Section 3 Public Finance as Seen from Lifetime Benefits and Contributions

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Chapter 3

Overall Assessment of Japan' s Public Finance

Section 3 Public Finance as Seen from Lifetime Benefits and Contributions

In Sections One and Two, we considered Japan' s fiscal conditions from the viewpoints of budget deficits, government spending, tax revenues and other flow indicators, and assets, liabilities and other stock indicators.

There is another important viewpoint in assessing fiscal conditions. That is how much each generation (e.g. the 30s group, 60s group, or future generations not yet born) benefits from and contributes to public finance. In this section, we use "generational accounting" to estimate lifetime benefits and contributions for each generation. The estimates reveal that the benefit-contribution relationship for the elderly generation is different from that for the younger generations, and that the future generations will have to shoulder some contributions for the present generations. This indicates that it will be difficult to achieve a balanced budget in the long run, if the current benefit and contribution structure is maintained with contributions being left for future generations.

1 Benefits and Contributions for Each Generation

How much will people contribute to and benefit from the government throughout their lifetime? "Generational accounting" is a mechanism for assessing public finance from this viewpoint.

Let' s consider what each generation' s benefits and contributions are in generational accounting and how benefits and contributions are distributed to individuals. As for benefits, police, fire, public health and other public services are taken as benefiting the people equally. Services of social infrastructure including roads are interpreted as benefiting the people equally over the duration of the capital. Public pension recipients are concentrated among elderly people(35). People benefit from health care services depending on their frequency of visits to doctors.

Among contributions, taxes are designed to cover common social costs and social insurance premiums are the costs people pay to receive health care and other specific social security benefits. Pension premiums are the costs people pay in order to receive pensions in the future, not the present.

By estimating and considering each individual' s annual benefits and contributions over his lifetime from the past to the future, we can grasp a long-term picture of fiscal conditions.

blackcircle Gaps between generations stemming from declining birthrate and aging population

In social security including pension, health care and nursing care, annual contributions exceed benefits for younger people. For elderly people, however, benefits including pensions and medical services for aged people exceed contributions. The benefit-contribution relationship thus changes according to aging. Under the concept of generational accounting, we can understand that a falling birthrate and aging population can cause a greater gap between the younger and elderly generations in the benefit-contribution relationship. As the birthrate falls with population aging without a sharp change in total population, social security benefit payments increase while total tax and social security contributions decline. The excess of benefits over contributions must be passed on to future generations.

Let' s review demographic changes in Japan. In 1970, Japan became an aged society as defined by the United Nations (elderly people aged 65 or older account for 7% or more of total population). Elderly people' s share of total population reached as high as 16.7% in 1999. The share took less than 30 years to rise by some 10 percentage points. Japan has thus been aging faster than any other country. It took 115 years for elderly people' s share to rise from 7% to 14% in France, 85 years in Sweden and 45 years in Britain. Japan' s birthrate has declined over the past years. The total fertility rate (the estimated number of babies one woman bears over her lifetime) stood at 1.35 in 2000, slipping far below the 2.08 level of that is required to maintain the present population(36). Japan' s demographic picture has thus changed dramatically. In 2010 when the baby-boomers join the elderly generation, Japan is expected to become the most aged society in the world (see Figure 3-3-1).

As the pyramid-shaped demographic picture has collapsed on the declining birthrate and aging population, gaps have emerged between generations in the lifetime benefit-contribution relationship regarding the health care and public pension systems.

Since health insurance premiums depend on contribution capacity including income under Japan' s health care system, the younger working generation generally makes more contributions than the elderly generation. On the other hand, benefits are more for the elderly generation due to its higher disease and benefit rates. Medical expenses for the aged are mostly covered by contributions from insured people including younger generations. If Japan were to maintain benefits at the present levels in spite of the falling birthrate and aging population, contributions would have to increase mainly from younger generations. In fact, health insurance benefits to the aged have continued to expand at a faster pace than economic growth, reflecting the fast-aging population and high per capita medical expenses for the aged (per capita medical expenses for the aged are some five times as large as those for younger generations (see Figure 3-3-2). Medical expenses for the Japanese people, including those for the aged, are expected to continue to expand in the future. According to the "Future Perspective on the Benefits and Burdens for Social Security (October 2000)" released by the Ministry of Health, Labor and Welfare, medical expenses for the Japanese people as a whole are projected to reach ¥81 trillion, of which those for the aged may account for ¥45 trillion, or more than half.

