Thorough analysis of consumption tax hike countermeasures and their effects

Comprehensive examination of income effect and substitution effect by age group, and industry

RSS

September 20, 2019

  • Shunsuke Kobayashi
  • Yutaro Suzuki

Summary

◆The consumption tax rate will be raised from the current 8% to 10% on October 1. In this report we examine the consumption tax increase and the content of countermeasures, while at the same time taking a comprehensive look at the consumption behavior of households as of this point in time, and examining the effects which the Japanese economy is likely to undergo after October.

◆A consumption tax hike influences consumption via two effects – the income effect and the substitution effect. The income effect can cause a long-lasting inhibiting effect on consumption, since real income declines at the same rate that prices of various products rise as a result of the consumption tax hike. The substitution effect consists of last minute demand before the consumption tax hike and the reactionary decline occurring afterwards.

◆First we examine the income effect in relation to the tax hike. A portion of household burden associated with the tax hike will be offset by the introduction of a reduced tax rate and social security enhancement measures such as free education. As a result, the net fiscal austerity effect is expected to be approximately Y2 tril less than the last time the consumption tax was raised (approximately Y8 tril). The negative income effect is expected to be resolved by various countermeasures, but the effect of these measures will gradually disappear through FY2020, giving way to the lingering effect of intermittent restraints on consumption.

◆Looking at the income effect as related to the consumption tax hike and the various countermeasures by age group, we see that younger households may likely gain more benefits, such as free education, making them able to avoid the negative effects of the tax hike. This variation in effects by age group also holds for trends in consumption by item.

◆The substitution effect associated with the tax hike shows a good possibility of being limited in comparison to the last time the consumption tax was raised. The last time the consumption tax was raised, it was initially expected that there would be an increase of 5%pt (5% to 10%). It was on this assumption that last minute demand was generated. Ultimately the tax was raised to only 8%, and this time around it will be raised by only 2%pt (8% to 10%). This may be partially contributing to the more muted demand this time around. Plus stock still remains in both the areas of housing and durable goods, which attracted many purchases five years ago. In fact, last minute demand prior to the consumption tax hike has not been observed in household purchases as of this point in time.

◆However, last-minute shipping has been generated in anticipation of last minute demand. Last-minute shipping in industries including motor vehicles, consumer electronics, pulp, paper and paper products, and chemicals has been especially conspicuous, as well as housing (measured in housing starts). It should be noted that it is highly likely the effect this has on increasing growth will disappear after the tax hike and move into a reactionary decline.

Daiwa Institute of Research Ltd. reserves all copyrights of this content.
Copyright permission of Daiwa Institute of Research Ltd. is required in case of any reprint, translation, adaptation or abridgment under the copyright law. It is illegal to reprint, translate, adapt, or abridge this material without the permission of Daiwa Institute of Research Ltd., and to quote this material represents a failure to abide by this act. Legal action may be taken for any copyright infringements. The organization name and title of the author described above are as of today.