Social security and consumption tax hike

The Yomiuri Shimbun

The government and the ruling coalition are scrambling to draft a detailed plan for raising the consumption tax rate so the integrated reform of the social security and tax systems can be implemented.

Past governments have only made halfhearted efforts toward raising the consumption tax rate. Will the situation persist in the current government led by Prime Minister Yoshihiko Noda?

Kenji Yumoto, counselor of the Japan Research Institute, and Ryutaro Kono, chief economist at BNP Paribas Securities, discussed some of the points that have been missing from recent debates on the integrated reform, and describe what they believe will happen if the consumption tax is not raised.

===

Tax hikes needed now to repair social systems

RYUTARO KONO

Many people are worried about the government's plan to raise the consumption tax rate as a revenue source at a time of low economic growth. At the same time, they admit it's necessary to reform the nation's social security systems. Economic analysis of the causes of slow growth show the necessity of securing continuous funding through tax hikes to swiftly rebuild the systems.

Since the 1990s, Japan's [average annual] economic growth rate has been 0.9 percent. The two decades that followed are known as the lost decades. However, the causes of the 1990s slump and that of the 2000s are quite different.

The stagnated economic growth of the 1990s was largely a result of bad loans made by financial institutions. Lending to growing business sectors was discouraged, resulting in lower expectations of economic growth. This led to reduced spending by companies and households, sending the economy into a slump.

The bad loans problem was resolved in the early 2000s. On a per-worker basis, growth entered an upturn phase. Though it is not widely known, Japan's per-worker economic growth rate in the 2000s was remarkably high among industrialized countries.

However, the condition of the economy as a whole was different. A decrease in the productive-age population (people aged 15 to 64) in the latter half of the 1990s has accelerated at the beginning of this century. This factor has limited economic growth.

My estimates show a per-capita growth potential of 1 percent to 1.5 percent in the coming 10 years. This rate is higher than that of Western countries affected by the European sovereign debt crisis. However, as Japan's working population will decrease by about 1 percent every year, the net potential growth rate for the nation will be zero to 0.5 percent. In short, the main cause of the low economic growth is a decline in the number of people working. So low economic growth doesn't necessarily mean a recession.

In the past 10 years, the government has postponed social security reforms on the assumption that the economy would be unable to withstand tax hikes during a period of slow economic growth. But if it is true that the population issue is the main cause of the stagnation, the government should secure funds for social security services as soon as possible.

The shrinking of the productive-age population--the chief cause of the slowdown--means an increase in the number of senior citizens receiving social security benefits at the same time as a decrease of the working population that pays into the social insurance system.

Social security services are already at a point where they can no longer be financed solely through revenues from insurance premiums. The government has already poured in a large amount of money. With a shortage of tax revenue as well, the reality is that these systems have been funded with increasing debt.

If the breakdown of the population--which is now an irreversible factor--is the cause of low economic growth, an increase in tax revenues cannot be expected in the foreseeable future. Unless the government moves to secure the necessary funds as quickly as possible, the nation's social security systems will inevitably break down.

The truth is that this problem has brought with it another issue. Since the 2000s, many in the working population began to doubt whether the social security systems could be maintained. As a result, they minimized their spending out of concern for their future.

The establishment of a system with a reliable revenue source will increase consumption in the working population, resulting in positive economic growth. On the other hand, if reforms are postponed out of fear of the adverse effects of the consumption tax hike, working people will continue to spend less, and the rate of economic growth will remain slow.

Japan's social security systems are designed on the dual premise of an increasing population and a high economic growth rate. A slowdown in the growth of the population and the economy immediately cause the systems to malfunction, thereby stifling the economy as a whole.

Precisely because the potential economic growth rate has been low, tax hikes can no longer be postponed.