The falling birthrate and aging population can affect Japan' s public pension system as well. Financial resources for pensions for elderly people include not only contributions that they made in the past, but also those that younger people are paying. As is the case with the health insurance system, contributions by younger people would have to be increased, if pensions were to be maintained at the current levels despite the falling birthrate and aging population.

If benefit and contribution rules are changed, the age for the elderly generation to begin receiving pensions will differ from that for younger generations. Therefore, gaps between generations will emerge in the lifetime benefit-contribution relationship. Looking at Japan' s postwar social security system improvements, we can observe that improvements since 1970 featured considerations given to the elderly generation. These improvements had allowed elderly people to pay no part of their medical expenses, substantially increased pension levels, linked pension levels to wages and introduced the indexation of pensions to prevent a real decline in pension levels even amid inflation. But recent changes have forced elderly people to pay some part of their medical expenses and corrected pension levels in order to achieve equilibrium between benefits and contributions.

2 Benefit-Contribution Relationship for Present Generations

blackcircle Changes in Generation-by-Generation Benefits and Contributions

The gaps between generations seem to have emerged in the lifetime benefit-contribution relationship as (a) the benefit-contribution balance for social security systems as a whole has deteriorated on the falling birthrate and aging population and (b) the benefit and contribution rules have changed on revisions to the social security systems.

We here realign annual government spending and revenue as benefits and contributions for an individual in each generation to quantitatively analyze the gaps between generations and the reasons for the gaps' emergence. Since data constraints in Japan make it difficult to estimate benefits and contributions on an individual basis, however, we estimate benefits and contributions on a household basis. We have divided present householders into five generations-the 20s, 30s, 40s, and 50s groups, and those in their 60s and older. Every householder is assumed to begin participation in economic activities at the age of 20 or more and to live up to the age of 80.

We have used the "System of National Accounts" of the Cabinet Office, the "Family Income and Expenditure Survey" of the Ministry of Public Management, Home Affairs, Posts and Telecommunications, and other data for reclassifying government revenues and expenditures as household benefits and contributions, as indicated below. The latest reporting year for which the latest data are available is the 1999. Benefit and contribution figures for age groups and generations are for one household in principle.

  • (a) Income, consumption and other tax contributions are distributed in accordance with tax payments and consumption for each household in each generation.
  • (b) Corporate tax is presumed to come from individuals through wages, dividends, product prices, etc.
  • (c) Among social security benefits, health insurance benefits for the aged are considered to belong to people who are aged 60 or over. Other social security benefits including health and nursing care insurance benefits, as well as relevant contributions are distributed in accordance with benefits to and contributions from each household in each generation.
  • (d) Of government expenditures, education expenditures are considered to be benefits to households. Other government expenditures, subsidies, savings, profits from public corporations and other government revenues and spending are distributed evenly to every generation.

(For details of the estimation method, see Appended Note 3-6 "Outline of Generational Accounting Estimates.)

Let' s look at relations between benefits and contributions for each generation in the latest reporting year (1999), before discussing lifetime benefits and contributions for each generation.

For people aged 60 or over, benefits exceed contributions by an annual ¥3.6 million on average. Younger people aged between 20 and 59 are net contributors. For people aged between 50 and 59 whose income is higher than for other people, tax and social security contributions are higher. Their annual net contributions average ¥1.8 million (see Figure 3-3-3).

It is natural that the aged are net benefit recipients while the younger generations are net contributors. In general, working people make tax (such as income and consumption tax) and social security (such as health insurance and public pension insurance) contributions to the government, while receiving education, health insurance and other benefits. As they age, their public pension, health insurance and other benefits from the government increase with their tax and social security contributions declining. For any year, therefore, contributions naturally tend to exceed benefits for the younger and slip below benefits for the elderly.

Such tendency has been substantially strengthened in Japan in the past three decades (although net benefits for the aged have tended to decline in the past years). Let' s look into the annual benefit-contribution ratios (= annual benefits / annual contributions), for the years up to the latest reporting year, that should indicate that change. (A ratio above 1.0 indicates net benefits and one below 1.0 signifies net contributions.)

The elderly aged 60 or over have consistently been net benefit recipients. Their net benefits expanded substantially in the 1970s and have remained high. On the other hand, the younger aged between 20 and 59 have had to gradually increase their contributions since the 1970s in order to maintain high benefits for the elderly.

