Japan's sales tax: What you need to know

People trying out laptops displayed at an electronics retail store in Tokyo on Nov, 16, 2014. Japan's economy unexpectedly slipped into recession in the third quarter on Nov 17, 2014, setting the stage for Prime Minister Shinzo Abe to delay an unpopu
People trying out laptops displayed at an electronics retail store in Tokyo on Nov, 16, 2014. Japan's economy unexpectedly slipped into recession in the third quarter on Nov 17, 2014, setting the stage for Prime Minister Shinzo Abe to delay an unpopular sales tax hike and call a snap election half-way through his term. -- PHOTO: REUTERS

Japanese Prime Minister Shinzo Abe has decided to postpone by 18 months a controversial sales tax increase. It was orginally scheduled for October next year, but has now been pushed to April 2017 after fresh data showed that Japan has slipped back into recession.

The planned hike is a follow-up to this April's increase, from 5 to 8 per cent.

The sales tax has been a political hot potato, with several Japanese leaders in the past losing their jobs over this unpopular levy.

Here's a look at what prompted Mr Abe's postponement, and how it could affect Japan's economic fortunes in the long run:

Background on the sales tax in Japan

The idea of a consumption tax was mooted by Prime Minister Ohira Masayoshi's administration in 1979, but it was abandoned because of public opposition. Japan waited until 1989 to catch up with other countries on this, and introduced a 3 per cent tax.

By 1997, soaring public debt prompted then Prime Minister Ryutaro Hashimoto to push the sales tax up to 5 per cent. The economy slid into a recession, pushing Japan deeper into deflation. The tax hike also cost Mr Hashimoto his job.

Mr Abe came into office in December 2012. He inherited the plan to raise the sales tax in two stages from his predecessor, Mr Yoshihiko Noda.

The first instalment of the tax hike - from 5 to to 8 per cent - was implemented in April this year. It was the first sales tax hike in 17 years.

On Nov 18, Mr Abe said he would delay the second planned hike to raise tax to 10 per cent. It would only take place in April 2017. He also announced snap elections.

Why the need for the sales tax?

Sales tax, by definition, is a fee charged on products and services. It serves to generate additional revenue for state coffers. In the case of Japan, revenue collected from the sales tax will help fund swelling social security costs in the fast-ageing country, and also curb a public debt that is already twice the size of the economy.

What led to the recent policy change?

The world's third-biggest economy unexpectedly shrank for a second consecutive quarter in July-September, fresh data released on Nov 17 showed. Analysts say it is a sign that the pain from April's hike was lasting longer than expected.

The April hike led to a fall in household and consumer spending, which account for nearly 60 per cent of the Japanese economy.

What next?

Analysts told CNBC the delay in a consumption tax increase would do little to foster economic growth. Some analysts say the delay was just a short-term solution which does not solve Japan's fiscal woes.

On Nov 18, Mr Abe took care to avoid the impression that Japan was abandoning fiscal reform.

"We are by no means surrendering the flag of fiscal reform," he said.

"The tax rise will not be delayed a second time," he said, adding that a legal clause allowing future delays would be removed.

SOURCES: Reuters, AFP