Japan to raise consumption tax to 8%?

The tax hike will further dent Japanese consumers' pockets when it takes effect in 2014.

By 2015, the consumption tax will be increased to 10%. These measures are enacted to bring down the government’s primary deficit by about 2% of GDP by FY2015. 

Due to the pre-announcement of tax hikes, consumers may start spending now, pulling up the GDP forecast of 1.5% for 2013, but negatively affecting 2014-2016. Inflation forecast for 2013-2016 will also require revisions.

Here's more from DBS:

The economic data for May including industrial production, retail sales and housing starts will be released today and tomorrow. Industrial production, as thekey data, is expected to fall about -3% MoM sa (consensus: -2.8%), dampening the earlier optimism about Japan’s post-quake recovery. Although investment and consumption should have held up relatively well thanks to the support of reconstruction and government stimulus, export demand has remained persistently weak. Meanwhile, the destocking pressures in the manufacturing sector haveincreased, with the inventory to shipment ratio rising to the highest level seen sinceMay11 (the period following the March 2011 earthquake). Business sentimentshould have also deteriorated recently because of the financial market turmoil,making firms more cautious when deciding their production and investment plans.This was indicated by the sharp decline in manufacturers’ production forecast forthe survey month of May.

On the other hand, inflation data would also exhibit a slowdown. CPI growth isprojected to drop to 0.4% YoY in May, down from 0.5% in April.The pickup in consumer prices earlier this year reflected the surge in energy prices,as well as a smaller-than-expected output gap. As oil prices have fallen since May,the downward pressures on headline CPI should have reemerged. Japan’s core CPIonly excludes fresh food and includes energy, thus it could also be depressed bylower oil prices.

On policy, the lower house of the parliament this week passed the bill of raising consumption tax. The upper house will vote in July, and a passage also seems likely, as the bill has obtained the support from the two main opposition parties. If legislated, the consumption tax rate will be raised from 5% at present to 8% in 2014 and 10% in 2015, which is estimated to reduce the central government’s primary deficit by about 2% of GDP by FY2015. This will mark the first, crucial step for the government to move towards the medium term fiscal consolidation, which should positively support investor confidence on the JGB and the yen, and reduce the worries about a European style debt crisis to occur in Japan some years later in mid-2010s.

That said, with the government’s primary deficit standing at more than 4% of GDPon average in the recent five years, the consumption tax hikes will not be able to help Japan achieve the target of balancing the budget or stabilizing the publicdebt to GDP ratio within this decade. Further reforms in the tax and social security systems will be needed. And it is more crucial for Japan to directly boost its growth potential through the supply side measures such as investment deregulations and productivity enhancement.

Note that the consumption tax hikes will inevitably affect the growth and inflation forecasts. Goods and service prices will be boosted directly and inflation expectations should be elevated. Higher taxes and prices will dampen real consumption growth, despite the cushion of household savings. Due to the pre-announcement of tax hikes, consumers may bring forward their spending, in anticipation of a jump in prices ahead. In short, there would be upside risks to our GDP forecast of 1.5% for 2013, but downside risks for 2014-2016. Inflation forecast for the period of 2013-2016 may also require upward revisions.