Conditions for a Breakout from Stagnated Personal Consumption: Redistribution placing emphasis on the working generation

UNAYAMA Takashi
Faculty Fellow, RIETI

Personal consumption has been sluggish. According to the Family Income and Expenditure Survey, consumption expenditure for January 2024 substantially decreased from the same month of the previous year by 6.3%, marking 11 consecutive months of negative figures. In particular, working households showed a significant decline of 7.7%, while out-of-work households, mainly consisting of retired and elderly people, showed a much smaller decline of 1.9%.

The Japanese government has decided on a fixed-amount tax reduction and benefits for low-income earners with the aim of propping up disposable income to correct the deflationary mindset of consumers.

Here, I will consider why personal consumption has become sluggish and what countermeasures the national government can take, based on mainstream economics.

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In economics, how consumption decisions are made is considered based on a framework called the life cycle theory. This theory serves as the basis of modern macroeconomics and describes the rational actions of individuals. It is applicable in comprehensively analyzing various phenomena concerning consumption and is considered to be a reasonable explanation of reality.

In the life cycle theory, consumption decisions are based roughly on two premises. The first premise is that people dislike fluctuations in consumption. Many people prefer to maintain a certain living standard rather than to enjoy a lavish life for some time but suffer from poverty in other times in life. Taking Aesop's Fables, "The Ant and the Grasshopper," as an analogy, people are apt to consider the Ant's life as a better outcome. This is the commonly accepted view of what constitutes rational human behavior in economics.

The second premise is that the households face budget constraints, meaning their total lifetime consumption is limited by their available economic resources (hereafter, lifetime disposable resources). Lifetime disposable resources refers to “ free cash” that can be spent, such as current income and financial assets like deposits, as well as future income and expected pension payments. Consumption decisions involve deciding when in life to use these resources.

Based on these two premises, the optimal consumption behavior is to spend lifetime disposable resources at a certain pace. In the simplest case, the optimal level of consumption should be set at each point in time to the amount obtained by dividing one's lifetime disposable resources by the length of a life. For example, suppose the average lifetime earnings for university-educated workers are approximately 300 million yen and they live economically independent lives from age 20 to age 80, then the optimal consumption would be 5 million yen per year regardless of age.

This idea is very simple and may seem to be nothing more than words on paper. However, past research has confirmed that Japanese households' consumption behavior is mostly consistent with this idea. The figure below is a symbolic representation of the validity of the theory.

Average Annual Income and Consumption by Age of the head of the Household
Average Annual Income and Consumption by Age of the head of the Household
Source: Prepared by the author based on the National Survey of Family Income, Consumption and Wealth (Ministry of Internal Affairs and Communications)

Compiling data for several years of the National Survey of Family Income, Consumption and Wealth (currently, the National Survey of Family Income Consumption and Wealth) by the Ministry of Internal Affairs and Communications, I prepared a graph with the age on the horizontal axis and average income and consumption on the vertical axis. For convenience, educational expenses, which cannot be smoothly spent, are excluded, and the values are converted to per single-adult household using the OECD equivalent scale to control for changes in the number of household members. Income increases up to around the age of 60 but decreases after retirement. On the other hand, consumption is kept flat to maintain the certain level mentioned above. This proves that the life cycle theory can explain the actual consumption patterns of individuals to a certain extent.

If the life cycle theory is reasonable, the cause of sluggish consumption is considered to be the stagnation of lifetime disposable resources. In other words, in addition to immediate economic conditions, longer-term factors must have exerted an influence on consumption. The fact that the decline in consumption is particularly significant for working households suggests the possibility that future income, which is the largest resource for the working generation, is seen to be stagnant and that people are pessimistic about future economic growth.

When premised on such a structure, there is little that the government can do to restore consumption. In particular, repeated consumption stimulus measures in recent years have had little effect. Stimulus policies were common choices under out-of-date Keynesian theories, but we must expect small impacts since income transferred by the government would be spent evenly throughout a lifetime-long period.

Even transfers in comparatively large amounts, like the Special Cash Payments (SCP) in 2020, are insignificant compared with the entirety of lifetime disposable resources, and so will bring about little change in consumption as a result. In fact, several studies have shown that SCP has had no significant effect. Therefore, similarly small effects can be anticipated from the fixed-amount tax cut in this June.

If the government intends to increase consumption, the key is a sustainable increase of income, not temporary one induced by transfer policy. In that sense, the government's aim to "achieve wage increases above inflation" is a correct policy target. However, what is important is not the extent to which wage increases can be achieved this year but whether people can expect that wages will continue to increase from the next year onward. Steady economic growth is required but there is no shortcut to achieving it. If present resources are wasted on ineffective policies, this will cause concern among the people regarding possible future tax increases and will further dampen consumption.

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Although it is difficult to increase consumption with policy, there is something that the government can do, which is redistribution that also changes resource allotment among households. Even if it is impossible to increase lifetime disposable resources in the macro economy as a whole, it is possible to achieve redistribution by the use of taxes and benefits. This is a significant challenge also from the perspective of achieving a "virtuous cycle of growth and distribution," which is a slogan of the Kishida administration, but is highly likely to exert an influence on the consumption level in the long term.

What is supposed regarding redistribution policies in economics is that transfers from the “rich” to the “poor” will occur. Ideally, this is an issue to be deliberated under an institutional framework, such as a progressive taxation system, but in recent years, mean-tested transfers have implicitly worked as redistribution policy measures.

Along with this line, the government is focusing more on resident tax-exempted households as the target of policy measures. In 2021, it was well recognized that benefits were granted to child-raising households, but at the same time, benefits of 100,000 yen each were also granted to resident tax-exempted households. In 2022, 50,000 yen was further granted to them to cope with increases in electricity and heating bills and food prices. Upon the coming fixed-amount reduction, 100,000 yen will also be granted to resident tax-exempted households, since they will not benefit from a tax reduction.

Resident tax-exempted households have incomes below a certain level, and this selection criteria seems to be reasonable at a glance. However, from the perspective of the life cycle theory, they are not necessarily appropriate targets for policy measures because the "income for any single given year" is not an appropriate criterion for selecting such targets, based on the fact that wealth accumulation is not taken into account.

As shown in the figure, income levels differ in accordance with the life stages of individuals. If a uniform criterion is used without considering such differences, elderly people are biasedly selected as low-income earners and most young, poor households will be excluded. In fact, 75% of resident tax-exempted households are those of people aged 65 or older. Conversely, when looking at the percentage of resident tax-exempted households only among households of people aged 65 or older, the percentage is 35%, which shows the fact that it is not that exceptionally poor elderly people are selected as targets. Nearly half of the households of people aged 65 or older hold assets over 15 million yen and cannot be considered as poor in terms of lifetime disposal resources. As such they are inappropriate as targets for redistribution.

Simply put, targets for redistribution should be the working generation. Their lifetime disposable resources have consistently stagnant due to the increasing burden of social security expenses, the slowdown of economic activities due to COVID-19, and rapid inflation. The disparity among the working generation and the poverty of elderly people is also a significant issue, but the gap between elderly people with stable incomes such as pensions and the working generation is evident in the consumption trend. In that sense, the use of a framework for tax reduction and the expansion of child benefits is preferable as redistribution methods that emphasize the working generation. It is necessary to keep an eye on redistribution among generations when considering future consumption trends.

>> Original text in Japanese
* Translated by RIETI.

March 25, 2024 Nihon Keizai Shimbun

June 28, 2024