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In-depth Tax and Reform: Dealing with Japan’s Runaway Debt
Clock Running Down on Social Security Reform

Yashiro Naohiro [Profile]


Fixing Japan’s public finances requires rethinking pensions, medical expenses for senior citizens, and other costs to the social welfare system. Yashiro Naohiro, visiting professor at International Christian University, looks at what reforms are needed to make social security sustainable as the population grays.

Making Social Welfare Reform a “Fourth Arrow”

Japan’s “Abenomics” strategy continues to pursue the goal of revitalizing the economy with its “three arrows” of fiscal stimulus, monetary easing, and a growth strategy driven by structural reforms. Returning to sustained economic growth, however, will first require Japan to put its mounting public debt in check to regain a sound fiscal footing.

The graying of Japan’s population is deeply reflected in public spending on social security programs, which increased on average by ¥2.7 trillion annually over the 20 years to 2013. During the same period, social insurance premiums, which are tallied according to household income, increased by just ¥800 billion a year, being held down by stagnant wages. This has resulted in an annual shortfall of nearly ¥2 trillion that continues to be subsidized by budgetary outlays at the national and local levels. Tax revenue and economic growth have remained flat, making public bond issues the lone means of covering increases in social security benefit payments.

The government, in a bid to rebuild public finances, will increase the consumption tax from 5% to 10% in two steps by 2015 (the first increase, to 8%, went into effect on April 1, 2014). The government expects the 5-point hike to add ¥13.5 trillion annually to public coffers, but rising social security expenditures mean that the amount will only cover shortfalls for five years. Without reform, social security will have to rely indefinitely on government bonds to remain viable. Japan’s national debt is already more than twice GDP, and confidence in government bonds is among the lowest among developed nations. Further inflating the debt will have unavoidable consequences.

As part of fiscal reforms, the cabinet of Prime Minister Abe Shinzō established the medium-term goal of putting the nation’s primary balance in the black by 2020. To accomplish this, the government must swiftly carry out what amounts to a “fourth arrow” of reforms targeting the social welfare system, a major driver of government debt.

Short-Sighted Politics Slowing Reform

The current public pension and healthcare systems were first devised toward the end of Japan’s period of high-speed economic growth cresting in the 1960s. They were based on an assumption of sustained economic expansion, which during this time averaged 10% annually. Population ratio estimates for senior citizens were set at an unrealistically low 20%, even for the year 2050, when the elderly population is projected to peak. This is only half of current, more realistic, estimates—a misjudgment that shows a lack of realistic thinking among policymakers of the day. Despite widespread social and economic changes since then, lack of sufficient governmental action to shore up social security finances has resulted in the problem being kicked down the road for coming generations.

This “generational imbalance” extends beyond growing the debt to meet current obligations to social welfare recipients. Compared to future obligations, the public pension system is estimated to have a shortfall in contributions of nearly ¥480 trillion, almost equal to Japan’s GDP. The amount, however, is tabulated “Off balance sheet” and not included in official calculations. Nonetheless, it will be up to future generations to pay this back.

In August 2013, the government’s National Council on Social Security System Reform issued its final report. Despite the acute risks facing social security, the council firmly backed the current system and presented only modest ideas for reform within the existing framework.

The public pension system is widely believed to be impervious to bankruptcy. This is based on the pretense that, unlike the private sector, the government can support the system by raising taxes. In reality, though, the government’s lack of resolve to adequately use its power of taxation has caused the red ink to swell.

An absence of political will has also held back social security reform. Concerned about short-term election outcomes, politicians have avoided the issue of reform, which is publicly unpopular. For instance, the Ministry of Health, Labor, and Welfare, which oversees the social security system, has habitually avoided essential reforms by including unrealistic assumptions as part of its policies. For example, pension reform enacted in 2004 included the extreme assumption of sustained annual investment returns of 4.1% over the long term. This created a scenario, the “100-year safe pension plan,” where steady increases of payments into the pool over the long term would sustain the pension system without need for ambitious reform. A slightly revised version of this policy was also included as part of 2014 budget reforms.

Postponing Pension Eligibility

Reducing benefit payments and raising insurance premiums are fundamental ways to improve the financial stability of a pension system. Lowering the ratio of pensioners is another way to control additional increases in payouts. In the current system, annual adjustments for inflation are the sole way benefits are kept from sliding in nominal terms. To date, no adjustments have been made during deflationary periods. These restrictions should be done away with and automatic adjustment mechanisms implemented.

Raising the age at which pensioners can start receiving benefits will also work to improve budget woes by extending the period workers pay into the system and reducing the payment period. The pension eligibility age in Japan is slated to be raised to 65 in 2025 for men and 2030 for women. This is excessively low when compared to the average of 67–68 in the United States and Europe. Given that Japan boasts one of the longest average life expectancies in the world, the government should aim to raise the eligibility age to at least 70.

All developed nations face the issue of graying populations, but one benefit Japan enjoys is high motivation for employment among its older citizens. 2010 employment figures for men 60–64 years old showed Japan, at 76%, well above the United States (59%) and Germany (56%). This can be attributed to the longevity of its citizens as well as the high standard of health compared to similarly aged populations in other countries. Labor practices favoring older workers also play a role. Regardless of the reasons, the environment is favorable for a higher retirement age and should be taken full advantage of.

  • [2014.05.20]

Visiting professor, International Christian University; specially appointed professor at Shōwa Women’s University. Born in Osaka in 1946. Received his BA in liberal arts from ICU, his BA in economics from the University of Tokyo, and his PhD in economics from the University of Maryland. Has worked at Japan’s Economic Planning Agency and the OECD and served as president of the Japan Center for Economic Research. His many works include Healthcare Issues in the United States and Japan (coeditor) and Kisei kaikaku de nani ga kawaru ka (What Will Regulatory Reform Change?)

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  • Confronting Japan’s Unpleasant Fiscal ArithmeticThe Japanese government has faced stiff resistance to planned increases in the consumption tax, the first of which was implemented on April 1. But according to recent calculations, even the 10% rate scheduled for 2015 pales beside the revenue increases needed to avert a financial meltdown over the next few decades. Keiō University economist Kobayashi Keiichirō reviews this “unpleasant arithmetic” and urges the government to plan accordingly.
  • The Barriers to Budget Balance in JapanDespite the crisis-level size of its public debt, Japan continues to run large deficits financed by additional borrowing. Economic historian Okazaki Tetsuji examines the barriers to restoring health in government finances.

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