Japan: Tax Hikes are No Fun

Japan: Tax Hikes are No Fun

May 18, 2008


OK, I’m still trying to get my head around what’s going on in Japan these days. This is my first-pass attempt. I’m not sure why this is so difficult. Sometimes it takes weeks to chew through things, which might finally be summarized in six or seven sentences. (But the right six or seven sentences.)

Junichiro Koizumi was always an unusual character, openly at odds with some of the biggest bureaucracies in the country. The fact that he became prime minister at all was very odd, as he is sort of a Ron Paul character. The fact that he was one of the most popular and long-lasting prime ministers of the last twenty years was even more unusual. The fact that he actually succeeded, as much as anybody could, at driving a stake through the heart of the postal savings system/public works machine, was extraordinary. The fact that he did it all with a silly movie-star haircut was unprecedented.

However, Koizumi was never an economics guy. The postal savings system (in essence a mammoth bank which invested in debt of public “authorities”) was never the cause of Japan’s economic difficulties, and reforming it (through privatization among other things) was never an economic solution. Indeed, Koizumi liked to have a bit of economic distress, which he could use as a lever for his “reforms” of bureaucracies. He tended to be a do-nothing on the economics side, unwilling to cut taxes (although his economics minister Heizo Takenaka had some modest supply-side leanings), and unwilling to raise them. On balance, this made him more popular than virtually all the other politicians, who talked about future tax hikes constantly.

Japan became successful with a two-party system that combined both the growth aspects and a focus on social, environmental or welfare concerns. The Liberal Democratic Party was the growth party. From 1950 to 1974, they cut taxes every single year, and the economy boomed. This resulted in enormous increases in tax revenues, which they disbursed to their political cronies via public works spending. In the 1950s and 1960s, there was enormous real need or benefit from public works spending. Besides all that had been destroyed in the war, the country built a fantastic train system. Road construction was always very difficult and expensive, due to the mountainous terrain.

By the end of the 1960s, this basic infrastructure was largely in place. Most politicians are just feeders at the trough of government largesse. They assumed that they got votes because they delivered cash. That was never really the case; they got votes because the LDP had been so enormously successful at running the country, via their extraordinary policy of continuous tax reduction.

Since the LDP pretty much had the growth and tax-cut angle wrapped up, the opposition parties focused almost entirely on welfare or environment-related issues. This was also important, and the threat of political loss was always just enough that the growth-focused LDP was willing to include these welfare and environment-related issues into their plans.

This happy combination changed at the end of the 1980s, when the LDP began a broad tax-hiking campain. Most of it was aimed at asset-related taxes, specifically a taxes on property, but there was also the introduction of the consumption tax at 3% in 1989. This was fantastically, enormously unpopular. The consumption tax has long been the “third rail” of Japanese politics. Politicians who grasp it are quickly broomed from public office. For reasons I never really understood, the Ministry of Finance has been pressing for a double-digit consumption tax since 1974. Japan used to have a consumption tax, in the 1940s. The economy was moribund. When the tax was eliminated in 1950, and other taxes lowered, the great post-war economic boom launched. You would think this would be rather good evidence that Japan didn’t need a consumption tax? Well, the MOF guys didn’t get where they are today by being smart.

MOF is able to twist the arms of politicians in many ways, mostly via their role in distributing the public works largess to various regions and localities. Prime Minister Masayoshi Ohira was the first to suggest a consumption tax in 1979. He went down in flames.

Prime minister Yasuhiro Nakasone tried to suggest a consumption tax in 1987. This led to a demonstration in Tokyo of 160,000 citizens in opposition to the plan. He backed down. You would think politicians would get the messsage, but they really are rather stupid. The next was Noboru Takeshita, in 1989. Takeshita was the prince, the ringleader, the example-setter, of that portion of the LDP which really saw its political base resting upon their ability to deliver government contracts. He owned a rural construction company. Thus, perhaps he was also most susceptible to MOF’s not-so-gentle hints that if he pushed through a consumption tax, his voting district just might coincidentally be showered with a bucket of money. In 1988, the government ran a surplus on the order of 2.1% of GDP. Takeshita’s threats to impose a consumption tax resulted in his popularity rating dropping to a low of 7%, which, I believe, still stands as a record in Japanese politics. In mid-April, 1989, Takeshita managed to push thorugh his tax hike plan. On April 25, 1989, he resigned from office, as his overwhelming unpopularity manifested in a scandal involving IPO kickbacks.

His successor was Sosuke Uno. Uno promised to continue with Takeshita’s consumption tax hike plan. He lasted in office a total of 67 days.

The opposition parties in Japan had no real background in pro-growth policies. They had always focused on welfare-type policies. But, by then it had become apparent even to these slow learners that the LDP’s consumption tax plans were unpopular. They had already tried to block Takeshita in April 1989 (thus delaying the budget from its normal passage before the start of the fiscal year on April 1). In July 1989, they won a majority victory in the Upper House for the first time in postwar history! In December 1989, they presented a bill to the Upper House of parliament that promised to repeal the brand-new consumption tax.

Lower House elections were to be held in February 1990. The possibility of the LDP losing power in both houses for the first time since World War II loomed. You would think that the opposition party would continue with its popular “repeal the consumption tax” platform. But, they abandonded it, and adopted a new promise: food and beverages would be taxed at a lower rate. The LDP won, and the opposition parties sank back into obscurity with their boring portfolio of social welfare programs.

The LDP’s switch from being a successful business and growth-oriented party to being a party of tax hikes and low-grade public spending pandering frustrated some key LDP members, most notably Ichiro Ozawa, who was LDP Secretary General in 1989. In 1993, as the economy crumbled, the stock and property markets collapsed, and the LDP piled one tax hike on another (particularly property-related taxes), Ozawa split with the LDP to form the tiny Japan Renewal Party. Ozawa was always a wheeler-dealer, and he was able to put together an opposition coalition centered on Morihiro Hosokawa. Hosokawa promised tax cuts, as an alternative to the LDP’s endless tax hiking.

The opposition coalition won the majority of the Lower House for the first time in postwar history, and Hosokawa became the first non-LDP prime minister. Here was the opportunity for real change! He was initially very popular, with a support rate of 72%, which set an all-time high.

Hosokawa’s collapse in popularity can be traced almost to the hour. I know the hour: 1 a.m., when Hosokawa called a suprise press conference. Unfortunately, I don’t know the day, but it was in February 1994. At the press conference, Hosokawa shocked his political supporters by calling for a rise in the consumption tax to 7%. What??? Hosokawa’s quick change of policy stance is attributed to MOF pressure. Hosokawa resigned on April 8, 1994.

For years afterward, the opposition parties were never able to cobble together a decent alternative to the LDP offerings. Ozawa had many worthwhile “reform” plans (I actually read his book!), but, for reasons I never understood, always stuck by his vision of a 10% consumption tax. When the LDP offered its plan to raise the consumption tax to 5% in 1996, the Ozawa-led opposition countered with a plan to raise it to 10%. The LDP won, and the consumption tax rose in 1997. This tax hike is widely blamed for contributing to the “second leg down” for the Japanese economy that began soon after, and lasted until 2003. (It did contribute, but increasing monetary deflation was also a major factor at that time.)

Much of this history is also covered (rather lightly) in my book. I’m repeating it here to give the background to the recent developments, which are very much a continuation of this story.

Well, that’s it for this week. This sure is taking a long time to get done.