and Industry, 2014, “1st Survey of the Pass Through of the Consumption Tax among SMEs.”
Keen, M., M. Pradhan, K. Kang, and R. de Mooij, 2011, “Raising the Consumption Tax in Japan: Why, When, How?” IMF Staff Discussion Note No. 11/13.
MLIT, 2018, “Survey of Housing Market Developments,” Ministry of Land, Infrastructure, Transport, and Tourism: Tokyo.
Newhouse, D. and D. Zakharova, 2007, “Distributional Implications of the VAT Reform in the Philippines,” IMF Working Paper No. 07/153.
Prepared by Aqib Aslam (FAD) and Kenichiro Kashiwase (OAP).
The VAT is more commonly referred to as the consumption tax (shōhizei) in Japan. The increase in its rate from 8 to 10 percent has been postponed twice. The increase was initially planned for October 2015, but was postponed to April 2017 in November 2014. In May 2016, Prime Minister Abe again postponed the increase to October 2019, due to concerns over prevailing macroeconomic conditions. On October 15, 2018, Prime Minister Abe announced that the consumption tax rate increase will proceed in October 2019.
Cashin and Unayama (2016) find evidence that the total consumption response between announcement and implementation of the April 2014 rate increase was approximately 5 percent—4 percent at announcement and 1 percent at implementation. Consumers expected to bear the full burden of the VAT rate increases in the form of higher prices, as in previous instances. Therefore, the income shock was roughly proportional to the expected cumulative tax rate increase of five percentage points (in 2014 and 2015), and consumption fell one-to-one with the income shock.
For example, business owners had invested in new operating systems in anticipation of the ending of the support for Windows XP in April 2014.
To take advantage of the low tax rate, the delivery of houses needed to be made before the VAT rate increase in April 2014. Hence, housing demand picked up over several months before the rate increase.
See, for example, promotional material produced by the Ministry of Finance: https://www.mof.go.jp/english/taxpolicy/publication/tax005/E 1822.pdf.
Prices inclusive and exclusive of VAT rate also need to be labeled clearly on purchases of food and beverages, to prevent any price confusion such as that which occurred in 1997.
Using a combination of IMF data, national sources, and OECD data on VAT rates, the averages are calculated across 91 episodes in which there was an increase in the standard VAT rate. The average fall in real consumption growth across OECD advanced economies rises to just over 0.8 percentage points for a subset of 35 episodes in which the standard VAT rate increases by 2 percentage points or more.
For example, new housing is VAT-exempt in Germany, which is contrary to best practice.
Typically, tax rate increases operate via two mechanisms: first, they decrease spending power, making households feel as if they have less income; second, they change the relative prices of goods. In the absence of microdata, the relative strength of these income and substitution effects are difficult to ascertain—see Cashin and Unayama (2016).
The empirical approach consists of regressing contemporaneous and future consumption growth on changes in VAT rates to estimate an impulse response function at various horizons, controlling for country fixed effects, time (quarter) fixed effects, lags and forwards of VAT shocks, and lagged consumption growth. Additional specifications also control for other factors such as changes in personal and corporate income tax rates, and real house prices.
These responses are at the point of implementation of the VAT rate increase. The response of consumption at the point of announcement was not estimated given the lack of information on the announcement dates for the majority of the VAT rate changes catalogued.
Following the October 2019 VAT rate increase to 10 percent, the reduced tax rate of 8 percent (inclusive of local consumption tax rate of 1.76 percent) will be applied to sales of food and beverages (excluding alcoholic drinks and dining out), and sales of newspapers published more than twice a week (under subscription contracts). See Ministry of Finance: https://www.mof.go.jp/english/tax policy/taxsystem/consumption/053.pdf.
The Outlook for Economic Activity and Prices by the Bank of Japan, published in April 2018, estimates a gradual effect of the October 2019 VAT rate increase on CPI inflation: an additional 1.0 percentage point for October 2019 onward.
The automobile acquisition tax is a transaction tax as it was initially introduced in 1968. Its effective tax rate ranges from 0 to 3 percent, depending on the level of emissions of the purchased vehicles. A zero percent is applied to certain types of environmentally-friendly and fuel-efficient automobiles. The environmental aims of this tax will continue to be met by replacing this automobile acquisition tax with an environmental excise in 2019.