Let' s discuss the characteristics of each generation. The benefit-contribution ratio for the elderly aged 60 or over had remained around 1.5 until the first half of the 1970s and expanded sharply to 2.5 in 1980. This reflected the introduction of the following measures in 1973, which has been called "the first year of welfare" in Japan:

  • (a) Elimination of medical costs to the elderly.
  • (b) Substantial expansions in public pensions and the adjustment of pensions to standard income (wages)
  • (c) Indexation of public pensions.

For those in their 50s, contributions have persistently exceeded benefits. Furthermore, their net contributions have gradually expanded. Those in their 40s have been net contributors since the mid-1960s, those in their 30s since the mid-1970s and those in their 20s since the mid-1980s. These younger people' s net contributions have also increased (see Figure 3-3-4)(37).

Substantial improvements in benefits to the elderly in the 1970s have been coupled with the falling birthrate and aging population to cause the large excess of government spending over revenues, or budget deficits.

blackcircle Lifetime benefit-contribution relationship for present generations

We have already discussed the benefit-contribution relations for a year. We here would like to consider lifetime benefits and contributions for each generation. To this end, let' s estimate lifetime net benefits (lifetime benefits-lifetime contributions) for each generation.

In estimating future benefits and contributions, we presume that benefit and contribution systems that were established by the latest reporting year (1999) will be maintained in the future. But we have taken into account the nursing care insurance system introduced in 2000 and new systems ready for imminent implementation, as well as planned system modifications including a gradual rise of the age eligible for pension (except for a premium hike indicated in the budget outlook that the then Ministry of Health, Labour and Welfare submitted when the pension system was revised in 1999). Past and future benefits and contributions are in real terms, or in 1999 prices, and represent present prices after inflation or deflation adjustments using a specific interest rate.

Lifetime net benefits, as estimated on the above conditions, total ¥57 million for those aged 60 or over (born in 1939 or earlier). Those in their 50s (born between 1940 and 1949) are still net benefit recipients (lifetime net benefits at ¥900,000). However, those under 50 are all net contributors on a lifetime basis. Lifetime net contributions for those in their 20s (born between 1970 and 1979 are the highest among generations, averaging ¥13 million.

There thus are gaps in the lifetime benefit-contribution relationship between older and younger generations. The lifetime net benefit gap between younger people in their 20s (born between 1970 and 1979) as the largest net contributors and elderly people aged 60 or over (born in 1939 or earlier) exceeds ¥70 million (see Figure 3-3-5)(38).

3 Additional Contributions for Future Generations

blackcircle Passing contributions on to future generations

We have so far discussed benefit-contribution relations for present generations. How would benefits and contributions be for future generations? Future generations cover those to be born in and after 2000, as well as living people aged below 20 who were born between 1980 and 1999 and will become new participants in economic activities in or after 2000.

Certain assumptions are required for looking into benefit-contribution relations for future generations. There are three major assumptions:

  • (a) Achieving a balanced budget in a wide sense over the long term From the latest reporting year to the distant future, benefits that all generations will receive (services through various government expenditures, public pensions, etc.) must match contributions that all generations will make (tax and social security contributions). The government cannot expand liabilities (including the so-called hidden liabilities) unlimitedly. This means the presumption of a balanced budget in a wide sense covering not only tax payments, and government consumption and investment expenditures but also social security benefits and contributions. Future benefits and contributions are discounted by a specific interest rate to represent present prices. If there are net government assets at present, contributions will be cut by their value.
  • (b) Continuation of benefit levels in the latest reporting year (1999) Benefit levels for each present generation will remain unchanged. When the future generations join the 20s (30s, -- ) generation, they will receive the same benefits as people currently in their 20s (30s, -- ).
  • (c) Even contributions for future generations

The future generations are assumed to shoulder additional contributions required to achieve a balanced budget in the long run. (Each generation covers 10 years. For example, one generation may be born between 2000 and 2009 and another between 2010 and 2019.) As future generations' contribution capacity increases in accordance with economic growth, however, distant-future generations are assumed to make more contributions than near-future ones in line with income growth accompanying economic expansion.

Estimating lifetime benefits and contributions for future generations (to be born in and after 1980) based on the above assumptions, we can observe that each future generation would have to make net contributions of ¥42 million (in 1999 prices) per householder. Such net contributions are more than three times as large as those for people currently in their 20s (born between 1970 and 1979, with net contributions of ¥13 million) (see Figure 3-3-5). This means that the government would have to impose greater burdens (tax and social security premiums) on future generations than on present ones in order to maintain present levels of benefits and achieve a balanced budget in the long run.

