Tax and Insurance Premiums as Financial Resources for Social Security

Author Name IWAMOTO Yasushi  (Faculty Fellow, RIETI)
Creation Date/NO. July 2008 08-J-034
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In this paper I study issues in choosing between insurance premiums and taxes as means of financing the social security programs. An outline of the present composition of financial sources is that general tax revenues are put into a social insurance program that has a difficulty in raising an insurance premium further, and that there is no clear division of roles between insurance premiums and taxes based on a sound principle. Since subsidies by tax revenues goes more heavily towards the elderly, the rate of increase in tax subsidies devoted to social security programs will exceed that in the burden of insurance premiums during the coming process of population aging. Under the current system, from the period of the Integrated Reform of Expenditure and Revenue to 2025, the increase in tax subsidies is projected to be just under 1.5% of GDP, and from 2025 to 2050 the increase is projected to be around 2% of GDP. At issue here is how to finance those costs.

An idea of financing the basic pension benefits by general tax revenue is derived from the judgment that the government is not able to manage social insurance. A major problem with this is payment defaults in the National Pension's system, but transforming it to the tax-financed scheme is not a workable solution to the past default problem. On the other hand, if the system is designed on the premise that the government can do what the private sector can do, pensions may be able to be managed under the social insurance scheme. The final judgment cannot be clearly made by only economic theory.

If the consumption tax is considered as a source of revenue under the tax-financed scheme, the aspect of the tax reform is actually important, although it apparently seems a matter of pension reform. Since the effects of social insurance premiums can be regarded as those of wage tax, it could be discussed as a transition from wage tax to consumption tax. The welfare of generations who already contributed insurance premiums would deteriorate, because the consumption tax burden to them would arise anew. The economic welfare of future generations improves through an increase in savings. Redistribution of income within generations would be strengthened further.