Zero consumption tax on food emerges as a key issue in Japan’s Lower House election, but market concern suggests hasty tax cuts should be avoided

■ Food consumption tax cuts a key issue
On January 23rd, Japan’s House of Representatives dissolved. Ahead of the general election, both the ruling and opposition parties are discussing the possibility of reducing the consumption tax on food products as part of their economic policies. The ruling parties, the Liberal Democratic Party and the Japan Innovation Party, have announced that they will accelerate discussions around cutting the consumption tax on food and beverages to zero for two years. Meanwhile the Centrist Reform Alliance, an opposition party, has proposed setting the rate of consumption tax on food products to zero permanently. They intend to fund this with returns from government-affiliated funds. Some other opposition parties have even pledged to abolish Japan’s consumption tax entirely. Food products are essential goods, and it is understandable that there are strong calls for tax cuts. However, I believe that hasty tax cuts should be avoided for the following reasons.

■ Consumption tax cuts risk further stoking inflation
Japan is currently facing a serious labor shortage and inflationary pressure. In this environment, excessive tax cuts may overheat the economy and further accelerate inflation. In other words, a consumption tax cut intended to address rising prices may instead exacerbate inflation. Attention must be paid to this risk. Further, while the ruling parties’ proposed temporary tax cut would stimulate consumption when implemented, consumer spending would drop back down once the reduction ends and tax rates return to normal. While the opposition has proposed a permanent tax cut funded by government-affiliated funds, there is no guarantee that the funds will consistently generate the required revenue of approximately five trillion yen each year. Should revenues fall short, there would be no choice but to rely on issuing deficit-financing government bonds, which would further strain public finances. Even more concerning is that long-term interest rates are currently rising rapidly while the yen is depreciating. This reflects market concerns that neither the ruling nor opposition parties are serious about fiscal consolidation. Should the yen fall substantially, imported inflation may outweigh the benefits of consumption tax cuts for households, worsening the hardship faced by consumers. Moreover, an increase in interest rates would both raise the government's debt-servicing costs, which would worsen the country’s fiscal health, and make mortgage repayments more difficult for households. It must be said that the risks posed by inflation and rising interest rates outweigh the benefits of a consumption tax cut for the public.

■ Fiscal debates should be calm, not election-driven
As the risk of a yen depreciation/ rising long-term interest rate spiral becomes increasingly difficult to ignore, fiscal consolidation is an urgent issue for Japan. Rather than engaging in popularity-seeking for electoral reasons, one would hope that both the ruling and opposition parties would engage in a sober debate based on an objective assessment of the fiscal situation. Given consumption tax cuts would also disproportionately benefit higher-income households with more financial leeway, I believe that the introduction of a refundable tax credit should be prioritized over tax cuts. Debates during the current election campaign and subsequent Diet sessions should not focus on competing over handouts, but rather on serious policy discussions that bear fiscal sustainability in mind.

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