TOKYO — Prime Minister Shinzo Abe went ahead Tuesday with a much debated sales tax hike needed to offset Japan's soaring public debt, gambling that the country's economic recovery is strong enough to absorb the shock.
The sales tax will rise to 8 percent in April from the current 5 percent, Abe announced at a policy meeting of ruling party and top government officials. The Cabinet also cleared the increase.
Abe promised a 5 trillion yen ($51 billion) package of tax breaks, plus 1 trillion yen ($10 billion) in tax cuts, along with other stimulus measures meant to counter the wallop to consumer demand from the tax hike. He said details would be worked out by December.
Economic stimulus without a tax hike would be unsustainable, and so would raising taxes without economic stimulus, Abe said.
"The only way is to do both," he said. "I seek your understanding."
In opting to press ahead with the tax increase, Abe judged the world's third-largest economy robust enough to withstand that blow. Holding back might have provoked a backlash from international investors worried over Japan's ability to handle its public debt, which is the highest among developed nations as a percentage of GDP. Experts say the tax increase is crucial to getting government finances under control.
The decision comes after a survey showed improved business confidence among Japanese companies.
Results from the Bank of Japan's "tankan" quarterly survey showed large manufacturers were especially upbeat, with a reading of positive 12, up from 4 in the July survey.
The tankan's results contrast, however, with data for August showing higher unemployment and lower factory production and household spending. Industrial output fell 0.7 percent from the previous month after a 3.4 percent jump in July, according to the Ministry of Economy, Trade and Industry.
Improved hiring and wages are needed to spur a rebound in consumer spending to help underpin a sustained recovery after years of stagnation, economists say.
"A key reason for the weakness in consumer sentiment is presumably the surge in inflation while wage growth remains subdued," Capital Economics said in a commentary that forecast growth would slow in the current quarter.
Abe said the economic package would link job creation and wage increases to tax breaks intended to encourage investment and home buying.
It also would pay subsidies of 10,000 yen-15,000 yen ($100-$150) per person to low income households.
Since taking office late last year, Abe has sought to jolt the economy out of the doldrums with a combination of ultra-easy monetary policy and hefty government spending. He has also promised to promote reforms, such as deregulation of some industries, meant to boost Japan's longer-term competitiveness — most of which have yet to be enacted.
Meanwhile, the weakening of the Japanese yen as the central bank has flooded the economy with cash from asset purchases has raised costs for both households and businesses, since much of the country's food and fuel is imported.
By "reflating" the economy, Abe hopes to break out of deflation that has discouraged investment by companies facing shrinking markets.
Public spending will help counter some of the impact from the sales tax, though "domestic consumption will be quite weak," said Hiromichi Shirakawa, chief economist in Japan for Credit Suisse Group.
If domestic demand weakens significantly, "2015 could be a tough year for Japan," he said.
The economy grew 3.8 percent in April-June after recovering from recession late last year. But it is expected to slow as boosts to public spending announced earlier in the year wind down. Economists expect a boost from "front-loading" of purchases by businesses and individuals ahead of the tax hike, followed by a blow to growth from higher prices and taxes over the next few years.
Abe's options were to shelve, delay or amend the tax hike if he judged it too risky.
He could have opted for a more gradual approach, raising taxes by 1 percentage point a year over several years. However, the Finance Ministry and central bank had pushed for faster progress on cleaning up the nation's finances.
Another increase is expected to raise the sales tax to 10 percent by 2015 — a decision Abe said would require further study.
While that is low by the standards of European countries where sales taxes can be over 20 percent, it is a tough sell in Japan, where the first sales tax, of 3 percent, drew howls of protest when it was imposed in 1989.
A hike in the tax to 5 percent in 1997 is widely regarded as misguided fiscal austerity that plunged Japan back into recession.
Associated Press writers Mari Yamaguchi and Emily Wang contributed to this report.