On Monday, Japan released gross domestic product numbers that signaled the country has officially slipped into recession. Instead of the modest economic growth that had been forecast, the economy shrank by 1.6 percent — the second consecutive quarter of contraction.
It was seen as a setback for Prime Minister Shinzo Abe’s “Abenomics” program. Abe’s government has sought to revive the long-stagnant Japanese economy primarily through stimulus, but officials recently raised a red flag on the country’s ballooning debt load. They said they needed to deal with the debt issue at the same time as the growth issue, and decided raising money by increasing the sales tax was the best approach.
It was, in a sense, the result of a treatment for one ailment (ballooning debt) exacerbating a second malaise (low growth).
“Sometimes in medical treatments there are certain kinds of medicines that are lethal in large doses but beneficial in small doses,” says David Stockton, senior fellow at the Peterson Institute for International Economics. “Maybe in this case the dosage was just too hard for the patient, and the patient has relapsed now.”
The “dosage” in this case was a 5 to 8 percent increase in the sales tax, beginning in April of this year.
“Sales taxes are typically on goods,” says Liz Malm, economist at the Tax Foundation research group. “You’ve got the classic law of demand kicking in here where if the price of a good goes up, you tend to get less consumption of a good.”
In Japan’s case, those goods included durable, big-ticket items like homes.
“If you’re buying eggs every week, you’re not going to stockpile eggs, because they’re gonna go bad,” says Josh Hausman, an assistant professor of public policy at the University of Michigan.
Japanese consumption increased prior to the April tax hike, but then decreased afterward. Many economists expected this to result in contraction in the second quarter, but most expected the economy to revert to growth in the third quarter.
“I think this sort of adds to a growing body of evidence that contractionary fiscal policy – so raising taxes or cutting spending –can be quite damaging,” says Hausman. “More damaging than many economists might have expected.”
Abe is now widely expected to delay a second dose of sales tax increases scheduled for October, 2015.