Japan's Abe faces another bruising debate over raising sales tax

By Tetsushi Kajimoto

TOKYO (Reuters) - Prime Minister Shinzo Abe faces a hard choice in coming months: whether to hike Japan's sales tax again, raising the risks of damaging a fragile recovery, or to back off and shake markets' confidence in his commitment to curbing runaway government debt.

After the economy stumbled into its deepest quarterly contraction in three years when Abe raised the tax in April, senior government officials are broaching the possibility of delaying a planned further increase in a bid to keep the recovery on track.

Analysts generally expect Abe to give the go-ahead in December to raising the tax in October 2015 to 10 percent from 8 percent. But the decision promises to be politically divisive, coming just as the government hammers out details of a promised cut in corporate taxes.

The government's "basic stance is to raise" the tax, although more care will be needed this time than when Abe decided to raise the tax from 5 percent - a decision that dominated market attention and political news coverage - said Vice Economy Minister Yasutoshi Nishimura.

Staying with the current plan, which doubles the sales tax over the course of 18 months, "would deal a considerable blow to the economy," Nishimura told Reuters on Wednesday. He expressed concern that the damage from the April hike is proving prolonged, while wages are not keeping up with inflation and exports remain sluggish.

BOLDEST MOVE IN DECADES

"The economy is at a make-or-break point on whether it could enter a virtuous cycle and return to sustained growth by overcoming the pullback in demand," he said.

The two-stage rise of the consumption tax is Japan's boldest move in nearly two decades to rein in government debt that has ballooned to more than twice GDP, the biggest burden in the industrial world.

The fiscal tightening was agreed on by the previous government and Abe's current coalition, with the provision that the government would have to certify the economy was healthy enough to weather each of the increases.

The powerful Finance Ministry is pushing hard for the tax hike to go ahead to lock in revenue so the government can meet its promise to balance the budget, excluding new bond sales and debt servicing, by the fiscal year ending in March 2021.

Failure to make steady progress toward that goal could roil the Japanese government bond market, economists say, and possibly spook investors in other markets as well.

A WARY CENTRAL BANK

The central bank, which now buys the equivalent of 70 percent of new government debt in a massive easing programme aimed at killing deflation, is also wary.

Bank of Japan Governor Haruhiko Kuroda avoids treading directly into Abe's fiscal policy purview. But the central bank's economic forecasts assume the full tax increase, and Kuroda this month urged the government to stick to its strong determination in restoring public finances, which has helped keep bond markets stable.

But pro-growth advisers to Abe - whose top policy priority is to pull the world's third-biggest economy out of nearly two decades of deflation and tepid growth - are urging him not to rush into a tax hike that could derail recovery.

Economist Koichi Hamada, an adviser to Abe who's not a government official, suggests softening the impact by raising the tax rate in stages.

"As we have seen, the shock from the consumption tax hike could be large," Hamada, professor emeritus of economics at Yale University, told Reuters on Wednesday. "So, ideally, we could raise it in a staged manner, such as 1 percentage point in October 2015 and another point after that."

Nishimura's boss, Economy Minister Akira Amari, said last week that it's best to raise the tax as planned, but "in the event we don't raise the consumption tax, if we don't demonstrate a solid fiscal reform plan, it would hurt confidence in Japan's government debt."

Abe himself has been tight-lipped about the decision, saying only that he will make a comprehensive decision after reviewing third-quarter GDP and other data.

For now, putting off the tax hike is just "a tail risk," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.

MORE HARM THAN GOOD?

"People around the administration may float various opinions, but those in the driver's seat must be well aware that putting off the sales tax hike would cause more harm than good," said Kumano, a former BOJ official.

Still, the politics of the decision will not make things easy for Abe. The debate will coincide with a decision on details of a promise to cut the corporate tax rate from around 35 percent, among the highest in world, to below 30 percent.

Raising the sales tax while cutting corporate taxes could heighten the impression that the Abe government is redistributing wealth from individuals to big companies.

Nearly two-thirds of the public opposes the tax hike, double those who favour it, a Nikkei newspaper survey showed on Monday. By contrast, private-sector economists strongly support the move: a Reuters survey this week showed 18 of 22 analysts advocating the increase.

Japan's main big-business lobby, Keidanren, supports raising the sales tax to 10 percent as planned, although some companies, especially those dependent on personal consumption, oppose the move.

"We hope they'll delay a conclusion" on the tax hike as consumption remains weak, said Mitsuo Takahashi, chief financial officer at major discount retailer Don Quijote Co.

(Additional reporting by Kaori Kaneko and Ritsuko Shimizu; Writing by William Mallard; Editing by Richard Borsuk)