Japan’s Prime Minister Shinzo Abe said his government will raise the rate of sales tax to 8% from 1 April next year, from the current 5%.
Policymakers have argued that the hike is key to reducing Japan’s public debt – which now stands as around 230% of its gross domestic product (GDP).
There have been concerns that such a move may hurt domestic demand.
However, analysts said recent data showing signs of a recovery in the economy had helped allay those fears.
Legislation passed by Mr Abe’s predecessor last year had called for the rate to be raised.
The government needs to increase its revenue as it looks to fund rising welfare costs, driven by an ageing population.
It is estimated that 40% of Japan’s population will be of retirement age by 2060.
Mr Abe was quoted by the AFP news agency as saying the tax hike was aimed at “maintaining the nation’s trust and handing over a sustainable social security system to the next generation”.
He added that his government would unveil a fresh stimulus package to ease the impact of the hike on businesses and households.
Earlier on Tuesday, the Bank of Japan’s closely-watched Tankan survey showed a sharp improvement in sentiment among Japanese manufacturers.
The big manufacturers’ index rose to plus 12 in the July-to-September quarter, from plus 4 in the previous three months.
Manufacturers also plan to increase their spending in the current financial year, which should help boost growth.
The improvement comes amid signs of a recovery in the Japanese economy after years of stagnant growth.
“Japan’s economy is on track, and the tankan has shown broad-based improvement in sentiment,” said Yasuo Yamamoto, a senior economist with Mizuho Research Institute in Tokyo.
“Manufacturers had been lagging the overall economy, but the tankan shows improvements in this sector are starting to catch up due to exports and a weak yen.”
The sentiment indexes are calculated by subtracting the percentage of respondents who say business conditions are poor from those who say they are good.
A positive reading means optimists outnumber pessimists.
Prime Minister Shinzo Abe, who came to power in December last year, has unveiled a series of aggressive policy measures aimed at reviving Japan’s economy.
LAST UPDATED AT 01 OCT 2013, 02:46 GMT
His moves, which have come to be known as Abenomics, have started to have some impact on Japan’s growth.
At the same time, Japan’s central bank, the Bank of Japan, has also taken some steps – including setting a 2% inflation target and doubling the country’s money supply – to help boost growth.
These measures have resulted in a sharp decline in the yen’s value. The Japanese currency has fallen nearly 25% against the US dollar since November last year.
A weak yen bodes well for Japan’s large manufacturers, who rely heavily on exports for their growth, as it makes their good more affordable for foreign buyers.
It also helps boost their profits when they repatriate their foreign earnings back home. Many leading Japanese firms have reported an improvement in profits recently.
Analysts said that an improvement in earnings, coupled with the signs of a recovery in the Japanese economy, had helped boost morale.
“Earnings recovery on the back of a weaker yen, which affected only limited sectors at the time of the previous survey, has spread to a wider part of industry,” said Yoshimasa Maruyama, chief economist with Itochu Economic Research Institute in Tokyo.