By Jeffrey Fung

As Japan’s GDP shrank at the rate of 7.1% in the second quarter of 2014, there have been numerous discussions and debates regarding the effectiveness of the proposed sales tax increase to 10% in October 2015. The disappointing GDP data is largely attributable to the earlier hike in sales tax from 5% to 8% that came to into effect in April this year. Due to Japan’s relatively weak economy, many critics are not convinced that the upcoming October 2015 tax increase will lead to any feasible improvements.

Seeking to boost the economy, the Bank of Japan has been purchasing government bonds and other assets in enormous quantities ranging from ¥6 trillion to ¥8 trillion every month. Along with keeping interest rates at 0 to 0.1%, the government has used such quantitative easing in order to encourage investments and domestic consumption. However, this is a cause for concern as the Bank of Japan now owns over 20% of Japan’s public debt. Additional increases in sales tax rates may run counter to the stimulus program and continue to slash the government’s tax revenue, as was evident in the impact of the April sales tax.Another one of Shinzo Abe’s goals for Japan is to raise the inflation rate to 2% through “Abenomics". Prices have risen since 2012, but the expected improvement in household spending and consumption has not followed. Wage increases have not kept up with inflation, mainly due to small and medium-sized enterprises’ incapacity to do so. To aggravate this diminution in consumers’ purchasing power, the April sales tax increase has further discouraged people from spending.In recent months, however, the economy has shown signs of positivity that have led some to believe that the impact of April’s tax increase may not accurately reflect the potential results of October 2015’s sales tax hike.Unemployment rate has fallen to 3.5% in August which was a 17 year low. In addition to that, average earnings have been rising steadily for the past 6 months – most recently at 1.4% in August. However, these numbers are potentially overstated. The unemployment rate decrease was mainly a result of fewer people participating in the work force rather than more people successfully getting employed. Moreover, when taking into account inflation, real wages actually shrank by 2.6% in August, exacerbating the already weakening purchasing power of the people. Although the statistics seem appealing at first glance, the picture is not necessarily as positive as it purports to be.Despite the arguably inconclusive indications of gradual improvement in the economy and labor market, the sales tax hike to 8% did not achieve its intended objective of increasing tax revenue while maintaining consumer spending levels. One can expect a further rise to 10% tax rates to create more uncertainty and bring about more troubling times for Japan.Sources:http://blogs.wsj.com/japanrealtime/2014/10/09/is-japans-economy-on-the-verge-of-a-recession/http://online.wsj.com/articles/boj-kuroda-convinced-2-inflation-will-benefit-japan-1412818837http://online.wsj.com/articles/japans-economy-remains-fragile-ahead-of-tax-decisions-1412038722http://uk.reuters.com/article/2014/10/09/uk-japan-economy-machinery-orders-idUKKCN0HY01120141009http://www.thestar.com.my/Business/Business-News/2014/09/30/Japan-real-wages-fall-at-faster-pace/