The government is looking into increasing business taxes, just a few days after the IMF adjusted Taiwan's annual economic growth rate down. With economic performance falling short of expectations, raising taxes will only discourage consumption, choke economic growth and create a snowball effect. It will, in fact, lead to a repeat of the so-called "Hashimoto effect" experienced in Japan seven years ago.
So what is the Hashimoto effect?
In 1998, then-prime minister Ryutaro Hashimoto determined to raise the consumption tax from 3 percent to 5 percent in a move that was very unpopular with the public. The result was reduced incentives for people to consume, and domestic demand fell off sharply. Manufacturers found it more difficult to sell their goods, and discount "everything for ?100" stores popped up all over the place. The policy put Japan in a bad situation, especially since non-performing loans, budget deficits and deflation were occurring at the same time.
The idea was that the tax increases would bring down the growing budget deficit. However, the main cause of the deficit was ineffectual investment by the government in public construction projects. What they should have done was to cut expenditures, rather than try to find ways to generate more revenues.
After the bubble economy burst in 1990, the Japanese government ploughed significant resources into construction projects in an attempt to stimulate the economy. From 1992, when Miyazaki Kiichi was prime minister, to 1996, when Hashimoto took office, the government spent ?60 trillion (US$556 million) in six investment drives to kick-start the economy. But the economy continued to barely sputter along because the decisions on where to invest were based more on local interests than a holistic view of what the economy required. The result was the construction of an inordinate amount of leisure facilities, unfinished and unused motorways stretching across the countryside and an even bigger budget deficit. In 1996 the shortfall stood at something like 70 percent of GDP.
Hashimoto set his sights on reducing the deficit when he took office in 1996 and targeted consumers, hoping to increase government revenue by raising the consumption tax. Not only did this policy fail to bring any relief to the economy, it actually reversed a lot of the hard-earned gains that had been achieved.
Further, it was the reason behind the pounding that Hashimoto's party, the Liberal Democratic Party (LDP), took in the 1998 House of Councilors election, which led to Hashimoto's stepping down. The Japanese economy has still not fully recovered.
Let's turn back now to the situation in Taiwan. When the economy started to decline in 2001, the government took a leaf out of Japan's book and increased spending on public construction to stimulate the economy. But these projects simply became political playthings for politicians. An example is the soon-to-be-completed high-speed railway. It will begin operations at a time when domestic airlines are losing money every day and politicians are under pressure to build airports, cutting into existing airports' business. And the budget deficit continues to grow every year.
The government's budget deficit already stands at 39 percent of GDP. The best course of action would be to tighten expenditures instead of concentrating on revenue generation. Still, the government seems to be sticking to the road taken by Japan. President Chen Shui-bian (陳水扁) is imitating Hashimoto's policy of raising taxes, hoping to return Taiwan's economy to its former glory. The deflation that results from the "Hashimoto effect," however, is hardly likely to be advantageous to Taiwan.
Tsai Zheng-jia is an assistant research fellow at the Institute of International Relations, National Chengchi University.
TRANSLATED BY PAUL COOPER
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