Elections and Alternatives for Pension Reform (1)
August 7, 2009
Public pension systems around the world can be broadly categorized into two types: the social insurance model and the universal model. Examples of countries employing the first model, in which people receive benefits or services in porportion to individual contributions made to an insurance scheme, include the United States, Germany, and France. The second model, in which benefits or services are received according to years of residency rather than contributions made, has been adopted by such countries as Canada, Australia, and the Netherlands. The critical difference is the linkage between contributions made and benefits received. In the former countries, individuals cannot receive pension benefits if they do not contribute through the payment of insurance premiums. Public assistance programs, which assess an individual’s income and assets, are available for low-income earners and others who for one reason or another have not been able to pay insurance premiums. In the latter countries, there is no clear linkage between contributions made and benefits received, and anyone who has lived in a country for a certain period (generally 40 years) can receive pension benefits. The system is, therefore, funded entirely by general tax. Moreover, excluding certain income-security measures such as housing assistance, income security in old age is provided for through the pension system, not public assistance. Although there is no direct linkage between contributions and benefits, it does not mean that a person receives pension benefits for free. This is because people normally pay income tax while working in their younger years, as well as paying sales tax. Their contribution through general tax is not directly connected to pension benefits. The choice of system, whether social insurance or universal, is based on the philosophy of what citizens think is fair and rational.
While Japan’s public pension system is in principle based on the social insurance model, the government calls it a universal system. This is theoretically contradictory because, while it has been noted that pension systems around the world are split between two models, Japan’s public pension system has characteristics of both. As will become apparent below, the fundamental problem with Japan’s pension system lies therein. Trust in the public pension system has eroded greatly in recent years as problems have arisen in relation to both contributions and benefits. On the contributions side, the number of people who cannot pay premiums has increased rapidly due to such factors as a rise in non-permanent employment. With regard to benefits, the amount received by some citizens was reduced as a result of the government’s inaccurate records of premiums paid. It is said that the total number of such cases, referred to as “unattended pension claims,” is 50 million. These problems show the social insurance system in Japan has broken down.
The Structure of Japan’s Pension System
Generally speaking, or according to official government documents, Japan’s public pension system is a two-tiered system, comprising a Basic Pension plan as the first tier, and pension plans for company employees and civil servants as the second tier. (There are also corporate pensions, which constitute a third tier.) In the first tier, all citizens pay and receive a fixed amount, while in the second-tier pension plans for company employees and civil servants, the insured person pays premiums and receives earnings-related benefits. But this explanation does not accurately reflect Japan’s pension systems. In reality, pension programs are divided by occupation. The National Pension is provided for self-employed and non-permanent employees, while occupational pension plans are provided for company employees and civil servants (see chart). Although the Basic Pension plan was introduced in 1985 through the amendment of relevant laws, it was not established as an independent pension scheme, but rather as a financial bail-out system, because the National Pension system was going bankrupt. Occupational pension plans consisted of flat benefits and earnings-related benefits, while the National Pension system was originally flat benefits. After the pension reform in 1985, the Basic Pension provided the same flat benefits for both pension schemes. In principle, Japanese citizens are required to join one of three pension plans. The fixed-benefit portion (the portion equivalent to the Basic Pension), however, is paid out of funds to which each pension plan contributes. Simply put, employees of companies are financially supporting such people as the self-employed. The complexity of this system has given rise to a number of problems.
Firstly, there is the problem of unfair distribution of burden for payment of insurance premiums. Individuals belonging to the National Pension plan (designated by law as “Type I insured”) pay a fixed monthly premium of approximately 15,000 yen, regardless of income. Insurance premiums for company employees and civil servants (designated as “Type II insured”) are flat-rate, namely contributions proportionate to the employee’s monthly salary, amounting to approximately 15% of the monthly salary (paid one-half by employees and one-half by employers). In short, the flat-rate contributions by employees and employers cover both flat benefits and earnings-related benefits. In other words, pension premiums for flat benefits are unknown, although they are estimated to be about 4 percentage points of the total 15% insurance premium. Moreover, the spouse of a company employee who is a full-time homemaker (designated as “Type III insured”) pays nothing.
