- Tax & Social Security Reform
Creating a Fair and Unified Public Pension System
May 18, 2020
On March 3, 2020, the Abe cabinet adopted a package of pension reform bills that it hopes to enact in the current Diet session. But the legislation, notes economist Eiji Tajika, stops far short of the structural changes needed to address the realities of our aging society and the basic inequity of Japan’s two-tiered system that penalizes nontraditional workstyles. The author calls for expanding the coverage of Employees’ Pension Insurance with a view to eventually unifying the national pension system.
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The need to restructure Japan’s pension system has been apparent since the 1990s. Wage growth has slowed dramatically since the collapse of the bubble economy three decades ago, and the population is aging rapidly. Yet measures to address the basic problems have been placed on the back burner time and again. The “macroeconomic slide” adjustment mechanism adopted in 2004 did no more than limit growth in payouts by indexing them to demographic and other trends affecting the financial status of the pension system.
The Outdated National Pension
Japan’s universal public pension system dates back to 1961, when the government established the National Pension to guarantee a minimal post-retirement income to individuals who were not covered by existing plans for private- and public-sector employees. The target of the National Pension was “self-employed persons,” a category that consisted primarily of small shop owners and farmers. Unlike the employees’ pension plans, in which contributions and benefits were tied to compensation, the National Pension was conceived as a fixed-benefit plan with flat-rate contributions.
This decision to set up a separate, simplified plan probably made sense at the time, given the profile of the typical self-employed person and the difficulty of clearly ascertaining such individuals’ income. What is difficult to understand is why this two-tiered system continues even today.
The Japanese labor market has changed dramatically since the 1960s. Today, the majority of those enrolled in the National Pension plan are part-time employees, contract workers, and temporary staff employed by businesses in the private sector. They often work side-by-side with regular, full-time employees and may even perform the same tasks. Yet their nonregular status excludes them from coverage by Employees’ Pension Insurance (EPI). From the employer’s standpoint, this is a plus in the sense that it saves the company money on pension contributions. In a world of rapidly diversifying workstyles, though, the two-tiered pension system no longer makes sense.
Today’s system is particularly problematic given the low level of benefits offered by the National Pension plan. Under this system, workers pay a flat-rate, monthly premium, currently set at ¥16,410, and those who pay the premium from age 20 to 60 are entitled to the maximum benefit, presently ¥65,000 a month, or ¥780,000 a year (roughly US $7,300). Clearly, this is nowhere near enough to live on after retirement. To this basic pension portion, the EPI plan for full-time employees adds a compensation-tied component, paid for by premiums divided evenly between the employee and the employer.
But the inequality does not stop there. As noted above, pension benefits are being gradually reduced in real terms by the macroeconomic slide. The cuts apply to both the fixed, basic pension benefits (received by National Pension and EPI participants alike) and the EPI’s additional compensation-tied benefits. However, the basic pension benefits are being cut by a bigger rate. This is because the compensation-tied benefits are adjusted only after the macroeconomic slide is applied to the basic pension benefits on the basis of the balance sheet of the National Pension, which is on a weaker financial footing than EPI.
For the growing ranks of workers who are not full-time, regular employees, the meager basic pension is the full extent of post-retirement income guaranteed under the public pension system. Moreover, those inadequate benefits are being disproportionately eroded by the macroeconomic slide. Ultimately, the only fair and sensible direction for reform is to scrap the outdated and inadequate National Pension and consolidate public pensions under the EPI scheme.
In a recent study, Yoko Aikawa and I show how the current two-tiered system has fostered an unequal distribution of pension burdens and benefits and discuss the challenge of establishing a unified pension system. In the following sections, I draw on that study to illustrate the effects of the current system on employment and workstyles, consider what must be done to overcome opposition to consolidation under the EPI system, and discuss the costs and benefits of such a reform.
Perverse Incentives of the National Pension System
As I have argued above, consolidation of public pensions under the EPI scheme is essential for the creation of an equitable system that offers a guaranteed, post-retirement income regardless of workstyle. However, the existence of the National Pension has made any such reform extremely difficult. Moreover, the criteria for coverage by the EPI plan are distorting employment patterns and hindering workstyle reform.
In terms of employers, EPI applies to all corporations and individually owned businesses with five or more employees. In terms of workers, it covers full-time employees under 70 years of age. Also covered are employees who log at least 75% of the standard full-time weekly work hours or monthly work days at that workplace. If we assume that a full-time workweek is 40 hours, then the system should cover everyone who works 30 hours a week or more. Those who work less than 30 hours at a given workplace are also eligible providing they fulfill the following five conditions: (1) they work at least 20 hours a week, (2) their employment is expected to last at least one year, (3) their monthly pay is ¥88,000 (¥1.06 million a year) or more, (4) they are not students, and (5) they are employed by a company with more than 500 employees.
The foregoing may give the appearance of extending EPI coverage to part-timers, but that appearance is deceptive, since all five of the abovementioned criteria must be met, including the condition that the company employ more than 500 workers. Because employers pay half of the EPI premiums, they have a cost-cutting incentive to exclude workers from EPI coverage. Moreover, since all workers who do not qualify for EPI coverage can rely on the safety net of the National Pension, employers feel no qualms about excluding them from full pension benefits.
