The Japanese economy is back in recession. One of the main reasons is the pattern of consumer spending. Ahead of the sales tax increase people made their purchases. Once the tax rise came in they cut back sharply, leading to a fall in demand and output. It was far less helpful in raising revenue to pay for public services than the increase in VAT introduced in the UK, which did succeed in raising more revenue and did not have the same impact on demand as the Japanese hike.
In the UK it was the rise in higher rate income tax and capital gains tax that led to losses of revenue. The halving of the increase in the higher rate helped bring in more money again. Despite the recovery of property values and the rise in share prices, capital gains tax revenue at the 28% tax rate is still well down on the levels it reached at the 18% rate before the crash.
The art of taxing is to find the rates and taxes that maximise revenue to pay for the health and education services and welfare that modern advanced democracies expect, so people can have the services and borrowing can be kept under control. The danger is governments set rates that reduce revenues or do considerable harm to economic activity as in Japan.
The Japanese tax rise initiated by a previous Japanese government has now led to the decision to delay the second planned rise, and to hold a general election for Mr Abe to seek a renewed mandate very early so he can get on with the economic reforms Japan clearly needs. Meanwhile, the price of the higher tax rate is more quantitative easing, as we have seen with the recently announced expansion of the Japanese programme.
Japan is the one of the world’s largest economies, in recession. Euroland, another of the world giants, is struggling to avoid another recession, generating very little growth. The strategy of bringing deficits down by growth is not working well in Japan or Euroland. The inclination to raise taxes instead has misfired in Japan, just as surely as it did in France. Governments need to learn that higher tax rates may be self defeating. They may lower output and incomes and may even lower revenues.