Effect of Japanese Tax Increase

I came across an article in the New York Times titled, “Tax Increase Proposal Raises Fear of Slowdown in Japan”. In this article, the author describes the two opposing viewpoints of an increase from 5% to 8% sales tax that Prime Minister Shinzo Abe is planning to implement in order to begin working towards diminishing Japan’s massive national debt. The tax is to be distributed evenly throughout all goods and services, in an effort to minimize changes to the recently thriving Japanese economy. Still, economists are worried that the drastic increase in sales tax is too much too soon, and that it will cause Japan to backslide into “the deflationary morass that has dogged it for 15 years” (Tabuchi).

…消費税と研究開発…

In Stephen Martin’s “Industrial Organization in Context”, Martin describes Sakakibara and Porter’s theory that domestic rivalry causes success in the international market. Sakakibara and Porter, which they support this assertion using evidence from the Japanese market. They found that “Japanese firms have a larger share of world exports the more they spend on research and development” (as cited in Martin), and this research and development is a result of firms trying to beat out other domestic competition.

How will the tax increase affect Japan’s firms in the international market? The fact that the sales tax is to be evenly distributed nationwide [better: is levied on all goods and services] suggests that domestic competition will remain the same, and thus the rivalry between firms in Japan will stay dynamic and active. According to Sakakibara and Porter’s assertion, this means that Japan will continue to be successful within the international market as well. However, we also have to think about how the increase in sales tax will effect how much money Japanese firms spend on research and development.

Since a sales tax across all goods and services is synonymous to a decrease in income throughout all consumers in Japan, it is reasonable to predict that the Japanese population will have less money for consumption, and will therefore consume fewer goods and services. m represents income. m/p1 is the maximum quantity that a consumer can buy of good 1, and m/p2 is the maximum quantity the consumer can buy of good 2. If m goes down, the budget line shifts inward, because the consumer cannot afford to buy as much of good 1 and good 2 as before. The nationwide sales tax is synonomous to a decrease in m for all consumers. Consumers’ budget lines have shifted inwards, and they can will no longer afford to buy as many goods as before. This means decreased quantity of sales for firms, and since revenue=price x quantity, firms will have less revenue that they can use towards research and development. The amount of research and development in Japan is central to Sakakibara and Porter’s assertion about international success, and thus it is not unreasonable to suppose that although higher sales taxes will not decrease domestic rivalry, its effect on research and development could have negative repercussions for Japanese firms in the international market.

3 thoughts on “Effect of Japanese Tax Increase

  1. I made a couple editorial changes in the text; I indicated a couple deletions partially to see what the “del” function in the blog toolbar actually does.

    The impact on behavior varies across firms depending on price elasticities of demand. If you continued with your model, that would be a result of the particulars of the utility function that lets you model which bundle of goods a consumer chooses. When demand is inelatic, firms won’t be affected as much in terms of quantity and revenue. Supply also matters: if supply is very ineleastic quantity won’t change much, but (supply) price will. But certainly firms don’t welcome the tax.

    What matters is expected (= future) revenue. Exporters aren’t affected by the tax. Many firms use large thresholds for development projects, if they use a 20% return as their internal hurdle – a way to account for uncertainty – then they won’t make any immediate change in plans, but on the margin it might have an impact the next year. However, the consumption tax doesn’t affect their own cost structure and doesn’t affect corporate tax rates.

    So with varying elasticities, some producers won’t be affected (consumers willingly pay the higher tax), in others elasticities work the wrong way. But there are other effects, since the discrete change isn’t trivial for big-ticket items, consumers have an incentive to purchase in March rather than wait until after April 1st 2014. April will be a very slow month for domestic car sales – Toyota will be concerned, but most of Mazda’s sales come from exports, so they will be less affected. [And in fact Toyota may undertake R&D inside Japan, but most of their cars are made and sold outside of Japan, so from a global perspective aren’t that affected by the tax.] Then tehre is the macroeconomic impact: 3% will be enough to affect GDP growth, a one-time lowering of the level of GDP, and that can be accentuted by the timing effect (since the implementation falls at the end of a quarter, not in the middle of one). Firms and others will see lower demand, but will be less certain how much is due to the tax, and how much due to other factors that continue beyond 1-2 quarters. So that can lead to delays in investment projects, amplifying the short-run impact on GDP. Hence I’m puzzled by the details, why not have the tax go up 0.75 percentage points every 6 months – bar codes are near-universal in Japan, and software really doesn’t care that it’s not a round number, and changing twice a year is not a big deal. It would avoid all these timing issues, and also make the next increment less of political target.

    But all that is far outside the scope of Industrial Organization. Think instead about whether a monopolist has an incentive to engage in R&D – why work hard to lower costs if you have the market to yourself? why come out with a new product if the main effect is to cannibalize sales of the existing one? You can play with our basic model to gain insights – ask and we can set it up in class tomorrow as an extension of the homework.

    • To answer the questions concerning monopoly at the end of the prof’s comment:

      The environment of the monopoly and the way in that they have a monopoly definitly influences their strategy in terms of lowering costs. If the monopoly is a local monopoly, they probably would not benefit much from research and development to lower the costs of running their business. This is because if this local monopoly exists in a secluded area, such as lexington virginia, lowering costs would not result in a drastic increase in business because there are not that many more people in the surrounding area. Thus, the cost of spending more money to lower costs would probably not be covered by increase in customers.
      If the monopoly is a large monopoly, they probably would gain benefit in the international market from research and development. There are always going to be more competitors if the company is making positive profits in a large scale, unless there are serious barriers to entry in that particular market. If there are barriers to entry that are off-putting enough to discourage entry, then lowering costs through research and development would most likely not be beneficial. If there are not barriers to entry, and there are positive profits, then it is critical to spend money on research and development to lower costs and create more innovative products, or else the monopoly could be subject to losing market share in the international market.

  2. Of course the scale of R&D undertaken by a large firm can be greater, but R&D can consist of a manager experimenting with product design, with plant or store layout, with different advertising, with different customer services. Conceptually this is the same thing as hiring an engineer to do something geeky, right?

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