Japan's Prime Minister Naoto Kan attends a news conference at his official residence in Tokyo on June 27, 2011.Toru Hanai/Reuters
The Japanese government's push to raise the sales tax has stalled because ruling party lawmakers fear the economy may be too weak to stomach it, even as inaction raises the risk of a sovereign rating downgrade.
Ruling Democratic Party members meet again on Wednesday to discuss the government's proposal but so far have been firm in their demands to make sustainable economic recovery a precondition for tax increases.
That effectively undermines the government's commitment to double the sales tax to 10 per cent by fiscal year 2015.
The government, rating agencies, the International Monetary Fund and many economists argue that higher taxes are necessary to prevent rising social security costs from blowing an even greater hole in Japan's finances, already saddled with debt twice the size of the economy.
But because of resistance within its own power base, the government has already missed a self-imposed June 20 deadline to agree on the tax hike, so additional delays or a weakened plan would damage its credibility further.
Moody's Investors Service has already warned that missing last week's deadline was a bad omen for Japan's debt rating, yet another headache for Prime Minister Naoto Kan, Japan's fifth premier in as many years. Mr. Kan faces rebels in his own party and hostile opposition that is using its control of Parliament's upper house to block legislation, hoping to force him to resign.
"The chance of a downgrade is increasing, and it seems the government is losing its ability to chart a course that repairs public finances," said Takahide Kiuchi, chief economist for Japan at Nomura Securities.
"Even if the government is able to reach a deal, it's unlikely that the opposition would go along and pass the legislation."
Economists also warn that even in its original form, the plan was not ambitious enough, with changes to social security actually leading to a rise in costs rather than savings necessary to reduce debt.
"A sales tax hike is necessary, but it is reckless to not cut welfare spending at the same time," said Hiroaki Muto, senior economist at Sumitomo Mitsui Asset Management Co.
Several lawmakers in Mr. Kan's Democratic Party want the government to be less specific about the timing and the size of the planned tax hikes. Some also say ending deflation and achieving a certain level of nominal gross domestic product growth should also be preconditions for tax hikes, which suggests serious delays given that Japan has been in and out of deflation and recession for the past decade.
Economists warn that the lack of political backing for the sales tax plan also boded ill for any plans to limit the debt impact of the disaster by using tax revenues to cover part of the rebuilding costs expected to exceed $200-billion (U.S.).
"Any other designs to raise taxes aren't likely to go smoothly. We could actually afford to delay on social security, but we cannot put off rebuilding after the quake," said Sumitomo's Mr. Muto, referring to Japan's March 11 devastating earthquake and tsunami.
A government panel recommended last weekend that higher taxes are needed for reconstruction work but it is unclear if any of the proposals will take shape any time soon given that Mr. Kan plans to resign.
Social security spending accounts for almost a third of the state budget, which totals 92.4-trillion yen ($1.15-trillion) for the fiscal year that started in April and grows about 1-trillion yen a year due to an aging population.
Moody's, which has Japan on review for a possible downgrade, warned earlier this week the country faces a third "lost decade" if it fails to tackle its debt. Standard & Poor's and Fitch also have negative outlooks on Japan's sovereign rating.