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Vol. 37, No. 1, February 2010

Social Security Reform

An urgent item on Japan’s economic agenda is reform of the social security system. According to the government’s Annual Report on the Japanese Economy and Public Finance for fiscal 2009 (April 2009 to March 2010), social security expenditures, which consist of pensions, healthcare, and other welfare outlays, have risen continuously over the past several decades, swelling from about 12% of gross domestic product in the 1980s to above 17% from 2003 on. And the biggest contributor to the increase has been pension benefits. Spending on these benefits rose from roughly 2% of GDP in the early 1970s to 9% in 2007 and now accounts for half of all social security expenditures.

This rapid increase in pension outlays is directly related to the aging of Japan’s population. Although Japan is not the only industrialized country where a demographic shift is driving up social security costs, few other populations in the world are aging as rapidly as Japan’s. In 1980, the aged dependency ratio (the ratio of people aged 65 and over to those between 15 and 64 years of age) was 13%, the lowest among the Group of Seven nations. This percentage grew dramatically in the 1990s, and by 2007 it was 33%, the highest in the world.

The Japanese government has already implemented a number of pension-system reforms aimed at restraining the growth in pension outlays as the population ages. The reforms of 1994 and 2000 raised the age of benefit commencement from 60 to 65 and cut benefit levels for the earnings-linked plans. However, these shifts in the balance between burden and benefits undermined younger workers’ confidence in the system, leading to a further drop in contributions.

Then in 2004, the administration of Prime Minister Koizumi Jun’ichirô announced a reform plan to guarantee "peace of mind for 100 years" with something called a "macroeconomic slide" mechanism. According to the official explanation, this mechanism would function to adjust benefit levels in order to stem the increase in premiums and impose a ceiling on the future burden of contributions while keeping payouts within the limits of contribution revenues in consideration of the dwindling number of contributors and the rise in longevity. But as Nishizawa Kazuhiko points out in his article in this section, the macroeconomic slide—which has no direct connection to macroeconomic trends—was designed on the assumption that consumer prices and wages would rise steadily over the next 20–30 years—conditions that the Japanese economy has failed to meet since the reform went into effect in 2004. To the contrary, ongoing deflation has created macroeconomic conditions exactly the opposite of those assumed by the system’s designers, with the result that the mechanism has done nothing to hold down pension payouts. Clearly it is imperative that the mechanism be overhauled with these problems in mind. But as none of our political leaders have pursued the issue, the situation continues under the new government led by the Democratic Party of Japan, which took power last September.

It is interesting to note, meanwhile, that in a recent opinion survey on the public burden and benefits (Shûkan Tôyô Keizai, September 12, 2009), respondents open to an increase in the consumption tax (the combined percentage of those answering "I favor it" and "It can’t be helped") outnumbered opponents 48.3% to 46.8%. The most common reason given for supporting an increase was the need to enhance healthcare, long-term care, and old-age pensions.

The current public pension system is a combination of three separate plans. The National Pension collects contributions from participants at a single flat rate and pays out universal benefits, referred to as the "basic pension." In addition, employed people are expected to enroll in either the Employees’ Pension or a mutual aid pension plan (depending on their profession), whose contributions (including a National Pension contribution) are set at a fixed percentage of their monthly income. In addition to contributions from participants and employers, the current system is financed by money from the national treasury and a reserve fund.

The electoral manifesto in which the DPJ set forth its policy platform last summer included a pledge to integrate the three aforementioned plans into a single unified system with two components. The first would consist of a guaranteed minimum pension financed by the consumption tax; the second would be an income-proportionate pension paid for by and commensurate with contributions. The former would attempt to address the problems of those who are ineligible for pension benefits or are delinquent in their payments by ensuring that every citizen receives pension benefits of at least ¥70,000 a month. The latter would integrate the Employees’ Pension and mutual aid schemes, thus allowing people to change professions without going through the cumbersome red tape of changing pension plans, and it would extend income-linked benefits to the self-employed and others previously eligible only for National Pension benefits. Thus, people currently enrolled in the National Pension scheme, who now pay a single flat-rate premium, would pay income-linked contributions and receive income-linked benefits.

But the DPJ’s reform plan leaves a host of questions unanswered. It is vague on the critical issue of financing, offering no timetable for the required consumption-tax hike. Another concern is the government’s ability to accurately assess the income of the self-employed. (The DPJ manifesto proposes addressing this problem by merging the Social Insurance Agency and the National Tax Agency to create a new "Revenues Agency" that would integrate the collection of taxes and social insurance premiums and by introducing a taxpayer identification number system.)

More importantly, as Nishizawa points out, the DPJ pension reform plan glosses over the harsh reality of Japan’s situation. Despite all the talk of an "income-linked pension," the fact is that Japan’s public pension system is funded on a pay-as-you-go basis, meaning that today’s workers are financing the benefits paid out to today’s pensioners. And the fundamental problem Japan faces is that a pay-as-you-go system is unsustainable in the context of a rapidly aging demographic structure. The Japanese people must be made to understand this.

The DPJ manifesto leaves unaddressed other practical issues as well. As Nishizawa points out, this kind of fundamental systemic reform cannot be accomplished overnight. How will the government manage the transition? How will it lay out for voters the nature of the system its reforms will usher in? Will the DPJ’s plan to fund the basic pension with the consumption tax placate those citizens who have dutifully paid into the National Pension system only to see the same level of benefits going to people who shirked their payments? Given these unanswered questions and the uncertainty of Japan’s economic outlook, one must ask whether the new administration can fulfill its commitment to put the legislative framework for the new system in place by 2013.

Meanwhile, one of the flagship policies of the new DPJ administration is a proposed universal "child allowance" of ¥26,000 per child per month, regardless of household income. Apart from the issue of financing, the policy’s basic problem is the lack of a coherent purpose. The Democrats themselves seem confused as to the object of the allowance: Some speak of it as a short-term stimulus measure to promote consumer spending, others seem to see it as a long-term policy to boost Japan’s low birthrate, and still others stress its importance as a social welfare policy to help households struggling with child-rearing expenses. These are three distinct objectives, and no economic policy can efficiently kill three birds with one stone. In the other article in this section, Miyamoto Tarô argues that the DPJ has an opportunity to design a coherent livelihood-security policy that would contribute to economic growth by focusing on employment. He notes in particular that benefits designed to make it easier for women to work after they have children can boost economic vitality over the long term. Of course, the other side of the coin is that an overly ambitious welfare program built on a weak fiscal foundation is sure to undermine confidence in the economy. Miyamoto warns that a poorly thought out mix of policies would not only drain the nation’s economic vitality but waste a precious opportunity to encourage sustainable job creation. Policies for short-term job creation are not always compatible with the goal of sustainable employment. The ability to balance and prioritize short-term and long-term needs has emerged as a major concern under the fledgling DPJ administration, and it will be a key focus of attention as the cabinet drafts a budget for the fiscal year starting in April 2010. (Nariai Osamu, Professor, Reitaku University)

© 2010 Japan Echo Inc.