Even when the bills to raise the consumption tax rate complete their journey through the Diet, the extra revenue accrued will fall short of the funds needed to reconstruct the nation's finances.
The consumption tax rate will be raised in two stages to 10 per cent by October 2015 from the current 5 per cent. However, the government's goal of turning the primary budget balance into a surplus by fiscal 2020 is unlikely to be achieved.
Further tax hikes will be inevitable to cover ballooning social security expenses.
"It is significant that nearly 75 per cent of House of Representatives members voted for the [tax hike] bills after overcoming confrontations [among parties]," Finance Minister Jun Azumi said at a press conference after passage of the bills through the lower house Tuesday.
According to the International Monetary Fund, Japan's debt-to-GDP ratio was about 230 per cent in 2011, the worst among developed countries and much greater that the 161 per cent chalked up by Greece, which is grappling with a serious financial crisis. In addition, Japan's social security burden is increasing annually as the population grays.
Raising the consumption tax rate to 10 per cent will improve this grave financial situation up to a point.
A major public concern is the tax hike's impact on the economy. The government expects a last-minute increase in demand in fiscal 2013 before the consumption tax is raised to 8 per cent in April 2014. The economy could shrink in fiscal 2014 after demand falls off.
"We'll keep an vigilant eye on the economy to prevent it from contracting. The period from the second half of 2013 to the beginning of 2014 will be especially important," Azumi said.
The government plans to make hefty budgetary allocations in such fields as the environment, medical services and disaster prevention. However, it would be counterproductive to fiscal reconstruction if the government recklessly pours money into projects.
The government hopes to halve the central and local governments' deficits in the primary budget balance recorded in fiscal 2010 by fiscal 2015, and turn it to surplus in fiscal 2020.
Primary balance is an indicator showing whether the government is able to fund expenditures on government policies through revenues other than government bonds, mostly through taxes. The goal of achieving a surplus in the primary budget balance means the government is determined not to rely on bonds from fiscal 2020.
However, this goal is unlikely to be achieved because of the delay in raising the consumption tax rate to 10 per cent. Initially, the government planned to raise the rate to this level in April 2015.
Under the current plan, there will be a shortfall of about 16.6 trillion yen (S$266 billion) in achieving a surplus in the primary budget balance in fiscal 2020 if the consumption tax rate remains at 10 per cent. To cover this shortfall with the consumption tax alone, the rate would have to be eventually raised to around 16 per cent.
Earlier this month, the IMF recommended the rate be raised to at least 15 per cent.
Kazuhiko Nishizawa, a senior economist at the Japan Research Institute, said the ideal consumption tax rate would be between 15 per cent and 20 per cent.
In addition to a further tax hike, Nishizawa said, "The government should discuss how to trim social security expenditures, such as by studying whether the pension system is financed properly."