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I wrote yesterday about Japan’s experience with the value-added tax, mostly to criticize the International Monetary Fund.

The statist bureaucrats at the IMF are urging a big increase in Japan’s VAT even though the last increase was only imposed two months ago (in a perverse way, I admire their ability to stay on message).

Today, I want to focus on a broader lesson regarding the political economy of the value-added tax. Because what’s happened in Japan is further confirmation that a VAT would be a terrible idea for the United States.

Simply stated, the levy would be a recipe for bigger government and more red ink.

Let’s look at three charts. First, here’s a look at how politicians in Japan have been pushing the VAT burden ever higher.

What’s been the result? Have politicians used the money to lower other taxes? Have they used the money to reduce government debt?

Hardly. As was the case in Europe, the value-added tax in Japan is associated with an increase in the burden of spending.

Here’s a chart (based on the IMF’s own data) showing that government is now consuming almost 35 percent of economic output, up from about 30 percent of GDP when the VAT was first imposed.

I’ve added a trend line (automatically generated by Excel) to illustrate what’s been happening. It’s not a big effect, but keep in mind the VAT never climbed above 5 percent until 2014.

Now let’s look at some numbers that are very unambiguous.

Japan’s politicians imposed the VAT in part because they claimed it was a way of averting more red ink.

Yet our final chart shows what’s happened to both gross debt and net debt since the VAT was imposed.

To be sure, the VAT was only one piece of a large economic puzzle. If you want to finger the main culprits for all this red ink, look first at Keynesian spending binges and economic stagnation.

But we also know the politicians were wrong when they said a VAT would keep debt under control

I’ll close with a political observation.

The left wants a value-added tax for the simple reason that it’s the only way to finance European-type levels of redistribution (yes, they also want class-warfare taxes on the rich, but that’s mostly for reasons of spite since even they recognize that such levies don’t actually generate much revenue).

But it’s very unlikely that a VAT will be imposed on the United States by the left. At least not acting alone.

The real danger is that we’ll wind up with a VAT because some folks on the right offer their support. These people don’t particularly want European-type levels of redistribution, but they think that’s going to happen. So one of their motives is to figure out ways to finance a large welfare state without completely tanking the economy.

They are right that a VAT doesn’t impose the same amount of damage, on a per-dollar-collected basis, as higher income tax rates. Or increases in double taxation (though it’s important to realize that it would still penalize productive behavior by increasing the wedge between pre-tax income and post-tax consumption).

But their willingness to surrender is nonetheless very distressing.

The bottom line is that the most important fiscal issue facing America is the need for genuine entitlement reform. Achieving that goal is an uphill battle. But if politicians get a big new source of revenue, that uphill battle becomes an impossible battle.

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It seems that the International Monetary Fund and the Organization for Economic Cooperation and Development have an ongoing contest to see which bureaucracy can be the biggest cheerleader for bad fiscal policy.

  • They compete (OECD vs IMF) to promote more spending.
  • They compete (OECD vs IMF) to push higher tax burdens.
  • They compete (OECD vs IMF) to advocate class warfare.

You can even see them competing to encourage bad policy in various nations.

In Japan, for instance, the OECD has been pushing for higher taxes while the IMF has been pushing for Keynesian spending.

But now the IMF is upping the ante by adding its bad advice on tax policy.

Japan’s politicians raised the value-added tax just two months ago.

But that’s not enough for the IMF. The bureaucrats already are urging a far bigger increase in the levy.

Japan needs to raise its consumption tax further to fund growing social security costs, the International Monetary Fund recommended… The tax “would need to increase gradually” to 15% by 2030 and 20% by 2050, the IMF said in a report. …IMF Managing Director Kristalina Georgieva praised the smooth implementation of the Oct. 1 hike that took the consumption tax to 10% from 8%.

Needless to say, one of the main lessons from this sordid experience is that it’s never a good idea to give politicians a new source of revenue.

Look at what’s happened ever since the VAT was first imposed in 1989.

And now the IMF wants to push the rate up to 15 percent. And then 20 percent.

By the way, it’s worth noting that Japan’s politicians actually welcome this bad advice.

The nation faces a big demographic crunch (increasing life expectancy and low birth rates), and that means entitlement spending is on track to consume an ever-larger share of economic output.

To give you an idea of what’s happening, here’s a chart from the IMF’s report on Japan. It only looks at health-related spending, so keep in mind that the red line would be significantly hihger if Japan’s version of Social Security was included.