The Ministry of Health, Labor, and Welfare has called the Basic Pension plan a social insurance system, but with the exception of the “Type I insured” (self-employed and part-time workers), pension premiums for flat benefits for employees are unknown. In short, the Japanese social insurance system cannot even identify the insurance premiums paid. This undermines the fiscal governance of the social insurance system, which should link benefits to burdens. Moreover, despite the introduction of a scheme to reduce premiums for low-income earners, the Basic Pension system at present makes those who earn 3 million yen a year pay the same premiums as those earning 100 million yen. This is a seriously regressive system. It is hard to describe this as a public system in which the people all take part to support each other based on their ability.
Secondly, aside from the fact that the National Pension plan differs completely from the pension plans for employed individuals in terms of distribution of contribution burden and treatment of spouses, a number of inconsistencies have arisen as a result of applying the financing adjustment only to the fixed-amount benefit portion of the system. A classic example is the problem presented by situation of the “Type I insured” housewife, who must pay into the system, versus the “Type III insured” housewife, who pays no premiums because her spouse (Type II insured) pays for her, but still receives the same benefits. Moreover, approximately 40% of the 21 million people who fall into the category of “Type I insured” cannot pay a monthly flat premium of about 15,000 yen. The decrease of contributors in the National Pension scheme is likely to increase the burden of employees who belong to occupational pension schemes. According to my calculations, company employees may pay roughly 20% higher premiums on average compared to the proportion of burden shared by all insured persons. The pension record problem is also the result of increasingly cumbersome and complicated procedures that are required if people change occupation.
Thirdly, the maximum amount of benefits per month under the Basic Pension system is 66,002 yen (in fiscal 2007), which is less than the 80,820 yen basic individual welfare benefit (in the 23 wards of Tokyo for senior citizens) from public assistance programs requiring means-testing. The actual average amount of benefits received under the Basic Pension is 47,000 yen (for National Pension plan contributors). While the purpose of each is different, 40 years’ worth of pension contributions still come up short in terms of welfare benefits. As such, there is little or no incentive for low-income earners to pay insurance premiums. On the other hand, since one half of the Basic Pension benefits are paid from general tax (from fiscal 2009), pension benefits for such high-income earners as corporate executives are also supported by general tax. Is this really an efficient use of tax revenue during a time of severe fiscal constraints?
In short, our country’s Basic Pension is a “virtual system” different from those of other countries. It is not clear whether it is an insurance system or a safety net. In countries like Canada and Australia, the basic pension system is identified as the latter; it is a universal model in which benefits are based on length of residency, wherein all citizens can receive the same benefits in principle. Naturally, it is financed by general tax. On the other hand, in countries such as the United States and Germany, the public pension system is based on the principle of social insurance, wherein public assistance, not a universal pension, plays a key role in covering deficiencies in pension benefits.
While half of the total benefits for the Basic Pension are financed by general tax from fiscal year 2009, the problems will not be solved if the current structure of pension systems remains as is. Whether it is in the form of insurance premiums or taxes, the burden on the public is the same. How to finance a pension scheme is determined according to the philosophy of the system. The MHLW says that the social-insurance-style universal pension is the basis of the Japan’s pension system, but this is theoretically contradictory. MHLW surveys even reveal that more than 1 million senior citizens aged 60 or older do not receive pension benefits. Why is it that there are so many without benefits when Japan supposedly has a universal pension system? Furthermore, given the recent dramatic increase in the number of people who work temporarily, the increase of non-contributors to pension schemes is likely to cause an increase in the number of non-recipients. It is common knowledge that the social insurance model cannot provide universal benefits; thus, the current Japanese social insurance model cannot solve the serious problems discussed in this paper.