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November 13, 2003

Pension Benefits Must Balance with Realistic Level of Contributions

Naosumi ATODA (Professor, Keio University)

Revision of the public pension system in Japan must seek to balance the benefits of the recipients and the contributions borne by the working people. The national contribution ratio will inevitably increase even if a hike of pension insurance premiums could reasonably be suppressed. Uniform curtailment of pension benefits should be avoided in consideration for those who are in real need of assistance.

Increased burden unnoticed as fiscal support is increased

The public pension program in Japan has been operated in the form of a social insurance and is in need of large-scale modification. The policy agendas of all of the political parties publicized in preparation for the recent general election propose increasing the portion of fiscal support, i.e. tax money to maintain the pension program. This proposal is in effect suggesting either to dilute the current pension insurance system or to abolish it altogether. It is obvious that the pension scheme needs to be dramatically revised in order to cope with the aging population and diminishing number of children in Japan. But if the objective of a new plan is merely to suppress the level of insurance premiums people are required to chip in, and leave the current level of benefits recipients enjoy, it would only mean that the people would be contributing in terms of taxes instead of insurance premiums and would not be relieving supporters' burdens at all.

The level of social insurance premium to support pension, medical, and nursing care has already reached the level of 22.78% of annual income of workers in 2002. A half of this is technically borne by employers, but it means the portion paid directly by employees already exceeds 11% of their earnings. By way of comparison, the amount of income and local income tax (juumin zei) combined for a household with two children at an income level of 7 million yen per annum is only 4.6%, which vividly illustrates the hefty share of social insurance cost.

At least a part of the reason for the very little, if any, criticism raised for the significant increase of premiums to support social programs in recent years is probably because during this time the income and local income tax (juumin zei) has been lowered constantly, making the total amount people must pay as taxes and social insurance premiums fairly constant. People may simply have been unaware of the fact that their contributions were constantly increasing.

As the further reduction of taxes (which has been realized with the aim of stimulating the economy through inducement of personal expenditure) is no longer possible, necessary increases in the form of taxes to support the social benefit program from now on will be an add-on to the existing tax burden. What is necessary, therefore, is to seek means to suppress the hike of the contribution to the social security system people must bear, so as not to hinder the viability of Japan's economy.

Pension benefits of existing recipients needs to be reduced

A draft proposal recently publicized by the Health Minister suggests the amount of pension benefit to be reduced from 59% of net income to 54%, and the proposal of December last year by the Health Ministry proposes a reduction from 59% to 52%. The difference of 2% between the plans is due to the speed in reaching the lowered figure, and the recipe to utilize the macro-economic slide formula is the same.

The macro-economic slide formula is a method where automatic increment of the benefits due to wage increase and inflation would be deflated to reduce the impact to the total system. This was devised to cope with the decreasing number of young people that would make it impossible to shoulder even the expected increment due to indexation. According to the proposal, if it were to be implemented those receiving 238 thousand yen per month would be receiving a little more than 200 thousand yen, less than now but an amount that still could be considered sufficient. However, the actual average per person of old age welfare annuity in 2001 was 174 thousand yen, and if the plan is to be implemented they could be receiving only 150 thousand yen, possibly not enough to maintain quality of life. This shows that if the macro-economy slide formula were applied universally, those who are already in the low-income bracket would have to further lower their living levels.

Introduction of the macro-economy slide formula is generally considered necessary to avoid increasing social insurance premiums, but the same result could be achieved by shaving 8 to 12% from the total amount of benefits being paid out. This would also allow for benefits to be adjusted for each recipient as long as the total volume is maintained. Accordingly, it would enable such adjustment among the recipients as to lower the benefit more for the high-income group while maintaining the previous levels for low-income people.

Another issue that needs to be raised is that the currently proposed reform plans do not discuss adjustments for the benefits of already existing recipients. Lowering the benefits being paid to the existing recipients in addition to the new retirees would relieve the burden on the whole system significantly. In fact, it would not be a restructure equitable and acceptable to the whole society unless the benefits of the current recipients are also scrutinized and adjusted impartially along with new recipients.

There are three major points in assessing pension reform plans from the contribution side. One is to devise a system to provide sufficient benefits to those in need but whose entitled benefits are small because their income levels were low when paying premiums, while progressively decreasing the level of benefits to those whose earnings were high before retiring. This would serve the core purpose of the public pension system, i.e. to support minimum income to sustain life. Second is to refrain from handing out benefits to those who enjoy high income through other means. This could be considered as enforcing the insurance aspect of the pension system by sharing the burden for those in need when they need it. The third point is to suppress the total benefit provided by the system to the level at which it would balance with the total premium collected at 15% of the incomes of contributors.

Both plans by the Minister and the Ministry propose a cap of 20% of income to be contributed as pension insurance premiums. This means there would be an increase of 6.42% for pension premiums until 2025. The amount to be borne by individuals (as half is picked up by the employer) would be half of that, by 3.21%, to the level of 10% of income. This is, however, considering the pension system only. Health and nursery care plans also require more money, each seeking about 3.1% increase in the plans, which makes the total premium increase to 9.52%. As a result, they add up to make the total burden of social insurance at 32.3% of earnings, which means it would place individuals' premiums at more than 16% of income. This, from past experience, is probably not a sustainable level.

Necessity to review the whole social security scheme

Translating this figure in terms of national contribution ratio (NCR) results in 16% for 2002, which then would increase to 21% in 2025. Of the 5% increase, the pension system would compose about 3%. This figure may not seem significant, but this is number crunching for the insurance part only. The plans call for tax money to be injected into the pension system, and the increasing fiscal support would raise the NCR by 5%. At this point, the NCR of tax and insurance premium in 2025 would become 48%, and this is not considering any tax increase other than to compensate for the shortage of social insurance funds.

If taxes were to be increased during the period for purposes such as fiscal rehabilitation, which seems inevitable, the NCR would easily exceed 50%. As the NCR is a figure to indicate the size of the government, increase of the NCR means more funds are funneled to the public sector from the private sector. This is against the present policy objective in place to execute structural reform, where the volume of this flow should be reduced.

It is envisaged that in order to suppress the rise of the NCR as much as possible, the total insurance premium for all the social programs should be limited to 25%, which for individuals means 12.5% of income. To achieve this level, the insurance premium for pensions should be limited to 15% with the rest for medical and nursing care, which must remain at current levels.

Although dubbed pension reform, the burden of social security as a whole needs to be analyzed to make the argument viable from the contribution side of the issue. This approach must be adopted and maintained for the vitality of the private sector to be sustained. Also, restructuring of the benefits to balance with the realistic level of contribution must be sought instead of raising insurance premiums or increasing fiscal support too leniently. Pursuit of policies along these lines would also make it possible to provide a social safety net for those who are truly in need.

(The original Japanese paper appeared in the October 24, 2003 issue of Nikkei Shinbun.)

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