The bottom line is that Japan’s politicians want options to finance a growing burden of government spending.

And since decades of failed Keynesian policy have saddled the nation with record levels of debt, ever-larger sources of tax revenue are their preferred choice.

Sadly, the IMF is more than happy to rationalize that bad approach.

P.S. Japan’s politicians could reform entitlements, of course, but don’t hold your breath waiting for that to happen. Instead, expect this “depressing chart” to get even more depressing.

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It’s not easy picking the most pessimistic chart about Japan.

The country suffered several decades of economic stagnation following the collapse of a bubble about three decades ago.

That means it’s a bit of a challenge to identify the worst economic numbers.

  • Is it the data on ever-rising levels of government debt?
  • Is it the data on an ever-rising burden of taxation?
  • Or is it the data on an aging population and falling birthrate?

For what it’s worth, I thought the tax data was the most depressing.

But now there’s a new challenger for the grimmest chart.

I’m currently in Japan, where it’s almost bedtime. I just heard a speech from the governor of the Tokyo Prefecture.

As part of her remarks, she shared a slide showing how Japan has plummeted in the IMD competitiveness rankings.

I don’t have her chart, but I found another version with the same data.

And Japan has dropped to #30 in the recently released 2018 version.

By the way, you won’t be surprised to learn that Economic Freedom of the World shows a similar decline.

Japan was ranked in the top-10 back in 1990, but now it’s dropped to #41.

This is not quite as pronounced as Argentina’s drop in the rankings for per-capita GDP, but it’s definitely a sign that something’s gone wrong in the Land of the Rising Sun.

P.S. Japan has a very strong entry in the contest for the world’s most inane regulation.

P.P.S. And if there was a contest for the most ineffective form of government waste, Japan would have a very strong entry for that prize as well.

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The value-added tax was first imposed in Europe starting about 50 years ago. Politicians in nations like France approve of this tax because it is generally hidden, so it is relatively easy to periodically raise the rate.

And that’s the reason I am vociferously opposed to the VAT. I don’t think it’s a coincidence that the burden of government spending dramatically increased in Europe once politicians got their hands on a new source of revenue.

Simply stated, I don’t want that to happen in America.

Now I have new evidence to support that position.

We’ll start by crossing the Pacific to see what’s happening in Japan, as reported by Reuters.

Japanese Prime Minister Shinzo Abe vowed to proceed with next year’s scheduled sales tax hike “by all means”… Abe said his ruling Liberal Democratic Party (LDP) won last year’s lower house election with a pledge to use proceeds from the sales tax increase to make Japan’s social welfare system more sustainable. …his plan to raise the tax to 10 percent from 8 percent in October next year. Abe twice postponed the tax hike after an increase to 8 percent from 5 percent in 2014 tipped Japan into recession.

I give Prime Minister Abe credit for honesty. He openly admits that he wants more revenue to finance even bigger government.

But that doesn’t make it a good idea. Japan has been experimenting with bigger government for the past 25-plus years and it hasn’t led to good results. The VAT was just 3 percent in 1997 and the Prime Minster now wants it to be three times higher.

All of which is sad since Japan used to be one of the world’s most market-oriented nations.

You also won’t be surprised to learn that the OECD is being a cheerleader for a higher VAT in Japan.

Speaking of which, let’s look at what a new OECD report says about value-added taxes.

VAT revenues have reached historically high levels in most countries… Between 2008 and 2015, the OECD average standard VAT rate increased by 1.5 percentage points, from 17.6% to a record level of 19.2%, accelerating a longer term rise in standard VAT rates… VAT rates were raised at least once in 23 countries between 2008 and 2018, and 12 countries now have a standard rate of at least 22%, against only six in 2008… Raising standard VAT rates was a common strategy for countries…as increasing VAT rates provides immediate revenue.

And here’s a chart from the study that tells you everything you need to know about how politicians behave once they have a new source of tax revenue.

Incidentally, there’s another part of the report that should be highlighted.

For all intents and purposes, the OECD admits that higher taxes are bad for growth and that class-warfare taxes are the most damaging method of taxation.

…increasing VAT rates…has generally been found to be less detrimental to economic growth than raising direct taxes.

What makes this excerpt amusing (at least to me) is that the bureaucrats obviously want readers to conclude that higher VAT burdens are okay. But by writing “less detrimental to growth,” they are admitting that all tax increases undermine prosperity and that “raising direct taxes” (i.e., levies that target the rich such as personal income tax) is the worst way to generate revenue.

