Japanese Parliament Enacts Controversial Sales Tax

Prime Minister Yoshihiko Noda scores a victory with a consumption tax increase, despite opposition from within his own party.

The lower house of Japan’s Diet approved an increase in the nation’s consumption tax on Tuesday, providing a significant breakthrough victory for Prime Minister Yoshihiko Noda but also possibly plunging his government in further turmoil.

Since taking office less than one year ago, the consumption tax bill has been one of Noda’s main policy goals in addressing Japan’s worsening fiscal situation. With its passage in the lower house, followed by its expected approval in the upper house next month, Noda will have notched an important gain in his pledge to reform Japan’s economy and reverse what has been three decades of economic malaise.

The bill will raise the consumption tax from 5 to 8 percent in April 2014 and to 10 percent in October of the next year. The sales tax was introduced in 1989 at 3 percent and increased in 1997 to 5 percent.

Though an overwhelming majority of lawmakers voted to approve the change, 57 members of Noda’s ruling Democratic Party of Japan opposed it, opening the prospect of defections which may then force the prime minister to dissolve the Diet and call new elections.

Such an outcome is not certain though, as analysts predict much would depend on how Noda reacts to lawmakers who voted against the bill, whether he cracks down on them or simply doles out a slap on the wrist.

Nonetheless, passage of the bill is indicative of the risks that Noda and other lawmakers are willing to take on, in passing a tax hike in a stagnating economy, in order to address Japan’s dire fiscal situation.

Japan’s debt to gross domestic product ratio is now over 200 percent, the highest among developed economies, with many fearing that the Japanese economy is vulnerable to becoming another Greece, unable to pay its bills with its debt growing out of control. However, Japanese government debt, while huge, is mostly owned domestically with the yield on Japan’s ten year bond currently below 1 percent. Judging by Japan’s borrowing costs, a fiscal crisis is not on the near horizon.

Passage of the bill, although anticipated, is welcomed by the financial markets all the same because it indicates that lawmakers are taking the initial steps of getting Japan’s fiscal house in order before events can spiral out of control.

Depending on the political outcome of the vote — whether Noda survives and his Democratic Party remains in the majority — Japan can be expected to join the Trans Pacific Partnership with other East Asian nations and the Americas. Such a move would further strengthen its economic prospects in the long term.