===

Consumption tax hike plans need to offer more detail

KENJI YUMOTO

Discussions on the integrated reform of the social security and tax systems have entered a critical stage. Prime Minister Noda has clearly expressed an intention to raise the consumption tax rate in stages up to 10 percent by the mid-2010s. However, coordinating opinions within the ruling Democratic Party of Japan will not be easy, as some members have voiced strong opposition to the tax hike.

The consumption tax rate needs to be increased to ensure the social security system has enough funds and to restore the nation's fiscal health.

The final draft of the reform, which was agreed on by the government and the ruling coalition at the end of June, stipulates that revenue raised by the consumption tax rate hike will be spent only on social security programs, meaning that all funds from the increased tax burden will be spent for the public good, not to bloat the bureaucracy.

However, if you study the final draft carefully, you will see that only 2.7 trillion yen in real terms, or the amount that would be raised by a one percentage point hike in the consumption tax rate, will make its way back to the public in the form of increased social security benefits.

The remaining amount, or the amount that would be raised by a four percentage point hike in the consumption tax, is to be used to restore the government's fiscal health, such as by offsetting the current lack of funds for social security programs or covering predicted expenditure increases due to the swelling ranks of people who receive social security benefits.

The prime minister needs to convince the public that the revenue raised from increasing the consumption tax rate will be put to good use.

The final draft of the reform says the nation will aim for a midsized but highly functional social security system, but it is extremely difficult to imagine what such a system would look like.

If you break down the above figures, you will see that the 2.7 trillion yen that is to go toward increased social security benefits includes 700 billion yen to support families with children, 2.4 trillion yen for improvements in medical and nursing care services and 600 billion yen for improving the public pension program to guarantee minimum benefits, such as additional pension payments for low-income people. The reform draft also calls for cutting by 1.2 trillion yen programs to improve the efficiency of medical and nursing care service providers. Among these changes, however, it is unclear which are to be given priority.

Also, the draft does not clarify the funding or timing of some measures, such as the minimum guaranteed pension.

Moreover, reforms that would have reduced some recipients' pension payments or increased their financial burdens would be postponed under the draft reform. These include raising the age of pension eligibility, increasing the amount that people aged 75 or older must pay for medical care, and adding 100 yen to the fees people must pay when they visit a clinic or hospital.

The government has yet to sufficiently explain why such changes were necessary.

Examining the 2.7 trillion yen more closely, it is apparent that 1.4 trillion yen, or about half of the amount, is to be spent on dealing with poverty and correcting income disparities. Thus one of the primary purposes of the envisaged social security reform is to increase the redistribution of income.

Although this is a noble goal, I cannot help but question whether the proposed reform will actually result in a reliable and sustainable social security system.

The shortfall of social security funds is expected to reach 12.8 trillion yen by 2015, which is equivalent to the amount of funds currently brought in by the 5 percent consumption tax. According to my calculations, an additional three-point increase is necessary to cover the expected increases.

Furthermore, the government has not sufficiently considered how to deal with the ever-increasing number of pension recipients caused by the aging of the population. And it will probably be necessary to further raise the consumption tax rate to put the nation's primary balance into the black by around 2020.

From this it is evident that a five-point increase is just not enough. The government should explain to the public that increasing the consumption tax rate to 10 percent is just the first step.

One of the campaign issues for the next House of Representatives election should be not merely whether to raise the consumption tax rate, but a comparison of detailed proposals from the ruling and opposition parties on what the consumption tax rate eventually needs to be and how revenue from a tax hike would be spent.

Raising the consumption tax rate will not have a major impact on the economy as long as the revenue raised is spent on social security programs and thus plowed back into the pockets of the people. However, the economic climate could be affected if the tax hike is only spent on restoring the government's fiscal health. The consumption tax rate should be raised when an end to the nation's prolonged period of deflation is in sight.

In any case, further discussions on raising the consumption tax rate cannot be delayed any longer. To win the understanding and consent of the public, the prime minister must provide a more detailed picture of what kind of social security system his government has in mind, as well as promise to reduce the number of lawmakers and cut the salaries of national government employees.