Establishing Principles for a More Sustainable Pension System in Japan, and Identifying Challenges

Author Name FUKAO Mitsuhiro  (Faculty Fellow) /KANEKO Yoshihiro  (Consulting Fellow) /NAKATA Daigo  (Fellow) /HASUMI Ryo  (Keio University)
Creation Date/NO. March 2006 06-J-012
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This paper looks into the intermingling of the self insurance and public assistance principles in Japan's government-sponsored pension system that has been eroding public trust in the system. Using a newly developed pension funding model (the RIETI model), we analyze options for reforms quantitatively by clarifying the respective roles to be played by the financially fair insurance model and public assistance to poor retirees. In particular, we have simulated a pair of reform options: (1) fund the entire Basic Pension by the national treasury as a form of minimum guarantee to all the people in accordance with the assistance principle and Employees' Welfare Pension will be purified as a earning-related financially fair system on top of the Basic Pension, (2) reorganizing the National Pension and Employees' Welfare Pension systems into a new integrated, single-tier pension based on an earnings-related financially fair mechanism, with a supplementary pension for low-income pension recipients paid entirely from the national treasury on the basis of the assistance principle.

In the first reform option, if the level of Employees' Welfare Pension contributions set out in the 2004 pension reform were maintained for second-tier contributions, a benefit multiplier of approximately 1.91 times the current rate could be achieved. If benefits were maintained at the levels set in the 2004 reform, the contribution rate for the second-tier pension could be reduced to about 11.93%. In these cases, an additional 7-point hike in the consumption tax would be required to fund Basic Pension benefits at the peak of old-age population. In the second reform option, the additional consumption tax would be relatively low, but the asset size of the earning-related pension system would greatly expand, creating a reserve fund twice as large as that under the current system. We have concluded that the capital market impact of introducing such a system needs to be taken into consideration. Furthermore, our simulations demonstrate that switching to such a system would significantly change the relationship between benefits and contributions. Therefore introduction of the new system would improve the return on contributions for some income groups and diminish it for others.