Smoking, Obesity, Social Security, and Finance

In the major developed countries, high and climbing public debt has been the subject of controversy in macroeconomic policy. Financial uncertainties emerged in Europe and still persist, as observed during the financial crises and surge in interest rates on the government bonds of Ireland and Greece. This is not just someone else's problem. According to the "Outstanding Government Bonds and Borrowings as of the end of 2010," announced recently by the Ministry of Finance, Japan's cumulative government debt has reached 919 trillion yen. As is well known, Japan's ratio of government debt to GDP is the highest among all OECD countries, causing Standard & Poors recently to downgrade Japanese Government Bonds (JGB) to AA-. Amid the increasing attention in the market to sovereign risk, it is vital to secure fiscal sustainability and avoid unexpected macroeconomic shocks.

The principal factors behind the deteriorating national finance are generally thought to be the increase in public investment as multiple economic stimulus packages were introduced during the "lost decade" in the 1990s, and the expansion of fiscal policy measures following the Lehman shock. However, the deeper structural problems are the rising social security benefits and the delay in securing financial resources to pay for such benefits. According to The Cost of Social Security in Japan for Fiscal Year 2008 report issued by the National Institute of Population and Social Security Research, social security benefits paid increased by 2.9% compared with the previous year, to over 94 trillion yen, and its proportion of national income also rose by 2.6 percentage points year on year, to 26.8%. The breakdown of the amount is as follows: "Medical care" rose 2.3% to 29.6 trillion yen; "Pensions" rose by 2.6% to 49.5 trillion yen; and "Welfare & Others" rose by 5.1% to 14.9 trillion yen. Thus, social security benefits grew in all areas (see figure 1). To address this situation, an integrated reform of taxation and social security has been a major item on the policy agenda.

There is a close relationship between smoking, obesity and social security benefit expenses; this has stimulated research on smoking and obesity in the growing area of economics. Studies on smoking and obesity are now often published not only in specialist journals on medical care and labor economics, but also in the top economics journals. Indeed, the theme of the panel discussion of the Japanese Economic Association last autumn was "Obesity, Smoking, and Multiple Consumer Loans: Social Pathology from the Perspective of Behavioral Economics."

A large body of empirical literature shows that smoking has harmful effects on health and longevity. For instance, Cutler et al. (2009) estimated that the decrease in the number of smokers contributed 1.2 percentage points over the past 30 years to the 3.9% fall in the mortality rate of American citizens aged 55 to 74 years old. For reference, the OECD Health Data reports that the smoking rate in Japan is approximately 26%, the 6th highest among the comparable 27 countries. Only Greece, the Netherlands, Ireland, Turkey and Spain have higher smoking rates, and several of these countries are now facing fiscal crisis.

Following a significant cigarette tax increase in Japan in October 2010, the price of Mild Seven was raised from 300 yen to 410 yen per pack. As a result, there was massive last-minute buying, and this had an impact on economic trends. According to the Survey of Household Economy, expenditure on cigarettes per household in September surged 145% year on year, then cigarette sales by volume in October plunged 70% year on year, causing the October sales of convenience stores to plunge 3.3% year on year, partly as a result of the decrease in "incidental buying" by customers. Faced with a 37% price hike in Mild Seven, if a smoker buys enough cigarettes to last several months prior to the hike, it should be a low-risk/high-return investment with a profit ratio of around 150% per annum. Even though the result would be different if the long-term health costs are taken into consideration, smokers' behavior was highly rational in the short run.

Meanwhile, in the United States obesity is now attracting more Frijters and Barón (2009) analyzed the relationship between obesity, medical expenses and longevity based on the Health and Retirement Study (HRS) data of the United States, and found that obesity is certainly a cause of chronic diseases that can shorten life, but obese people have a high tendency to live longer than non-obese people through early detection of disease when affected by cardiac/lung diseases, as they tend to undergo many expensive medical examinations. Further, their study also noted that almost 85% of approximately 70 billion dollars on annual medical expenses relating to obesity is borne by society as a whole, not the obese people themselves; given such externality of obesity, one possible economic response would be a tax in the form of different medical expense payments by obese people depending on their degree of obesity.

The OECD Health Data shows that in Japan, the obesity rate is 3.4%, the lowest among the comparable 25 countries. But if "overweight" people are included, the number jumps to 25.1%, although this is still much lower than the percentages in Europe and the United States. In Japan, the "Specific Medical Checkup/Medical Health Guidance" (the so-called Medical Checkup for Metabolic Syndrome) was introduced in 2008. There are concerns of a growing witch-hunt against obesity, similar to that against smokers.

Liu et al. (2010) discussed—based on their analysis of the relationships between smoking and body weight in the United States—that the probability of obesity for smokers is 9.4% or 18.5 percentage points lower than that for non-smokers and those quitting smoking, and estimated that a ban on smoking in the workplace led to a 0.31 percentage point increase in obesity, with a decrease in smoking likely to cause an increase in obesity. Hence, smoking and obesity are not independent phenomena.

Let us return to the opening story and the relationship between smoking, obesity, public finances, and social security. Although non-smokers are generally considered to help cut medical expenses and thus have a favorable impact on fiscal policy, it is not so simple. Michaud et al. (2009) conducted an interesting study, using a microsimulation model based on the HRS data of the United States, and estimated the impacts of the trend of increasing obesity and decreasing smokers on medical expenses, labor supply and fiscal balance. The key feature of their study was that it considered the impacts not only on medical expenses but also on pension benefits. They concluded that an increase in obesity and a decrease in smoking will negatively affect the fiscal deficit. While the increase in obese people will reduce pension benefits through shorter longevity, the surge in medical expenses will overwhelm the decrease in pension payments. On the other hand, the decrease in smokers will cause the mortality rate to fall, leading to an increase in the burden of pension payments which will exceed the relatively small decrease in medical expenses. As a consequence, net government debt will rise. Although it is not acceptable to encourage smoking and discourage obesity on economic grounds alone, this research paper shows that these two factors are important in social security calculations.

The aforementioned studies indicate that cigarettes are actually closely related with not only tax revenues but also budget expenditure, and that the medical system and pension system, which tend to be discussed separately, have various trade-off and complementarity relations.

Naturally, given the difference in the medical and pension systems, as well as the difference in smoking rate and obesity rate between Japan and the United States, the results for the US cannot be applied directly to Japan. Also, it is hard to imagine that a change in the cigarette tax rate and the change in the metabolic syndrome examination program will affect interest rates on JGBs. However, those papers do suggest that smoking and obesity are likely to affect fiscal sustainability through unexpected channels. Also, they highlight the importance of analyses based on detailed basic data including HRS data reflected in the evidenced-based policy formation. RIETI is now establishing a series of panel surveys of middle-aged and older people (JSTAR), and will apply the results to empirical studies.