Meanwhile, the criteria for coverage by EPI distorts employment patterns and workstyles in a way that undermines the government’s efforts to mitigate the strains demographic aging is placing on both the pension system and the labor market. For the purposes of this article, I will focus on two examples, one pertaining to women and the other to senior citizens.
Under the current system, the dependent spouse of an employee is covered under a special category of EPI and is exempt from paying pension premiums. This exemption, which applies overwhelmingly to married women, remains in effect as long as the wife’s annual earnings are less than ¥1.06 million. However, once she starts earning more than that, both she and her employer must start paying EPI premiums apart from those of her husband. This creates an incentive on both sides to keep the woman’s income and hours under the minimum required for EPI coverage, undermining the government’s official policy of boosting women’s participation in the labor force.
Another issue concerns employees covered by EPI who wish to continue working after they reach the age of 65, when they become eligible to begin receiving pension benefits. Under the existing system, employers have an economic incentive to limit such employees’ hours to less than 20 a week in order to avoid paying EPI premiums. For the employees as well, this may seem like a rational option: After all, if they apply for benefits at age 65 while working part time, they can begin to receive full benefits without paying any further premiums. Employers may even get away with paying a smaller wage to these senior workers, who can supplement their earnings with pension benefits.
This may seem like a rational decision from a short-term perspective. Unfortunately, it deludes the purpose of a public pension, which is to guarantee a stable post-retirement income for however long it may be needed. Given the rising life expectancy of the Japanese people and the growing strains on the current system, a more sensible policy would be to require that both employer and employee continue paying premiums into the EPI plan for as long as employment continues and increase pension benefits for those who work past 65. This would help ensure an adequate post-retirement income for all, while at the same time contributing to the system’s financial sustainability. But that is unlikely to happen under the current EPI exemptions.
Overcoming the Opposition
Let us now consider what needs to be done in order to begin integrating the public pension system.
The first step to creating a fair and unified pension system is to eliminate the exemptions that have hindered the expansion of EPI coverage. However, this is difficult, owing to the added burden of EPI premiums that would result from such expansion.
As indicated above, any company with fewer than 501 workers can avoid enrolling employees in the EPI plan. The rules governing large companies with more than 500 employees are stricter, and the government has considered extending the same rules to any business regularly employing more than 50 workers. But the proposal faces stiff resistance.
According to a report in the daily Sankei Shimbun (November 21, 2019), Akio Mimura, chairman of the Japan Chamber of Commerce and Industry, expressed deep reservations about the expansion of EPI at a meeting on pension reform in the Prime Minister’s Office, arguing that it would place an additional burden on already-overburdened small and medium-sized enterprises. At a press briefing following the meeting, he unequivocally declared himself against the idea. However, the same article reported that Keidanren (Japan Business Federation), led by Japan’s big corporations, had called for scrapping EPI exemptions for smaller companies, calling such size-based criteria “irrational.”
The stance of big business notwithstanding, we need to think carefully about the potential impact of EPI expansion on SMEs, which account for the majority of jobs in Japan. Since people enrolled in EPI are automatically eligible for Employees’ Health Insurance as well, such employers would also be saddled with new healthcare and nursing care premiums. That could be a devastating blow for many small businesses.
Simply expanding EPI would disproportionately impact those who can least afford the added burden—small businesses and low-income workers. Without special measures to offset that burden, integration of the pension system under the EPI system is unfeasible. The government needs to move ahead with the integration of taxes and social security and introduce tax credits and other breaks to offset the added burden of pension premiums. An important question to consider in this connection is whether to provide breaks for both individuals and businesses.
Economics of Consolidation
Pension reform of the type outlined above will mean a heavier burden for some, but this is the unavoidable cost of scrapping the cut-rate National Pension plan in favor of a rational, unified pension system that treats everyone equitably, regardless of workstyle.
The economic costs and benefits of such a reform would depend on the number of people added to the EPI rolls and their income. The Health, Labor, and Welfare Ministry has estimated that if everyone earning as little as ¥58,000 a month were to be covered by EPI, basic pension benefits would increase by 21.7%. Of course, such an increase would entail larger outlays by the government. According to my own estimates, the cost (in 2019 terms) would amount to approximately ¥174 trillion. In addition, it will be necessary to provide low-income households and small businesses with subsidies or credits, as noted above. Again, this is the price we must pay for decades of overreliance on a cheap, substandard pension.
In the foregoing, I have made the case for consolidation of Japan’s outdated public pension system under the Employees’ Pension Insurance plan. The current two-tiered system, a relic of the 1960s, is both inequitable and irrational. It is also undeniable that the low-cost but woefully inadequate National Pension plan has had the effect of delaying much-needed reform. The time has come for pension reform geared to an equitable distribution of burdens and benefits in the era of diverse workstyles.
 Eiji Tajika and Yoko Aikawa, “Tayo na hatarakikata e no zei/shakai hoken seido no taio: Futan no kohei o do jitsugen suru ka” (Adapting the Tax and Social Insurance Systems to Diverse Work Styles: How to Achieve Fair Distribution of Burdens and Benefits), Sozei Kenkyu, January 2020, 97–112.