Issues Facing the Japanese Economy in 2013 (January 2013)
Resuming the Discussion on the Separation of the Social Security Budget is the Key to Achieving Reform for the Next 25 Years
Consulting Fellow, RIETI
2013 is the 25th year in the Heisei Period—marking its quarter-century anniversary. During this period, the Japanese economy has managed to survive the collapse of the bubble economy, the non-performing loan problem followed by the financial system crisis, and the collapse of Lehman Brothers followed by the European debt crisis.
On the other hand, various issues remain unsolved, including the decreasing growth rate and deflation, nuclear power generation and energy, and the aging population and the low birthrate associated with rapidly increasing social security costs and government debt (as a share of the gross domestic product (GDP)).
With the new administration's framework being formulated, new policies are expected to be announced over time. It is hoped that this milestone year will be a turning point in the Japanese economy.
Looking ahead at the coming 25 years, without being short-sighted, is important in discussing this turning point. The crucial question we face today is how to rebuild the nation's social security system at a time when its population is aging rapidly due to a persistently low birthrate.
Cost of social security benefits topping 100 trillion yen
The amount of social security benefits paid in fiscal 2010 (April 2010 - March 2011) exceeded 100 trillion yen. As shown in the chart below, this is in line with the forecast by the Ministry of Health, Labour and Welfare (MHLW) in its "Forecast of Benefits and Costs of Social Security" (May 2006), and social security payments will continue to increase in the future.
(Source) Prepared based on "The Cost of Social Security in Japan" (Fiscal Year 2007) published by the National Institute of Population and Social Security Research (IPSS) and "Forecast of Benefits and Costs of Social Security" (Estimates as of May 2006) by the MHLW
The question we are facing is how to control the swelling cost of social security benefits. Against this backdrop, the National Council for Reform of the Social Security System started its discussions in late November 2012. It plans to discuss mainly the four areas of issues—pension, medical care, and long-term care programs, and measures to increase the number of children—toward framing conclusions by August 2013. Reportedly, measures to control the cost of benefits, such as raising the pension eligibility age, are expected to become the focal point.
Separating the social security budget from the rest is the key
However, while raising the pension eligibility age is an important topic of discussion, social security reform is doomed to fail if the amount of benefits paid out continues to exceed that of premiums collected. Thus, what is of foremost importance is to clarify how the cost of social security benefits is being financed and separate the social security budget from the rest of the government budget (i.e., elimination of transfers from the general account to the social security account.)
The concept of separating the social security budget from the rest of the government budget was discussed in and around December 2008 in the last days of the previous Liberal Democratic Party (LDP) administration led by Taro Aso, before the Democratic Party of Japan (DPJ) came into power following the September 2009 general election, in response to the final report of the National Council on Social Security (November 4, 2008, chaired by Hiroshi Yoshikawa, professor at the University of Tokyo). An element of the idea can be observed in the underlined portion of the "'Medium-term Program' for Establishing a Sustainable Social Security System and Securing of Its Stable Revenue Sources" (Cabinet Decision dated December 24, 2008) below.
The above underlined part referring to "rigorously separated from other budget accounts" is particularly important. As shown in the above chart, the cost of social security benefits (paid under the pension, medical care, and long-term care programs) are covered presently not only by social security premiums but also by transfers from the government, namely, tax revenue. For example, 50% of the cost of basic pension benefits is covered by taxes (transfers from the general account). The medical care and long-term care programs operate in the same manner. This means that a rapid increase in the cost of social security benefits due to the aging population will automatically translate into a rapid increase in the amount of transfers from the government.
The overall costs of social security, including the portion financed by transfers from the government, are expected to increase at a pace of over one trillion yen per year. The political leaders will again have to face the difficult question of how to secure revenue sources to cover the ever-increasing cost on the government. Issuing government bonds (increasing the fiscal deficit) would be one way to achieve this end. This approach, however, has its limitations given the current fiscal condition of the nation. Or, the government could save on other expenditures to make more funds available for social security expenditures, but this would have only a limited impact as the costs of social security are expected to increase by over 10 trillion yen in the coming decade.
In the case of taking either of the above approaches, the same questions—i.e., how much the government can and should borrow and where to cut expenditures to squeeze out funds for social security—would arise and invite a conflict of political interest each time additional funds become necessary to cover bloated social security expenditures resulting from further population aging. A lack of clarity of what constitutes the primary revenue source to cover increasing social security costs is the biggest reason for this.
Thus, in order to end the shoestring operation, we should first define the primary revenue source—preferably, a single source and does not include proceeds from government bonds—to cover social security costs. We can then introduce a pre-funded scheme (i.e., a reserve account earmarked for alleviating the future rise in the social security burden with the aging of the population) as a new component of the social security system (pension, medical care, and long-term care), which is predominantly a pay-as-you-go system at the moment. While increasing the pre-funded aspect of the system, we should make it a rule to adjust the rate of the tax designated as the primary source semi-automatically with changes in the estimated cost of social security benefits over the medium- to long-term horizon. That is, if the total amount of social security benefits payable over the medium- and long-term period is estimated to be 100, the tax rate would be set to a level at which the total amount of social security burden over the same period would be 100 as well. Or, if the maximum limit for the burden is 70, the total amount of benefits should be immediately reduced to 70.
What should be the primary revenue source? The medium-term program (Cabinet Decision dated December 24, 2008) shown above seems to consider the consumption tax as the primary revenue source. Actually, it does not matter whether it is collected under the name of consumption taxes or social security premiums as long as the benefits and costs of social security are generally balanced for each generation.
After all of the above measures are implemented, the social security budget should be separated from the rest of the government budget, eliminating fund transfers from the general account. In other words, the primary revenue source for social security should be defined as funds usable exclusively for social security purposes and separated from other revenues sources.
Three advantages of separating the social security budget
This approach has three advantages. First, the relationship between the benefits and costs of social security becomes clear for each generation. Second, once the level of benefits is determined, the level of costs is adjusted automatically in essence. As a result, the social security system as a whole is expected to be stabilized—both working and elderly people can plan their lives without anxiety as they can estimate the amounts to pay and receive. Third, there will be no need to force reductions in other budgetary areas to secure funds for social security. As no other expenditures are to be sacrificed for the sake of social security, budget plans for future growth (e.g. investment for research and development) can be rationally formulated according to the needs.
As aforementioned, discussion is underway at the National Council for Reform of the Social Security System toward making its concluding proposal by August 2013. What is already apparent, however, is that the success or failure of the reform hinges on whether the social security budget can be segregated from the rest. The discussion initiated under the previous LDP-led government was interrupted after the DPJ came into power in 2009. Now that the LDP has made a powerful comeback, it is hoped that the new government will achieve fundamental social security system reform, including separation of the social security budget, looking ahead over the coming 25 years.
January 17, 2013
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