Which is what I’ve been pointing out!

Last but not least, I’ll recycle my video explaining why a VAT would be very bad news for the United States.

Everything that has happened since that video was released in 2009 underscores why it would be incredibly misguided to give Washington a big new source of tax revenue. And that’s true even if the people pushing a VAT have their hearts in the right place.

The only exception to my anti-VAT rigidity is if the 16th Amendment is repealed, and then replaced by something that unambiguously ensures that the income tax is permanently abolished. A nice goal, but I’m not holding my breath.

P.S. One of America’s most statist presidents, Richard Nixon, wanted a VAT. That’s a good reason for the rest of us to be opposed.

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I’m currently in Tokyo for an Innovation Summit. Perhaps because I once referred to Japan as a basket case, I’ve been asked to speak about policies that are needed to boost the nation’s competitiveness.

That sounds like an easy topic since I can simply explain that free markets and small government are the universal recipe for growth and prosperity.

But then I figured I should be more focused and look at some of Japan’s specific challenges. So I began to ponder whether I should talk about Japan’s high debt levels. Or perhaps the country’s repeated (and failed) attempts to stimulate the economy with Keynesianism. And Japan’s demographic crisis is also a very important issue.

But since I only have 20 minutes (not even counting Q&A), I don’t really have time for a detailed examination on any of those topics. So I was still uncertain of how best to illustrate the need for pro-market reforms.

My job suddenly got a lot easier, though, because Eduardo Porter of the New York Times wrote a column today that includes a graph very effectively illustrating why Japan is in trouble. Simply stated, the country is on a very bad trajectory of ever-higher taxes.

To elaborate, Japan used to have a relatively modest tax burden, as least compared to other industrialized nations. But then, thanks in part to the enactment of a value-added tax, the aggregate tax burden began to climb. It has jumped from about 18 percent of economic output in 1965 to about 32 percent of gross domestic product in 2015.

Even the French didn’t raise taxes that dramatically!

By the way, I feel compelled to digress and point out that Mr. Porter’s column was not designed to warn about rising taxes in Japan. Instead, he was whining about non-rising taxes in the United States. I’m not joking.

American tax policy must stand as one of the great mysteries of the global political economy. In 1969…federal, state and local governments in the United States raised about the same in taxes, as a share of the economy, as the government of the average industrialized country: 26.6 percent of gross domestic product, against 27 percent among the nations in the Organization for Economic Cooperation and Development. Nearly 50 years later, the tax picture has changed little in the United States. By 2015, …the figure was 26.4 percent of G.D.P. But across the market democracies of the O.E.C.D., the share had climbed by an average of more than seven percentage points. …Americans are paying dearly as a result, as their comparatively small government has proved incapable of providing an adequate safety net…there is no credible evidence that countries with higher tax rates necessarily grow less.

Americans are “paying dearly”? Are we “paying dearly” because our living standards are so much higher? Are we “paying dearly” because our growth rates are higher and Europe is failing to converge? Are we “paying dearly” because America’s poorest states are rich compared to European countries.

Now that I got that off my chest, let’s get back to our discussion about Japan.

Looking at the data from Economic Freedom of the World, Japan ranked among the world’s 10-freest economies as recently as 1990. Today, it ranks #39. That is a very unfortunate development, though I should point out that the nation’s relative decline isn’t solely because of misguided fiscal policy.

I’ll close by noting that even the good news from Japan isn’t that good. Yes, the government did slight lower its corporate tax rate so it no longer has the highest burden among developed nations. But having the second-highest corporate tax rate is hardly something to cheer about.

P.S. Since today’s column looks at the most depressing Japanese chart, I should remind people that I shared the most depressing Danish PowerPoint slide back in 2015. I may need to create a collection.

P.P.S. I doubt anyone will be surprised to learn that the OECD and IMF have been encouraging bad policy for Japan.

P.P.P.S. If I had to guess, I would say that Japan’s government is probably more competent than average. But that doesn’t mean it’s incapable of some bone-headed policies, such as a regulatory regime for coffee enemas and a giveaway program that was so convoluted that no companies asked for the free money.

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I’ve looked at some of the grim fiscal implications of demographic changes the United States and Europe.

Now let’s look at what’s happening in Asia.

The International Monetary Fund has a recent study that looks at shortfalls in government-run pension schemes and various policies that could address the long-run imbalances in the region. Here are the main points from the abstract.

