Noda’s Potentially Pyrrhic Policy Victory

It seems Japanese Prime Minister (of the moment) Yoshihiko Noda won passage of his signature legislation Friday. At the same time, this victory may yet cost him a bigger political defeat.

Ever since taking office, Noda’s championed plans to hike sales taxes—in fact, forcing consumers to pay more is his primary policy platform. In this case, the plan increases sales tax rates from 5% to 8% in April 2014 and subsequently to 10% in October 2015.

Why double rates? It seems Mr. Noda’s quest is to hunt down more tax receipts for the government. (A common goal among global governments of late.) Many observers seemingly nod along with Noda, as they consider it a key aspect of Japanese near-term debt reduction. In their view, that’s an important—and time sensitive enough goal to force all Japanese consumers to chip in.

Yet it seems many others disagree. Like the 50 former members of Noda’s Democratic Party of Japan (DPJ) whose resignation hinged on opposing the tax. And bond markets, which just aren’t signaling a near-term Japanese debt implosion is remotely likely. Japanese 10-year bond yields finished last week at 0.8%—far from levels implying investors are shunning their debt. Now, that doesn’t mean all’s rosy in Japan, but it seemingly indicates the market’s assessment is Japan’s pretty darn unlikely to go Greek (with their current 10-year yields of about 23%) any time soon.

Now, we wouldn’t be surprised if Noda’s gambit paid off in terms of increased tax receipts. Sales taxes are, after all, a bit tough to dodge (though purchases can be pulled forward in the very short term before a hike). The last hike, passed in 1996 and implemented in 1997, did exactly that. In fact, 1997’s sales tax receipts jumped to ¥9.3 trillion from 1996’s ¥6.1 trillion—a big leap, no doubt.¹ But, particularly a year-plus removed from the devastating earthquake and tsunami, it seems a bit strange to target a big, short-term jump in receipts as the principal leg of domestic economic policy—and hang your administration’s hat on it.

Our sense is the other way to generate increased tax receipts—broad economic growth—is a more repeatable and effective means. And in fact, it speaks to the broader point: Government revenue probably shouldn’t be the one mattering most. After all, if you boost non-government revenues (including incomes) you likely get that tax receipt boost anyway. Admittedly, relying on the more gradual increase economic growth would likely bring might not be as sharp as hiking sales tax rates—but again, there’s little evidence a tax receipt moonshot is necessary. In the end, though, the effect of higher rates here is likely only on the fringes—and probably doesn’t impact Japanese (or global) growth much at all.

But one can’t say the same for Noda’s political future. Not only has this tax cost him 50 supporters in the DPJ, but bargaining with the opposition to secure enough votes for passage required him to call for early elections. Given Japan’s had six PMs since 2007 and considering the party defections, it’s not a stretch to suggest Mr. Noda’s on thin ice. So if recent history is any indication, the chances Noda presides over a Japan with an 8% or 10% sales tax are slim indeed. In this regard, last week’s big policy victory for Noda may prove pyrrhic.