AN UNFORTUNATE GAMBLE
What explained the decision by the Japanese government to increase taxes in the 1990s when the economy
was still suffering from a recession?
The Japanese government sharply increased taxes on consumption in 1997—just as Japan was in the midst of its prolonged
recession. Why did the government do this?
The reasons were clear. As the economy slumped, fiscal deficits were increasing, as taxes fell and government spending rose.
Policy makers understood that their society was aging rapidly and that this would mean even more demands on the public
sector in the near future. They became convinced that the current fiscal deficits plus the inevitable future demands on the
government would lead to long-run increases in government spending. To avoid crowding out of investment in the future,
they decided to tax consumption in order to reduce it. Their goal was to match the increases in government spending with
decreases in consumption spending and therefore not experience crowding out of investment.
Although policy makers were right to consider the long-run consequences of increases in government spending, they made
the unfortunate gamble that the short-run effects of the tax increase would not hinder the economy’s recovery. They were
wrong, because the tax increase prolonged the recession. Although it is important to consider the long-run consequences of
policy, it is important to understand the short-run consequences as well.
-According to the application, what was the reason why the Japanese government increased consumption taxes in the 1990s?