We have so far looked at net contributions per household for future generations. We here consider the total additional contributions the whole of future generations would have to make in order to achieve a balanced budget in the long run. If structural benefits for each of the present generations (20s, 30s, 40s, 50s, and 60s and older) are assumed to remain unchanged, future generations as a whole will have to make additional contributions worth ¥2,100 trillion (in 1999 prices) in order to achieve a balanced budget in the long run.

What are the reasons why future generations as a whole will have to make additional contributions worth ¥2,100 trillion? There are three major ones:

  • (a) Additional contributions will be required to eliminate budget deficits (outstanding central and local government bonds) accumulated in the past.
  • (b) The past and present elderly generations have posted lifetime net benefits that the present younger and future generations will have to cover.
  • (c) Public finance has been in deficit recently. If future benefits and contributions increase at the same pace in accordance with economic growth, public finance will remain in deficit. Additional contributions will be required for future generations to eliminate future budget deficits.

blackcircle Simulation of additional contributions for future generations

Based on benefit and contribution gaps between generations as previously discussed, our estimates indicate that future generations will have to make ¥2,100 trillion in additional contributions in order to achieve a balanced budget in the long run. Tax and social security contribution hikes and restrictions on benefits may be combined to cover the additional contributions. We here give estimates using the consumption tax rate as a yardstick to provide a specific image of the additional contributions. The consumption tax rate given here is a yardstick to measure additional contributions and no estimates here represent future outlooks or specific policy measures.

First, we observe that if future generations to be born in and after 1980 were to make all of the additional contributions, the consumption tax rate would have to be 90% in order to achieve a balanced budget in the long run. (This is for the extreme case that present benefit and contribution rules remained unchanged until 2058 when people currently in their 20s retire from economic activities before additional contributions are made in and after 2059.)

The tremendous size of the additional contributions indicates that it would be difficult to achieve a balanced budget in the long run if the present benefit and contribution structure is maintained with additional contributions being passed on to future generations.

Let' s consider the case where the present generations receiving benefits were to make additional contributions instead of leaving all additional contributions for future generations. If additional contributions were to start in 2005, the consumption tax rate would have to be 23% in order to achieve a balanced budget in the long run. If additional contributions were to start in 2020, the consumption tax rate would have to be 34%.

However, any plan to depend on additional contributions alone for achieving a balanced budget in the long run is inappropriate at a time when Japan is pursuing "simple, efficient government." Some additional contributions may be a requirement, but any plan to achieve a balanced budget in the long run should combine additional contributions with restrictions on benefits for each generation through the contraction of the present systems and the improved efficiency in administration (restrictions on health insurance, public pension and other social security benefits, and reductions in government spending). If benefits for every generation are held down, additional contributions for future generations will be lower (see Figure 3-3-6).

We here have used the consumption tax rate as a yardstick to measure additional contributions in the simplest manner. But we will have to consider specific revenue expansion measures separately. National debates will be required on a thorough review of spending programs, the level of public services, and the people' s contributions to cover such government spending or services.

blackcircle Reconstruction of social security systems

Social security systems are the most important livelihood infrastructure for the people. Without confidence in these systems, the people cannot feel assured or enjoy stable lives. However, it is unsustainable for social security to expand faster than the economy in the long run. In future, any idea for more benefits and less contributions will not stand. Based on the spirit of self-help and self-reliance, Japan must reconstruct social security systems that should allow benefit and contribution equilibrium between generations and secure their mutual support and should be sustainable and reliable.

We here introduce the government' s social security system reform efforts. The Cabinet in June 2001 decided on the "Basic Policies for Macroeconomic Management and Structural Reform of the Japanese Economy," or the so-called "Basic Policies," which cited social security system reform (insurance-enhancing program) as one of the "Seven Programs of Structural Reform" and gave the following guidelines:

(1) Challenges for Social Security Systems

Major common challenges facing social security systems follow:

  • (a) The government will consider the creation of an account to be tentatively named "individual social security account" to easily indicate personal social security benefits and contributions.
  • (b) The elderly will be required to make contributions in accordance with their economic contribution capacity.
  • (c) The most efficient combination of pension, health and nursing care insurance systems will be developed to correct overlaps in benefits and realign security functions.
(2) Public pension system reform

