Shinzo Abe. Photo Credit: AFP/Getty Images/Ted Aljibe
This week’s second-quarter GDP figures for Japan were about the worst possible news for prime minister Shinzo Abe that a good set of figures could be. Any other Japanese prime minister of the past 20 years (and there have been 14 of them) would have greeted with joy the 2.6% annualized growth reported for April to June, a third successive quarter of expansion for an economy long becalmed. It was, though, short of private analysts’ expectations and lower than the downwardly revised 3.8% of the first quarter.
Even more awkwardly for Abe, it was a pace of growth that leaves him with a quandary over whether to go ahead with a planned increase in sales tax next April, the first of a two-step hike intended to take a bite out of Japan’s humongous deficit. The tax increase, passed by the previous government, requires the incumbent prime minister to affirm the economy is robust enough to absorb it.
Abe has signaled that he will decide by October, with the second-quarter GDP number factoring large in his decision. He will by then have the revised second-quarter number — particularly important in this case. One of the weakest parts of this week’s number was capital spending and the drawing-down of business inventories, both of which are notoriously prone to revision.
Beyond the economic question of whether Japan’s recovery is robust enough to absorb a tax hike lies a political one. The issue is dividing Abe’s ministers and advisors. The archers — the reflationists who support Abe’s “three arrows” policy plan to revitalize the economy — want a delay or a watering-down of the tax hike. The powerful bureaucrats at the finance ministry and the central bank, however, argue that tackling the country’s dire finances is too urgent to delay.
Bank of Japan Governor Haruhiko Kuroda, an Abe appointee, and Abe’s Economy Minister Akira Amari both say the tax hikes are needed and won’t hurt the economy, pointing to the broad-based strength of consumption and the small but steady improvement in labor markets. But the archers include some of Abe’s closest private advisors, such as the economist Koichi Hamada. And they want to see a 4% growth rate first.
The price of a compromise between the two camps — one that would let the sales tax increase go ahead as planned — is likely to be either targeted tax cuts to boost business investment or an across-the-board cut in corporate tax rates to 25%-30% from 38% (the second-highest rate in developed economies after the U.S.). While either would undermine the revenue-raising goal of the higher sales tax ($13.5 trillion a year when fully implemented; a 30% corporate tax rate would cost an estimated $3 trillion a year), it would let Abe present himself as both fostering economic recovery and containing Japan’s enormous public debt.
Targeted tax cuts to boost investment are favored by the finance ministry as being more efficient (for which read less expensive), but many members of Abe’s Liberal Democratic Party favor the across-the-board corporate tax cut. Memories within the party of the recession that followed tax hikes in 1997 are long. That recession in turn was followed by an election that cost the party control of the upper house of parliament — and prime minister Ryutaro Hashimoto his job.
Times are very different now. Both Abe’s political and economic bases are more secure than Hashimoto’s. We would hazard that the prime minister will decide to go ahead with the sales tax increase as planned, buying off the dissenters with a corporate tax rate cut and trusting the bureaucrats to come up with a much improved revision of second-quarter GDP growth.
