Everyone loves to complain about taxes. While we all make a fuss, how much do taxes influence our lives? Japan just ran a small tax experiment and the results are very clear. Even relatively small changes in sales taxes have a big impact on when we purchase things.
The Japanese government has a very large debt in both absolute and in per person terms. Prime Minister Abe decided to deal with this problem by increasing the country’s sales tax from 5% to 8%. This means on a $100 purchase you would spend $3 more. The change was discussed widely in the media before it happened on April 1st. While the tax increase was an unpopular political decision in Japan, in my mind it was economically necessary to bring tax and spending policies back into balance. Before any of this happened Japan’s economy was growing about 2% per year.
What happened to economic growth just before and then just after raising the sales tax by 3 percentage points? In the first quarter of 2014, just before the tax increase, Japan’s GDP rose by 6.1%. Then in the second quarter, just after the tax rate increase, GDP fell by 6.8%. For those of you who want more details you can read more here.
People appear to have reacted to the tax increase by changing their buying habits. They purchased many durable high value items like cars, phones and appliances just before the tax increased and then dramatically cut back these kinds of purchases after the tax increase. Overall, the 6.1% increase followed by a 6.8% decrease suggests that the tax changes reduced Japan’s GDP and this year’s GDP will be slightly smaller in absolute terms than last year.
What is the message that politicians and their advisers should take away from this preliminary data? Raising sales taxes or the VAT even by relatively small amounts can temporarily chill retail business.