Japanese Prime Minister Sanae Takaichi's approval ratings have suffered due to her government's sluggish response to soaring living costs. During the election campaign in February, she pledged to lower the consumption tax on food and beverages. After months of political deadlock, the Japanese government plans to reduce the rate to 1% for a two-year period starting in April. This move might help curb the decline in Takaichi's support, potentially sparing her the fate of previous leaders who were ousted by public anger over rising prices. However, significant uncertainties remain: how much consumers will actually benefit, how the tax cut will be financed, how the market will view its fiscal impact, and whether the government can smoothly revert the rate to 8% after two years.
What is the scale of the pressure on the public? Over the past four years, Japanese citizens have faced the most severe inflation shock in generations. Supermarket food price increases have far outpaced the overall inflation rate. Japan's food inflation has been growing faster than the headline inflation rate, with food prices rising 3.2% year-on-year in June. In 2023, food inflation peaked at 9%; over the last two years, the price of goods like rice has even doubled. According to Teikoku Databank, as many as 20,000 food items may see price hikes this year. Disruptions to supply chains caused by the Iran war have driven up transportation, raw material, and packaging costs, ultimately passing through to the prices of everyday items like bread and coffee. The situation is compounded by a weaker currency, which raises import costs. Japan relies on imports for over 60% of its food by calorie count, and the yen hit a 40-year low against the US dollar earlier this year. Household finances are clearly strained, forcing people to allocate a larger share of their budgets to food. The proportion of household spending on food has climbed to nearly 30%, the highest level since 1981.
How is the government addressing this issue? The government has decided to lower the consumption tax on food and non-alcoholic beverages from the current 8% to 1% for two years, starting in April 2027. It will also provide cash handouts to low-income households, effectively reducing the tax burden to zero for eligible families. The decision to cut the rate to 1% rather than to zero stems from retailer feedback that fully exempting the tax would require more time to reprogram their cash register systems. Economists generally believe this policy package will help lower inflation. Hideo Kumano, an economist at the ABC Economic Research Institute, calculates that reducing the food tax to 1% would cut food prices by about 7 percentage points year-on-year and lower the overall inflation rate by roughly 1.5 percentage points. However, economists caution that the actual effect could be significantly weakened if companies retain some of the tax savings as profit instead of passing them on to consumers. International experience, including in Germany, shows that retail price reductions are often smaller than the magnitude of consumption tax cuts.
Why not simply raise interest rates? The conventional policy response to inflation is to raise interest rates. But Japan's situation is unique. After decades of stagnant or falling prices, successive governments have worked to generate moderate inflation to create a virtuous cycle of wage growth, increased consumption, and economic expansion. With this national objective in mind, the Bank of Japan can only raise rates cautiously, avoiding the risk of extinguishing the inflationary momentum. Consequently, the burden of easing the cost-of-living pressure on the public has fallen more heavily on the government's fiscal policy.
Will the tax cut boost Japan's economic growth? The stimulative effect of the tax cut on consumption is uncertain. Koya Miyamae of SMBC Nikko Securities estimates the policy could boost private consumption by approximately 1.3 trillion yen (equivalent to 80 billion US dollars), adding about 0.22 percentage points to real GDP. Kenji Yamamoto of Daiwa Securities is more skeptical, suggesting that people are likely to save the money saved from the tax cut rather than spend it.
Is this a standard policy tool in Japan? This would mark the first reduction in Japan's consumption tax since its introduction in 1989, reversing a decades-long policy direction of raising the tax to fund growing social security costs. The consumption tax is Japan's largest source of revenue, with tax revenues in the fiscal year ending March 2026 approaching 27 trillion yen. Historical experience from previous gradual increases over the decades shows that raising taxes on food often carries a heavy political cost, leading to a sharp drop in consumption and subsequent economic strain. This also means that after the two-year tax cut period ends, the government will face the challenge of restoring the original rate. Japan's last consumption tax increase occurred in October 2019, four years later than originally planned, after multiple delays due to concerns about its impact. Given Japan's history of postponing unpopular policies, the market widely questions whether the government can successfully return the rate to 8% when the time comes. Energy subsidies introduced in 2023 have been extended multiple times, and a tax increase approved in 2022 to fund higher defense spending has also been delayed. Currently, the income tax hike is scheduled for 2027.
What does this mean for Sanae Takaichi? The tax cut measures could potentially boost Takaichi's consistently falling approval ratings. Voters are growing increasingly dissatisfied as she appears more focused on long-term goals and her personal political agenda—including a 14-year investment plan and revising the imperial succession law—rather than more immediate issues like rising prices. The political benefit from the tax cut will depend on whether consumers perceive tangible savings once the measure takes effect next spring. The lengthy delays and slow implementation have also raised questions about Takaichi's political management skills. Five months passed between her campaign promise and the announcement of the rate cut to 1%, with a further nine-month wait before the policy actually takes effect. Takaichi previously referred the matter to a cross-party study group, which failed to reach a consensus, ultimately returning the decision to the prime minister. This outcome may reinforce criticism that Takaichi makes all key decisions unilaterally—a criticism voiced even within her own Liberal Democratic Party. If her position within the party weakens further, she may find it increasingly difficult to advance her other policy agendas.
How will the tax cut be financed? The tax cut will create a revenue shortfall of over 4 trillion yen annually, which the government must find ways to fill. Takaichi has pledged not to issue deficit-covering government bonds for this purpose, instead planning to cut wasteful spending and seek additional revenue sources. Higher-than-expected tax revenues could provide some help. Boosted by inflation and strong corporate earnings, Japan's tax revenue hit a record high last fiscal year. However, cutting spending is likely to be much more difficult. The government set up a special task force last year to review various subsidies and tax breaks. According to Japanese media reports, after examining about 120 preferential measures, the committee ultimately identified only one policy that could be abolished. Japan's public finances are already under severe strain, with government debt exceeding twice the size of its GDP. The issue of funding has unsettled investors since Takaichi first proposed the tax cut before the February election. These fiscal concerns have triggered a sell-off in Japanese government bonds, which has also affected global bond markets. Japanese bond yields are on a rising trend. Furthermore, Takaichi must also find funding for several other costly policies, including increasing defense spending and the ambitious goal of driving an additional 370 trillion yen in domestic investment over the next 14 years.
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