Posted: March 23rd, 2015

The announcement of increasing sales tax resulted in a shopping frenzy as the Japanese tried to avoid higher costs of commodities. The massive shopping spree increased private consumption before the implementation of the proposed sales tax increase. Consequently, the aggregate demand for various items increased exponentially during the first quarter of the year. Once the tax was implemented, the aggregate demand suffered a great contraction during the second quarter. The contraction occurred because many people sought to lower their expenditures by reducing the amount of money spent on luxury items. The sales tax also increased the prices of goods and this discouraged buying. Investment in the housing sector and business growth also increased as the GDP reduced by an average of 1.7%.
Increasing sales tax rates can be classified as a contractionary economic policy since it results in reduced aggregate demand of products. When the government increase sales taxes, the price of commodities also increases and this discourages spending. Higher sales taxes reduce public consumption since the amount of disposable income decreases. Consequently, the inflationary pressure is decreased.
Increasing the sales tax when the economy is experiencing an economic slow-down is not a good idea. This is because increasing sales taxes increases the price of commodities and discourages households from spending. Higher sales taxes also result in less disposable income available to households. When households have less disposable income, or are discouraged from spending, businesses suffer because they make less profit. This makes the businesses to reduce their investment expenditures. Eventually, the government is adversely affected by the cascading effect of increased sales taxes because unemployment rates increase while the GDP reduces. The government also affected because the net exports from the country are reduced as productivity of businesses reduced.

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