Asian economies are aging fast, with significant implications for their pension system finances. While some countries already have high dependency ratios (Japan), others are expected to experience a sharp increase in the next couple of decades (China, Korea, Singapore). …This has…implications. …pension system deficits can increase very quickly, limiting room for policy action and hampering fiscal sustainability. …This paper explores how incorporating Automatic Adjustment Mechanisms (AAMs)—rules ensuring that certain characteristics of a pension system respond to demographic, macroeconomic and financial developments, in a predetermined fashion and without the need for additional intervention— can be part of pension reforms in Asia.

More succinctly, AAMs are built-in rules that automatically make changes to government pension systems based on various criteria.

Incidentally, we already have AAMs in the United States. Annual Social Security cost of living adjustments (COLAs) and increases in the wage base cap are examples of automatic changes that occur on a regular basis. And such policies exist in many other nations.

But those are AAMs that generally are designed to give more money to beneficiaries. The IMF study is talking about AAMs that are designed to deal with looming shortfalls caused by demographic changes. In other words, AAMs that result in seniors getting lower-than-promised benefits in the future. Here’s how the IMF study describes this development.

More recently, AAMs have come to the forefront to help address financial sustainability concerns of public pension systems. Social insurance pension systems are dominated by defined benefit schemes, pay-as-you-go financed, with liabilities explicitly underwritten by the government. …these systems, under their previous contribution and benefit rules, are unprepared for population aging and need to implement parametric reform or structural reforms in order to reduce the level or growth rate of their unfunded pension liabilities. …Automatic adjustments can theoretically make the reform process politically less painful and more likely to succeed.

Here’s a chart from the study that underscores the need for some sort of reform. It shows the age-dependency ratio on the left and the projected increase in the burden of pension spending on the right.

I’m surprised that the future burden of pension spending in Japan will only be slightly higher than it is today.

And I’m shocked by the awful long-run outlook in Mongolia (the bad numbers for China are New Zealand are also noteworthy, though not as surprising).

To address these grim numbers, the study considers various AAMs that might make government systems fiscally sustainable.

Especially automatic increases in the retirement age based on life expectancy.

One attractive option is to link statutory retirement ages—which seem relatively low in the region—to longevity or other sustainability indicators. This would at the very least help ameliorate the impact of life expectancy improvements in the finances of public pension systems. … While some countries have already raised the retirement age over time (Japan, Korea), pension systems in Asia do not yet feature automatic links between retirement age and life expectancy. …The case studies for Korea and China (section IV) suggest that automatic indexation of retirement age to life expectancy can indeed help reduce the pension system’s financial imbalances.

Here’s a table showing the AAMs that already exist.

Notice that the United States is on this list with an “ex-post trigger” based on “current deficits.”

This is because when the make-believe Trust Fund runs out of IOUs in the 2030s, there’s an automatic reduction in benefits. For what it’s worth, I fully expect future politicians to simply pass a law stating that promised benefits get paid regardless.

It’s also worth noting that Germany and Canada have “ex-ante triggers” for “contribution rates.” I’m assuming that means automatic tax hikes, which is a horrid idea. Heck, even the study acknowledges a problem with that approach.

…raising contribution rates can have important effects on the labor market and growth, it would be important to prioritize other adjustments.

From my perspective, the main – albeit unintended – lesson from the IMF study is that private retirement accounts are the best approach. These defined contribution (DC) systems avoid all the problems associated with pay-as-you-go, tax-and-transfer regimes, generally known as defined benefit (DB) systems.

The larger role played by defined contribution schemes in Asia reduce the scope for using AAMs for financial sustainability purposes. Many Asian economies (Hong Kong, Singapore, Australia, Malaysia and Indonesia) have defined contribution systems, …under which system sustainability is typically inherent.

Here are the types of pension systems in Asia, with Australia and New Zealand added to the mix..

For what it’s worth, I would put Australia in the “defined contribution” grouping. Yes, there is still a government age pension that serves as a safety net, but there also are safety nets in Singapore and Hong Kong as well.

But I’m nitpicking.

Here’s another table from the study showing that it’s much simpler to deal with “DC” systems compared with “DB” systems. About the only reforms that are ever needed revolve around the question of how much private savings should be required.

By the way, even though the information in the IMF study shows the superiority of DC plans, that’s only an implicit message.

To the extent the bureaucracy has an explicit message, it’s mostly about indexing the retirement age to changes in life expectancy.