The following efforts will be made to develop a sustainable public pension system that will not have to be revised dramatically over a long period of time:

  • (a) Pension-related tax will be reviewed to secure equity between generations.
  • (b) A ban on a hike in pension insurance premiums will be lifted at an early date to prevent contributions becoming excessive for future generations. A plan to increase the government' s share of contributions to common basic pensions for all the people out of the public pension system (from the present one-third to a half by 2004) will be seriously considered in combination with specific measures to secure stable relevant financial resources.
(3) Health care reform

The health care system will be redesigned to improve the efficiency of health care services for better quality and lower costs in order to harmonize the whole of medical expenses, including fast-rising expenses for the aged, with the economy. In this respect, the program for more efficient health care services, as in the basic policy framework, calls for the following measures:

  • (a) In order to improve the cost-benefit ratio in health care, the ways for medical expense payments and the drug price system will be reviewed.
  • (b) Patients will be required to shoulder an appropriate share of medical expenses and pay appropriate health insurance premiums. Especially for medical services for the aged, equity in patients' costs encompassing medical and nursing care services at home and special facilities will be secured to correct uses of the services.

The "Reform Work Schedule," as released by the Council on Economic and Fiscal Policy in September 2001, specified funding actions and dates of implementation for specific measures for these reforms. The government is determined to fulfill the duties that itself has imposed.

blackcircle Health care reform efforts

In order to further specify the government' s health care reform policy, the Ministry of Health, Labor and Welfare submitted a draft health care reform program in September 2001 for deliberations at the CEFP. The draft program pursues the construction of health care systems responding to the falling birthrate and aging population. To this end, it proposes the following dramatic modifications to all health care systems (the insurance-based health care service system, the medical treatment fee system and the health insurance system):

  • (a) The insurance-based health care service system should be modified to give better-quality services more efficiently. To this end, the government should promote health campaigns and disease prevention measures, disclose more information, expand choices for patients and step up the function-oriented division and consolidation of health care services.
  • (b) The medical treatment fee system should be systematically modified to appropriately reflect medical technologies and costs for management of medical facilities.
  • (c) The health insurance system should be modified to unify benefit rates among insurance plans and generations. Since medical expenses for the aged have been rising fast, the health care system for the aged should be reformed through the following measures:
    • whitecircle Introduction of a system to control growth in medical expenses for the aged (setting a target for growth in medical expenses for the aged in each year, by multiplying the growth rate of aged population by the per capita economic growth rate)
    • whitecircle Raising the age of eligibility for medical services for the aged and reviewing the government' s share of expenses (Raising the eligible age gradually from the present 70 to 75 and increasing the government' s share of expenses from the present 30% to 50%)
    • whitecircle Reviewing patients' costs (The present system calls for patients to pay 10% of medical costs within a monthly limit. The monthly limit should be eliminated. Patients' costs should be raised to 20% for those aged between 70 and 75 and those who gain more income than ordinary people.)

The draft reform program is based on the ideas put forward in the Basic Policies and represents the first phase of health care reform. After deliberations on the draft at the government-ruling coalition consultative body on social security reform and the CEFP, the government plans to compile an official health care reform program by the end of 2001.

At the CEFP, expert members submitted the following opinions:

  • (a) Medical treatment fees and drug prices should be fundamentally reviewed from the viewpoints of improvements in the cost-benefit ratio in health care services and the recent price and wage trends. Medical treatment fees could be reduced in accordance with the recent economic trend.
  • (b) In order to harmonize medical expenses as a whole with the economy, the government should introduce a system to control all medical expenses including those for the aged.
  • (c) The government should specify the theoretical grounds and effects of reform measures including a raise in the age of eligibility for medical treatments for the elderly and an increase in patients' costs. It should also comprehensively consider the pains caused by the reforms to the people and health care providers.

blackcircle Timing is key for future reforms

Timing will be the key for future reforms. Reforms should be implemented as early as possible to build social security systems that will be able to work as a safety net for the future. The government should not only impose more burdens on the people but also simplify administrative procedures and increase the efficiency of administrative services in social security, in response to complaints that the social security systems contain wasteful elements.

As indicated in discussions on generational accounting, it will be difficult to achieve a balanced budget in the long run if the present benefit and contribution structure is maintained with additional contributions being passed on to future generations. Future budget reforms should be designed not only to achieve equity between generations in contributions but also to prevent additional contributions being passed on to future generations.

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