Commentary / Japan

Can the social security system be sustained?

by Hisakazu Kato

When the government’s draft budget is compiled at the end of every year, attention focuses on the scale of social security expenditures, which now account for a major part of the government’s annual spending. The social security system can’t sustain itself without the government chipping in. As the aging of Japan’s population has accelerated since the 1990s, social security spending has increased rapidly.

In 2016, social security expenditures including public pensions, medical insurance and other benefits reached ¥116.9 trillion — almost double the amount in 1993 just after the collapse of the bubble boom. The so-called 2025 problem is often cited with widespread concern — in 2025, all of the postwar baby boomer generation will have turned 75 or older, further pushing up the cost of social security benefits. 2025, however, will just be a starting point; social security expenditures are estimated to hit around ¥190 trillion in 2040 — more than 1.6 times the cost in 2016, according to the Cabinet Office. The population of people 65 or older is forecast to peak in 2042 at 39.35 million — a 16 percent increase over 2015.

Social insurance programs such as the public pension, health insurance and nursing care insurance for the elderly are financed not only by insurance premiums but also through government expenditures. As the cost of social security benefits expand rapidly, revenue from insurance premiums cannot cover the entire cost. Year by year, public expenditures on social security continue to increase, squeezing the government’s general expenditure.

In the government’s draft budget for fiscal 2019, adopted by the Cabinet in late December, social security expenditures rose by more than ¥1 trillion year-on-year, including about ¥477 billion in an increase attributable to the aging of the population. Social security expenditures account for 34.2 percent of the government’s annual spending.

The national government continues to incur budget deficits and depend heavily on bond issues to finance the gap. Japan’s public debt has reached the worst level among OECD countries, with the long-term government debt now equivalent to 236.6 percent of the nation’s gross domestic product. The Finance Ministry blames the mounting debt in recent decades on the ballooning social security spending.

To get off the path toward fiscal collapse we have to change our ways, but we do not have a clear navigation map of fiscal sustainability. Meanwhile, the fact that we depend heavily on the issuance of government bonds to pay for the cost of social security benefits means that the cost is being passed on to future taxpayers.

When we look at the specific menu of social security programs, a large part of them are for the elderly population, such as the public pension, nursing care and health insurance. Of course, the younger generations use health insurance and receive other benefits as well, but the per capita cost of such programs is much larger for elderly people. In addition, much of the cost of social security is borne by younger people in the form of social insurance premiums and taxes paid by the working population. We need to consider changing the way we pay for the cost of social security so that all generations can share the burden of sustaining the system. Specifically, we should consider using more of the revenue from the consumption tax to finance the social security system because both younger people and retirees pay this levy.

The government will raise the consumption tax from the current 8 percent to 10 percent in October. Many people oppose consumption tax hikes because of the tax’s regressive nature — it imposes a relatively higher burden on low-income people than on high-income taxpayers. However, the social insurance premium is more regressive for young working people. For example, the national pension premium is fixed at ¥16,340 a month — irrespective of the income levels of the people who pay the premium.

Given the mounting government debt and the ballooning cost of maintaining the social security system in an aging population, further increases in the consumption tax may be inevitable. A 10 percent consumption tax in Japan is still much lower than the levels of similar indirect taxation in other rich, industrialized economies, such as the European Union’s 15 percent standard level for its value-added tax, Sweden’s 25 percent, France’s 20 percent and Germany’s 19 percent.

In Japan, inter-generational inequality remains an important topic — the inequality arising from the differences between generations in terms of the net benefit (the benefit minus the burden of cost) of public services such as social security over one’s lifetime.

In its 2005 white paper on the economy and public finance, the government estimated that there is a gap of more than ¥100 million in terms of net burden between elderly and future generations. That is, the elderly generations get more benefits than they paid into the system in the form of insurance premiums and taxes, but the situation is the opposite for younger people.

Although the younger generations hope to correct this inter-generational disparity, that involves a politically difficult process due to objections by elderly voters, who gain nothing by having the gap corrected. The difficulty is exacerbated by the nation’s so-called silver democracy — attributed to the larger proportion of elderly people in the electorate.

Social security programs are indispensable to people’s lives. Due to the rapid aging of the population and ever-declining births, the burden on working generations to sustain social security will become even heavier unless the current system is fixed. It is time not just to consider spreading the burden more widely across all generations, but to also think hard about what should be the benefits of social security. In short, it might be necessary to limit the benefits of public pension or health insurance programs to only the people who really need them.

It can be said that due to the demographic changes, the welfare state that many developed countries aimed to create in the mid-20th century is now out of reach.

Hisakazu Kato is a professor of economics at Meiji University and former senior research fellow at the National Institute of Population and Social Security Research.