Japan's government approved on Friday a bill to double the nation's consumption tax by 2015, which is seen as an important step towards putting the public finances on a sustainable path.
This will happen in two stages with the first increase from the current 5 percent rate to 8 percent taking place in April 2014. The tax will reach 10 percent in October 2015.
The hike is an initiative of Japanese Prime Minister Yoshihiko Noda, who ignored the opponents of the legislation even within the ruling Democratic Party.
Raising the consumption tax appears to be the best option, and it could actually support growth, says Capital Economics.
Notably, the consumption tax will provide a stable source of revenue in an ageing society like Japan. It provides a broader base than a tax on labor income, which will decline as the working population declines.
The rate of consumption tax in Japan is also very low by international standards, Capital Economics has noted. Increasing the rate to 10 percent would still leave it at half the level of the UK and half the average in the Eurozone.
Opponents to the current tax hike say the economy is not strong enough to support the increase. They say the government first had to resolve Japan's problem with deflation. But this is a misguided argument, says Capital Economics.
The International Monetary Fund has forecast that an incremental increase in the consumption tax to 15 percent over five years will lower gross domestic product growth by just 0.3 percentage points per year on average during the first three years. After five to six years the impact on GDP growth will turn positive as public debt declines, and improved confidence reduces precautionary saving and boosts spending.
According to Capital Economics, the current fiscal year would be a good time to implement the first increase in the consumption tax. Any detrimental effects on GDP growth will be largely offset by the boost from reconstruction spending.