On 20 June 2016 the IMF issued a concluding report following the conclusion of discussions with Japan under Article IV of the IMF’s articles of agreement.
Japan’s economy is expected to grow at around 0.5% in 2016 but slow to 0.3% in 2017. The weak global recovery, higher uncertainty and currency appreciation are expected to hold back net exports and investment. The IMF considers that Japan must commit to fiscal consolidation in the medium term and replace the large discretionary consumption tax rate increases with a series of smaller but sustained consumption tax increases over a longer period.
The first consumption tax increase achieved fiscal savings, and at that time the economy reached full employment and modest increases in base wages. However the consumption tax hike led to a contractionary fiscal stance in 2014 and the stop-go fiscal policy with annual supplementary budgets and discretionary changes in consumption tax rises have contributed to policy uncertainty.
The government’s decision to adopt further stimulus packages and to postpone the 2017 consumption tax rise by two and a half years shows that it is difficult to both stimulate the economy and move to fiscal sustainability in a short period of time. The IMF therefore considers that the government should chart a fiscal consolidation course with a pre-announced series of consumption tax increases. This would address the problems of fiscal sustainability and policy uncertainty.
A gradual increase in the consumption tax rate towards 15%, in steps of 0.5% or 1% per year at regular intervals, would achieve a balance between supporting growth and achieving fiscal sustainability in the long term. The government should also consider the administrative burden for the tax authorities and compliance costs for firms. The gradual consumption tax rate increases could begin soon and replace the planned hike in 2019, reducing uncertainty for consumers and avoiding shifts in spending at the time of the tax increases. Japan should retain the single tax rate and any concerns about the impact on households could be addressed by targeted cash transfers.
Investment
Uncertainty and low confidence in future economic prospects due to the ageing and shrinking population is holding back investment. In an attempt to deal with this issue the government has cut the statutory corporate income tax rate below 30% in the fiscal year 2016. So far no positive impact on investment has been observed.
Labor market
The government has been calling for higher wage increases and has announced a 3% floor on annual minimum wage increases. Government policy strategy also includes provision of childcare to improve labor force participation; and a social security system that allows people to continue working while providing care to family members.
The IMF considers that Japan should eliminate disincentives to full time work that may arise due to the tax and social security system. This may involve looking at the spousal deduction and spouse allowance.