That’s probably better than doing nothing, but there’s an unaddressed problem with that approach. It forces people to spend more years working and paying into systems, and then leaves them fewer years to collect benefits in retirement.

That idea periodically gets floated in the United States. Here’s some of what I wrote in 2011.

Think of this as the pay-for-a-steak-and-get-a-hamburger plan. Social Security already is a bad deal for workers, forcing them to pay a lot of money in exchange for relatively meager retirement benefits.

I made a related observation about this approach back in 2012.

…it focuses on the government’s finances and overlooks the implications for households. It is possible, at least on paper, to “save” Social Security by cutting benefits and raising taxes. But such “reforms” force people to pay more and get less – even though Social Security already is a very bad deal, particularly for younger workers.

The bottom line is that the implicit message should be explicit. Other nations should copy jurisdictions such as Chile, Australia, and Hong Kong by shifting to personal retirement accounts

P.S. Speaking of which, here’s the case for U.S. reform, as captured by cartoons. And you can enjoy other Social Security cartoons here, here, and here, along with a Social Security joke if you appreciate grim humor.

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When I warn about the fiscal and economic consequences of America’s poorly designed entitlement programs (as well as the impact of demographic changes), I regularly suggest that the United States is on a path to become Greece.

Because of Greece’s horrible economy, this link has obvious rhetorical appeal.

But there’s another nation that may be a more accurate “role model” of America’s future. This other country, like the United States, is big, relatively rich, and has its own currency.

For these and other reasons, in an article for The Hill, I suggest that Japan is the nation that may offer the most relevant warning signs. I explain first that Japan shows the failure of Keynesian economics.

…ever since a property bubble burst in the late 1980s, Japan’s economy has been in the doldrums, and its politicians deserve much of the blame. They’ve engaged in repeated binges of so-called Keynesian stimulus. But running up the national credit card hasn’t worked any better in Japan than it did for President Barack Obama. Instead of economic rejuvenation, Japan is now saddled with record levels of debt.

In other words, Japan already is a basket case and may be the next Greece. And all this foolish policy has been cheered on by the IMF.

I then highlight how Japan shows why a value-added tax is a huge mistake.

Japan’s politicians also decided to impose a value-added tax (VAT) on the nation. As so often happens when a VAT gets adopted, it turns into a money machine, as legislators start ratcheting the rate higher and higher. That happened in Europe back in the 1960s and 1970s, and it’s happening in Japan today.

And regular readers know my paranoid fear of the VAT taking hold in the United States.

But here’s the main lesson in the column.

The combination of demographic changes and redistribution programs is a recipe for fiscal crisis.

…the biggest economic threat to the country is the way Japan’s welfare state interacts with demographic changes. It’s not that the welfare state is enormous, particularly compared with European nations, but the system is becoming an ever-increasing burden because the Japanese people are living longer and having fewer children. …America faces some of the same problems. …if we don’t reform our entitlement programs, it’s just a matter of time before we also have a fiscal crisis.

To be sure, as I note in the article, Japan’s demographic outlook is worse. And that nation’s hostility to any immigration (even from high-skilled people) means that Japan can’t compensate (as America has to some degree) for low birth rates by expanding its population.

Indeed, the demographic situation in Japan is so grim that social scientists have actually estimated the date on which the Japanese people become extinct.

Mark August 16, 3766 on your calendar. According to…researchers at Tohoku University, that’s the date Japan’s population will dwindle to one. For 25 years, the country has had falling fertility rates, coinciding with widespread aging. The worrisome trend has now reached a critical mass known as a “demographic time bomb.” When that happens, a vicious cycle of low spending and low fertility can cause entire generations to shrink — or disappear completely.

Though I guess none of us will know whether this prediction is true unless we live another 1750 years. But it doesn’t matter if the estimate is perfect. Japan’s demographic outlook is very grim.

By the way, the problem of aging populations and misguided entitlements exists in almost every developed nation.

But I mentioned in the article for The Hill that there are two exceptions. Hong Kong and Singapore have extremely low birthrates and aging populations. But neither jurisdiction faces a fiscal crisis for the simple reason that people largely are responsible for saving for their own retirement.

And that, of course, is the main lesson. The United States desperately needs genuine entitlement reform. While I’m not overflowing with optimism about Trump’s view on these issues, hope springs eternal.

P.S. In yesterday’s column about Germany, I listed bizarre policies in Germany in the postscripts. My favorite example from Japan is the regulation of coffee enemas. And the Japanese government has even proven incompetent at giving away money.

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