Japan's Timing Disaster: A second tax hike followed by the coronavirus crisis.

• Author: Sakai, Yoshihiro

Japan, the world's third-largest economy, has enjoyed the fruits of Abenomics for seven years. But the risk of a deep recession looms for the first time under the Abe administration.

Japan's GDP in the fourth quarter of 2019 contracted 1.6 percent, almost double the market forecast of 1.0 percent, after growth in the previous quarter of 1.8 percent. This was the largest drop after the 4.8 percent contraction in the first quarter of 2009 following the Lehman shock and the 1.9 percent contraction in the second quarter of 2014 when Prime Minister Shinzo Abe raised the consumption tax from 5 percent to 8 percent in April of that year.

The Abe administration carefully prepared for last October's consumption tax hike from 8 percent to 10 percent. It introduced measures to alleviate the burden of the hike, including a reduced tax rate of 8 percent for food and newspapers and a 5 percent rebate for consumers who use credit cards and electronic money. These measures will expire in June of this year.

Because of these measures, both the government and the Bank of Japan were optimistic, expecting a smaller negative economic impact than the previous hike. Governor Haruhiko Kuroda of the Bank of Japan said on November 1 at a regular press conference that we should not be so pessimistic due to the lower last-minute demand in comparison with the last time consumption taxes were raised. And on January 22, Kuroda announced that consumption of non-durable goods had been steady, and that of durable goods such as electric appliances had recovered.

However, the magnitude of the negative impact of Abe's second tax hike was not different from the previous experience, nor from the 1996 tax hike from 3 percent to 5 percent.

NO EXCUSE

Japan faced negative GDP growth when the consumption tax was introduced in 1989 and each time it was raised--in 1997, 2014, and 2019.

We can determine the impact of the tax on economic growth in each quarter when it began by subtracting the four-year average trend of economic growth from the quarterly GDP growth. We use a four-year average because a five-year average would include the impact from the previous consumption tax hike in 2014.

The answer is a negative impact of 5.4 percent in 1989, 2.55 percent in 1997, 2.9 percent in 2014, and 2.75 percent in 2019. We can easily imagine that the negative impact is greatest during the year the consumption tax is introduced. But it is important to understand that the negative impact of the...