Japan has been here before, and the outcome was far frompleasant. Yet it seems the wheels are in motion. The country willdouble its national sales tax, from 5% to 10%. The move, justifiedas a way to help the country deal with its precarious fiscalsituation, has raised serious concerns, since this kind of taxhike, applied for much the same reason, was widely blamed for thecountry's destructive recession in the late 1990s. Though some inJapan claim that the current environment is different, thishistory, the already weak global economy and Japan's recent declineinto a balance-of-payments deficit argue forcefully for a differentroute to fiscal reform.

The need to address Japan's budget situation is beyond cavil.Japan has the distinction of facing the worst fiscal situation inthe developed world. This year, the country will likely seedeficits rise to about 10% of its gross domestic product (GDP).Huge deficits plagued Japan for years as the government tried toprop up the economy's meager growth prospects. Now Japan also facesa huge debt overhang. According to the Ministry of Finance,outstanding bond obligations of the central government equal closeto 150% of GDP. Including local governments, the outstanding debtis almost double GDP. Debt servicing costs have roughly doubled asa percent of total outlays since 1980 and this fiscal year, evenwith interest rates as low as they are in Japan, will amount toabout 25% of all government expenditures. There is a real concernthat matters have reached a point when these expenses will crowdout other necessary and legitimate government functions and bringon the untenable situation in which government goes deeper intodebt largely to meet the obligations on its existing debt.

But if the need for fiscal reform is obvious, questionsnonetheless remain over whether a sales tax hike is the way to goabout it. History would argue otherwise. Back in April 1997,then-Prime Minister Ryutaro Hashimoto went this route despite a lotof opposition within Japan's Diet (parliament) and the public. Arecession began immediately after he raised the national sales taxfrom 3% to 5%. Consumer spending, which had been growing at betterthan a 4% annual rate, fell during the second half of that year andinto the middle of 1998. At the slowdown's worst, the Japaneseconsumer made real cutbacks at a yearly rate of over 4%. Though theJapanese consumer is a less significant part of Japan's economythan the American consumer is of the U.S. economy, the economiceffect was profound. Japan's real GDP sank, and knock-on effectskept it declining. The country did not show positive growth untillate 1999, more than two years after the tax went into effect.Because of the economic shortfall, the budget deficit, rather thanshrinking, about doubled from its 1996 level.

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