In historic step, Japan PM to hike tax; will cushion blow to economy

Reuters

* Japan PM Abe to announce sales-tax hike, stimulus package

* Hike is biggest fiscal-reform move since 1997

* Stimulus to offset some 5 trln yen of 8 trln yen hike

* Japan under pressure from credit rating agencies

By Shinji Kitamura and Takaya Yamaguchi

TOKYO, Oct 1 (Reuters) - Japan's Prime Minister Shinzo Abewill take a step on Tuesday that none of his predecessors hastried in more than 15 years - making a dent in the government'srunaway debt.

Abe, riding a wave of popularity with economic policies thathave begun to stir the world's third-biggest economy out ofyears of lethargy, will announce that the government will raisethe national sales tax to 8 percent in April from 5 percent, afinal draft of the government economic plan, seen by Reuters,shows.

But at the same time he will soften the blow to the nascentrecovery. As the tax increase is set to raise an additional 8trillion yen ($81.42 billion) a year, Abe will also announce aneconomic stimulus package that, according to the draft, is worth5 trillion yen.

A source involved in the process said the size of thepackage could increase somewhat, depending on how some corporatetax issues are dealt with.

The tax increase marks the first serious effort since 1997to rein in Japan's public debt, which recently blew past 1,000trillion yen ($10.18 trillion). At more than twice the size ofthe economy, this is the heaviest debt load in the industrialworld.

The government has done little to rein in spending and iswatering down the impact of the tax hike, so some critics doubtTuesday's move will be enough to get Japan on track to achieveits goal of halving the budget deficit - excluding debt serviceand income from debt sales - by the fiscal year to March 2016and balance it five years later.

"Even if Abe's policies go well, we still will not eliminatethe primary budget deficit," said senior Standard & Poor'sofficial Takahira Ogawa.

"It will just slow the pace of growth in outstanding debtand slow the pace of budget-deficit growth, but things wouldstill be deteriorating," Ogawa, the ratings firm's Tokyo-baseddirector of sovereign ratings, told reporters last week.

S&P could cut Japan's rating if it does not shrink itsbudget deficit, he said.

Still, pressing ahead with the tax hike bolsters the imageAbe has sought to foster of a decisive leader, withstandingopposition from his advisers and some of his own party.

"This plan was already in the works, but we have to give Abesome credit for following through with it," said Hiroaki Muto,senior economist at Sumitomo Mitsui Asset Management Co.

Abe is seeking a difficult balance with massive fiscal andmonetary stimulus to end 15 years of deflation and tepid growth,while setting the groundwork to get the government's finances inorder over time.

Financial markets have given Tokyo the benefit of the doubt:the government can borrow 10-year money for less than 0.7percent. But government officials and private economists havelong feared a crisis in confidence in Japan's creditworthinessthat could cause a crippling spike in interest rates.

The tax hike is part of a package agreed last year by theprevious government and the two current ruling parties, as thefirst step in a doubling of the consumption tax - similar to agoods-and-services tax in other countries - over two years. Thelaw stipulates that the government must confirm that the economyis strong enough to weather the tax hike before proceeding.

Japan posted the strongest growth among the Group of Sevenpowers in the first half, expanding at an annualised 3.8 percentrate in the second quarter after a 4.1 percent surge in thefirst. Abe chose Tuesday for the announcement as it should givehim the final economic justification he needs: the release ofthe "tankan" survey from the Bank of Japan.

The closely watched quarterly survey is expected to showthat positive sentiment outweighed gloom among Japan's bigmanufacturers for the first time since September 2011, accordingto a Reuters poll of economists.

But the tax increase remains an economic and political risk.

ENDURING TRAUMA

Japan spiralled into deep recession after the sales tax wasincreased in 1997 to 5 percent from 3 percent. Economists aredivided on how much the hike was to blame, as the Asianfinancial crisis and then Japan's own banking crisis followedshortly afterwards.

Regardless of the economic impact, the tax increase becamean enduring trauma for Japanese leaders after it helped end thepolitical career of then-premier Ryutaro Hashimoto. Even thepopular Junichiro Koizumi was unable to make significant headwayon fiscal reform during his 2001-2006 term.

To ensure that the fiscal tightening does not derail therecovery, Abe ordered his government to compile the stimuluspackage to be announced on Tuesday.

It features public-works spending for the 2020 TokyoOlympics, tax breaks to promote corporate capital spending andan early end to a corporate tax add-on that has fundedreconstruction from the 2011 earthquake and tsunami, which willsave companies 900 billion yen.

The stimulus could add 0.5-0.6 percentage point to economicgrowth in the fiscal year starting in April, but after that theimpact is likely to fade away, said Sumitomo Mitsui's Muto.

The package offers some goodies to individuals, such as aidto home buyers, but with the tax breaks mostly targetingcompanies and the tax hike directly hitting consumers, Tuesday'ssteps bolster the view of critics that "Abenomics" favourscorporate Japan at the expense of the little guy.

The stimulus offsets some two-thirds of the money beingsucked out of the economy via the tax hike. This means thecombined measures effectively resemble proposals from some ofthe premier's reflationist advisers: to raise the tax by just 1percentage point instead of 3 to protect the recovery.

Still, any improvement in government revenue from the taxincrease is likely to be quickly overwhelmed by expenditures ina country where a rapidly ageing society and generous publicservices are blowing an ever-bigger hole in the budget.

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