The looming hike in value-added tax (VAT) may not be welcomed by Japanese consumers, but for discerning investors it will present opportunities.

History tells us the two-percentage-point increase in VAT to 10%—due to be implemented on October 1—will likely tip Japan’s economy into contraction.

It comes at a challenging juncture. China’s slowing growth, weakness in industrial production and manufacturing amid deterioration in international trade, and the impact of prolonged ultra-loose monetary policies globally are already weighing heavily on Japan.

Both previous VAT hikes in 1997 and 2014 were followed by recessions. On each occasion, people accelerated spending ahead of the hikes to pre-empt the tax rise. Economists refer to it as brought-forward demand, which made the subsequent pullbacks in spending more acute.

But we are seeing a more muted increase in spending in the run-up to October 1. In fact, Japan’s consumer confidence index has been falling each month for the past year.

While we forecast that Japan’s economy will contract in the fourth quarter of this year, we have reason to believe this could be short-lived.

We suspect the real income squeeze associated with this VAT hike will be more modest, given that government offsets such a free pre-school education will weigh on inflation.

Further, we think next year’s Olympic Games in Tokyo will act as a catalyst for tourism and spark a rebound in spending. It lifts our economic outlook for the spring and summer of 2020.

Raising revenues
There are reasons to be positive. Japan will benefit from increased tax revenues over the longer term. Its present system of direct taxation—income and corporation taxes applied automatically—is inadequate.

Its population is both ageing and declining. Growing numbers of retirees living off pension savings won’t be liable for income tax. Moreover, Japan is home to a large number of loss-making companies. Those that don’t turn a profit, don’t pay tax. It underscores why the largest and most successful businesses bear a disproportionate share of the tax burden.

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