Pension reform must accompany consumption tax hike

Economist Haruo Shimada talking at Roundtable Japan 2019 in Tokyo this July

First published by The Japan Times

The heavily taxed Swedes reportedly are among the world’s happiest people. Their cheerful disposition may arise from knowing the Swedish social security system offers real protections from life’s worst hardships. In contrast, the more gloomy Japanese worry their pay-as-you-go public pension system, never designed for people to live much past 70, is unable to support them in retirement. To end the fear, the government must place comprehensive social security reform at the top of the political agenda.

National governments can afford to give citizens generous pensions so long as growth and population rapidly expand. But when growth slows and population declines — as in Japan’s case — the infinite Ponzi scheme ceases to work. “Then the government must claw back the pensions of those already retired, tell those nearing retirement that their pensions are smaller than promised or tell young people paying into the system that they will not receive back the same amount they put in over their lifetimes,” explained economist Takatoshi Ito, now at Columbia University. Such worries underpin Japan’s deflationary mindset.

The economy doesn’t grow because people aren’t spending. They don’t spend because people don’t trust the stability of the public pension system. They know they must save a second private pension amounting to at least ¥20 million per household, according to a recent Financial Services Agency report (withdrawn in an attempt to quash people’s fears). The consumption tax hike from 8 percent to 10 percent planned for October will therefore likely cause consumer spending to slump, as it did in 2014 when the rate rose from 5 percent to 8 percent.

Alas, a tax hike from 8 percent to 10 percent is insufficient. Rates must rise to 20 percent to bring Japan’s fiscal deficits down to sustainable levels. Policymakers hoped to cushion the tax hike blow through faster economic growth. After years of failed attempts, any illusions of attaining the needed annual growth have all but evaporated.

It is not that Japanese workers are unproductive. Productivity growth per worker, at about 2 percent, is similar to that of workers in other advanced economies. However, population decline reduces Japan’s potential growth rate down to 0.3 percent or 0.4 percent. The Bank of Japan is out of ammunition. Short of adopting Modern Monetary Theory — which advocates printing and spending money — government can do little more than lift consumption tax rates to European levels.

Many economists, including Musashino University’s Mitsuhiro Fukao, think MMT’s stimulative effects are unsustainable. “There is a limit that you shouldn’t test,” he says, fearing MMT’s destabilizing effects. Instead, he and others propose consumption tax hikes of 1 percent per year until the rate reaches 20 percent.

“People will, of course, not accept paying it,” says Haruo Shimada, president of Shimada Research Institute and a former Cabinet Office adviser. He believes government must strike a new social contract with citizens to make tax hikes palatable. The new deal: “Government asks people to pay a 20 percent consumption tax for 50 years. In return, they provide people with a seamless and comprehensive cradle-to-grave social security system,” Shimada proposes.

Perhaps half of the tax hikes would pay for increased social benefits and the other half used to reduce national government debt. Pension payouts drawn from “funded” past contributions should replace those paid for by current workers. Coverage should also extend beyond health care and pensions to include education, birth assistance and end-of-life terminal care, he suggests.

Social security reform is on Prime Minister Shinzo Abe’s agenda, but it is not at the top. Abe spends most of his political capital pursuing constitutional change. Other important issues, like labor reform, are moving forward far too slowly. So it seems unlikely Abe will use his popularity to drive through needed comprehensive social security reform. Still, “Abe has big political capital. He should try to make the country a place where the future generation of youth can live, steadily and comfortably” as they do in Scandinavia, says Shimada.

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