“Inflation Keeps Wallets Shut” Japanese Household Spending Contracts for Eighth Straight Month, as Tax Cuts Raise Revenue and Fiscal Risks

Japanese household spending squeezed by high inflation and declining disposable income
“From 8% to 1%”: Takaichi government moves to cut food consumption tax
Backlash feared when tax rate is restored, alongside fiscal strain from revenue shortfall

Real household spending in Japan continues to decline. Persistently high inflation and falling disposable income have prevented households’ spending capacity from recovering. Prime Minister Sanae Takaichi’s Cabinet is pursuing a food consumption tax cut to counter the downturn, but questions remain over the policy’s sustainability. The measure is unlikely to deliver a substantial economic boost and risks compounding fiscal pressure by creating a massive shortfall in tax revenue.

Japanese Consumer Spending Contracts

According to Reuters on Sept. 4, citing Japan’s Ministry of Internal Affairs and Communications household survey, inflation-adjusted spending by households with two or more members fell 3.6% year over year in July. The decline was more than twice the 1.6% contraction forecast by the market and marked the eighth consecutive monthly decrease since last December. By category, housing expenditure fell 16.4% to $112, slipping into negative territory for the first time in six months, while spending on fuel, utilities and water dropped 9.2% to $119, extending its decline to a fifth straight month. Transportation and communications expenditure also fell 8.5% to $283, marking a third consecutive monthly contraction.

Elsewhere, medical and healthcare expenditure fell 6.0% to $104, its first decline in 14 months, while education spending contracted 5.4% to $47. Expenditure on clothing and footwear edged down 0.3% to $65, and other consumer spending decreased 3.5% in real terms to $278. Food expenditure rose 2.2% in nominal terms to $618, but fell 1.3% after adjusting for inflation, extending its decline to a second consecutive month.

Inflation Erodes the Benefits of Wage Growth

Prolonged inflation is widely regarded as the principal factor weighing on household consumption. According to Japan’s Ministry of Internal Affairs and Communications, the nationwide consumer price index (CPI) rose 1.9% year over year in July. This was 0.3 percentage points higher than June’s 1.6% increase. Core CPI, which excludes both fresh food and energy, also rose 1.9%, accelerating by 0.2 percentage points from 1.7% the previous month. The corporate goods price index (CGPI) surged 7.2% year over year in July, far outpacing consumer inflation. The cost pressures accumulated at the corporate level are therefore likely to be passed through further to retail prices after a time lag.

Soaring prices have substantially offset the improvement in purchasing power generated by wage growth. Data from the Ministry of Health, Labour and Welfare showed that nominal cash earnings per worker rose 3.4% year over year in June, while scheduled cash earnings, which correspond to base salaries, also increased 3.4%. However, according to the Ministry of Internal Affairs and Communications, the average monthly income of working households with two or more members fell 1.7% in nominal terms year over year to $4,455 in July, while real income calculated using the CPI excluding imputed rent for owner-occupied housing declined 3.8%. Real disposable income after non-consumption expenditure fell 3.1% to $3,582, while the average propensity to consume—the share of disposable income used for consumption—declined to 58.2% from 60.5% a year earlier, a decrease of 2.3 percentage points.

Takaichi Plays the Tax-Cut Card

The Japanese government is pursuing a sweeping tax-cut plan to ease the consumption slump. Since last year, Japan’s political establishment has faced persistent calls to lower the consumption tax itself and expand households’ spending capacity, amid arguments that cash handouts and wage increases alone would be insufficient to revive domestic demand. Ahead of last July’s House of Councillors election, major opposition parties, including the Constitutional Democratic Party of Japan and the Japan Innovation Party, pledged to reduce or abolish the consumption tax on food, while Komeito proposed cutting the current rate from 8% to 5%. Prime Minister Takaichi, who took office last October, subsequently pledged to abolish the current 8% food consumption tax for two years when she called an early House of Representatives election in January.

After securing a landslide victory in the February House of Representatives election, Takaichi’s Liberal Democratic Party began designing the policy. During the deliberations, a proposal to lower the food consumption tax rate from 8% to 1% for two years beginning in April 2027 gained momentum, reflecting concerns over the burden that system upgrades would impose on distributors and retailers. Takaichi finalized the government proposal on July 30, and the government formally approved the underlying policy at an extraordinary Cabinet meeting on Aug. 5. Officials are currently coordinating details such as how prices will be displayed following the rate change, and the relevant legislation is expected to be submitted to an extraordinary Diet session this autumn.

Clear Limitations in Policy Design

The problem is that the policy could trigger substantial repercussions. The Takaichi Cabinet plans to lower the food consumption tax rate next year and restore it to the current 8% two years later. For consumers accustomed to the lower rate for two years, however, restoring the tax is likely to be perceived not merely as the expiration of temporary relief but as an effective tax increase that drives food prices higher again. Public opposition could be even stronger if wages have not risen sufficiently by the time the tax cut expires or if food prices remain elevated. The government therefore plans to introduce an “income-linked benefit” when the rate is restored, under which a fixed amount is deducted from the tax owed and any portion of the deduction exceeding the tax liability is paid in cash to low- and middle-income workers. However, the income-linked benefit is scheduled to be paid each autumn, creating a support gap of roughly six months in 2029 between the consumption tax increase in April and the disbursement of benefits in the autumn.

It also remains unclear how the government will offset the revenue shortfall created by the consumption tax cut. Daiwa Institute of Research estimates that lowering the food consumption tax rate from 8% to 1% would reduce annual tax revenue by $28.43 billion, while increasing gross domestic product by only $1.94 billion. This means that the economic stimulus generated by the tax cut alone would be insufficient to compensate for the lost revenue. Takaichi has said that the government will not rely on additional deficit-financing bond issuance, but no concrete alternative funding source has yet been presented.

Table 1. Expected Adverse Effects of the Takaichi Government’s Tax-Cut Policy

Market Attention Turns to Fiscal Risks

The revenue shortfall could deal a substantial blow to Japan’s public finances, which are already burdened by massive debt and interest payments. Japan has issued enormous volumes of government bonds at low interest rates under its prolonged ultra-low-rate policy. According to Japan’s Ministry of Finance, the outstanding balance of general government bonds is projected to reach $7.40 trillion by the end of fiscal 2026. Given the recent full-fledged rise in interest rates, the government’s interest burden is also likely to increase further as low-yielding bonds reaching maturity are refinanced with new securities issued at higher rates. The Japanese government’s interest payments in fiscal 2026 have already surged to $84.01 billion, approximately $16.15 billion higher than the $67.85 billion allocated in the original budget for the previous fiscal year. The ministry explained that $9.69 billion of the increase resulted from the refinancing of existing government bonds.

Investors are already reacting sensitively to these risks, with particularly pronounced changes emerging in the bond market. The yield on Japan’s 10-year government bond climbed as high as 3.023% intraday on Sept. 2, its highest level in roughly 30 years since 1996. Ultra-long-term yields also rose sharply that day, with the 20-year bond trading at 3.885%, the 30-year bond at 4.155% and the 40-year bond at 4.250%. Yields have since fallen only marginally. As of Sept. 4, the two-year government bond yield remained at approximately 1.82%, the five-year yield at 2.22%, the 10-year yield at 2.89%–2.91%, the 20-year yield at 3.70%–3.73%, the 30-year yield at 3.97%–3.99% and the 40-year yield at 3.97%–4.07%. The steep upward-sloping yield curve, with rates rising from short- to long-term maturities, indicates that investors are demanding higher risk premiums for medium- and long-term inflation, the prospect of further interest-rate increases and mounting fiscal burdens.