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Japan’s big gamble to stave off fiscal nightmare

Japanese Prime Minister Yoshihiko Noda has wrangled a deal with the opposition to double the consumption tax and whittle down government debt, which is already double GDP. On paper, it's a good start. In Japan's toxic political environment, though, it's a big risk. Because the tax hike will hit the country's growing population of retired voters, the bill's passage – or indeed failure – could wind up costing Mr. Noda his job. That would derail other reforms needed to avoid a sovereign debt crisis.

Japan has two big concurrent problems: Its debt is growing while its population is shrinking. The government's ¥959.9-trillion ($12.3-trillion) of debt has doubled in the past 15 years, and, net of Japan's overseas lending, now amounts to around 125 per cent of GDP. Thanks to longer lifespans and falling birth rates, its population is aging – nearly one in four Japanese are 65 or older – and shrinking. The number of Japanese declined by 0.2 per cent last year and is on course to shrink a third by 2060. It could face a Greek-style fiscal crisis much sooner, when more retirees begin drawing down on their savings, which today finance the country's borrowing.

Raising income taxes isn't likely to be particularly effective in a country where a large and rising segment of the population no longer works.

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Doubling the sales tax could cut net debt by 2.5 per cent of GDP by 2020, the IMF estimates. But that's not enough to keep it from rising. For that, Japan needs to raise the consumption tax rate to as high as 15 per cent as well as cut corporate taxes, increase the retirement age and reduce tax and pension exemptions for homemakers.

None of these options will appeal to aging or already-retired voters. Opposition politicians appear to have won a promise from Mr. Noda's party for snap elections in return for their support. But rebel party members on both sides of the aisle may scuttle the deal, forcing the Prime Minister to call elections. Either way, the read for markets is bleak: No Japanese government looks capable of staving off the country's coming fiscal nightmare any time soon.

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