Japan proceeds with sales tax hike to fix tattered finances

Japan rolled out a twice-delayed increase in the sales tax to 10% from 8% on Tuesday, a move that is seen as critical for fixing the country’s tattered finances but that could tip the economy into recession by dampening consumer sentiment.

The government has already applied measures to mitigate the pain on consumption, mindful of avoiding the effects of the last increase, in 2014, which led to a severe economic downturn.

Television broadcasters showed images of crowds buying items such as wine, cosmetics and jewellery before the increase hit.

“I was a bit worried whether I can buy this at 8% tax rate, but now I’m relieved that I made it,” a 45-year-old woman told public broadcaster NHK after buying a 70,000-yen ($647) bed at a department store in Tokyo.

When the government raised the tax to 8% from 5% in April 2014, a last-minute buying spree and a subsequent pullback in demand caused a big downward swing in consumer spending.

The bitter memory led Prime Minister Shinzo Abe to twice delay the increase to 10% until Oct.1. But the higher tax rate will still hit an economy suffering from slowing global demand and bitter trade tensions.

Abe said the tax hike would help pay for social security services in an ageing society, such as making preschool education free, lowering nursing care insurance premiums, and providing payouts to the elderly with low pension benefits.

“This will be a step to proceed with an insurance system for all generations, under which children and the elderly can feel at ease,” Abe told reporters on Tuesday. “As for impacts from the tax hike, we’ll take all possible steps.”

The government and central bank policymakers expect the impact from the 2%-point tax hike to be much smaller than that of the previous increase.

To ease the pain on low-income households, some food and non-alcoholic beverages will be exempt from the higher tax rate.

The government has also set aside 2 trillion yen for discounts and shopping vouchers as well as public works spending. Another 300 billion yen will be spent on tax breaks for housing and car purchases. But that may not be enough to boost consumption.

“The reduced tax rate and reward points system may limit the pain to shoppers,” said Koya Miyamae, a senior economist at SMBC Nikko Securities. “Still, consumer sentiment tends to deteriorate before and after a tax hike, which will in turn dampen economic activity.”

Reuters