The Journal The Authority on Global Business in Japan

Economics | Abenomics

September 2013

The proposed tax hike could fix Japan’s debt problem

By Jesper Koll

Abenomics is keeping me extremely busy. Over the past two months, I have met, or had conference calls, with more than 1,000 global investors. This is about five times more than the number of such interactions I have had in the past over the same period, and unprecedented for a time of year generally characterized by a summer lull.

A recent Japan macro-related lunch in New York was attended by almost 150 investors, although when I held it in summer last year, barely 10 people showed up. But even more telling is the fact that, of the 150 who attended, barely one quarter had actually been to Japan.

Make no mistake: the dream of Abenomics has turned Japan into a very hot market for global investors. Moreover, it is not the experienced old Japan hands, but a new breed of true global fund generalists who are interested and excited about Japan investment opportunities. At the very least, Japan is no longer viewed as a career killer as a result of Abenomics.

Abenomics means different things to different people, and it is tempting to get lost in a heated debate of what should—or should not—happen on the policy front.

Having Prime Minister Shinzo Abe at the helm means the end of policy indecision and lack of government leadership. Clear-cut majority rule is back in Japan, and with it comes hope of consistency and credibility.

Whether you like team Abe or not is less important than the fact that they will be running the country for at least three, if not four, years. Predictability brings a premium.

What needs to get done? By far the biggest threat to Japan’s future prosperity comes from the fiscal deficit, now running at almost 250 percent of national income.

But there is good news. While Japan has mortgaged much of her future prosperity, there is ample room to avoid the debt trap and rebuild national wealth. How? Japan’s tax system can easily be made more efficient.

To get out of debt, an economy needs two forces. First, economic growth; second, an efficient tax system. Right now, Japan has neither, and Abenomics must deliver both. Japan’s current tax system is one of the least efficient in the world. To judge the system, economists look at the tax multiplier, to see how much public revenue grows for every 1 percent growth in national income. A fair system has a multiplier of one, so that if the total pie grows by 1 percent, so does the public part of it.

But in Japan, the tax multiplier stands at just below 0.7, which is to say that the public take grows at a much slower pace than the overall economy. Most of the Organization for Economic Co-operation and Development economies boast a multiplier of around 1.2 to 1.4.

There are many reasons for Japan’s inefficiency. The main one is wage deflation for the young and the demographic push toward retirement for the elderly. Both these factors work to pull people’s income down into lower tax brackets.

To fix this, wages for the young must go up, retirement for the elderly be postponed, or the tax collection system must change from taxing incomes to taxing consumption. The third alternative is a particularly elegant, indeed fair, solution. The young earn and spend their own hard-earned income, but the elderly only consume out of income received from the young, possibly supplemented by drawing down their own savings.

Why is it fair? Remember, Japan’s demographic reality is that, when today’s elderly (pensioners) were young (working), it took about six of them to support one elderly individual. Today, however, it takes about three young (working) people to support one elderly (pensioner) individual.

Maybe today’s workers are not quite as enthusiastic as previous generations, because they know full well that about one-third of their hard-earned income is siphoned off to support Japan’s growing number of retirees.

Over the next three to five years, the growing number of retiring baby boomers will give even more of a boost to Japan’s generational inequality.

The easiest way to fix this is to tax everyone when they consume, i.e., introduce a higher consumption tax. Indeed, a higher consumption tax rate would be a most elegant way to ease the burden and transfer wealth from the older generation back to the younger one.

Opinions differ greatly on how high the consumption tax needs to go to attain true fiscal consolidation. Estimates vary from between 15 percent and 30 percent, compared with the current 5 percent.

I believe such calculations are necessary but, at the same time, relatively useless as there are far too many variables that dictate the actual fiscal dynamics in any macro economy.

Most countries with sizable deficits have experienced deficit reduction running at a much faster pace than previously calculated, since once the economy starts growing, the positive multipliers multiply. This is true for Sweden and the United States in the 1990s, and remains true for the United States today.

I am certain the same will happen in Japan, with, for example, rising wages for the young poised to feed positive surprises on the income and spending side. As we said, to fix Japan’s debt problem we need two things: an efficient tax system and economic growth. When you get these, the fix turns into a self-enforcing virtuous cycle of wealth creation.

Of course, many worry that the consumption tax hike starting next April will derail the recovery. Let me counter this fear by quoting my favorite economist, Frenchman Jean-Baptiste Say (1767–1832), who said that,“In times of political confusion and under an arbitrary government, many will prefer to keep their capital inactive, concealed and unproductive, either of profit or gratification, rather than run the risk of its display” (Treatise on Political Economy, 1803).

In my view, these words summarize Japan’s past decades very well. Uncertainty over the policy regime kept savings and risk capital frozen and inactive, particularly as the rise in future liabilities—the fiscal deficit—was becoming increasingly worse. But finally, next year promises to bring an end to the uncertainty.

Political leaders are taking action and the beginning of a fix is coming into sight. Risk capital and savings are poised to be mobilized and to take action—as long as the political leadership stays the course and sticks to its promises and commitments.

By contrast, a reversal would send Japan back to political confusion and arbitrary government. I trust that the prime minister has what it takes to do the right thing, namely, deliver what is necessary to attain a sustainable recovery in Japan. His decision regarding a consumption tax hike will offer the first insight into whether he has the qualities needed to forge an economic upturn. •

Jesper Koll - ACCJ JournalJesper Koll is a Managing Director and Head of Research at J.P. Morgan Securities LLC.


To get out of debt, an economy needs two forces. First, economic growth; second, an efficient tax system. Right now, Japan has neither.”


Most countries with sizable deficits have experienced deficit reduction running at a much faster pace than previously calculated, since once the economy starts growing, the positive multipliers multiply.”