Academic journal article Contemporary Economic Policy

The Effects of the 1.03 Million Yen Ceiling in a Dynamic Labor Supply Model

Academic journal article Contemporary Economic Policy

The Effects of the 1.03 Million Yen Ceiling in a Dynamic Labor Supply Model

Article excerpt

I. INTRODUCTION

The "1.03 million yen ceiling," which in this paper refers to the tendency of married women in Japan who work part time to limit their earnings to no more than 1.03 million yen (approximately 10,000 U.S. dollars), has recently attracted much attention in policy debates over Social Security and tax reform in Japan. Wives of salaried husbands whose earnings do not exceed 1.03 million yen are eligible to receive several types of benefits. Their benefits include the following: (1) a married woman with low earnings is eligible for Social Security and health-care benefits through her husband's coverage, with no additional premium contribution for the wife; (2) the husband can claim the "exemption for spouse" or the "special exemption for spouse" on his income tax return; and (3) the husband often receives an allowance for his spouse from his employer if the wife's earnings are lower than a specified threshold.

The work disincentive effects of the 1.03 million yen ceiling have been pointed out by Higuchi (1995), Abe and Ohtake (1997), Nagase (2001), Nagase and Nawata (2005), and Akabayashi (2006), among others, in the context of static labor supply. In the previous literature, the 1.03 million yen ceiling has been criticized for two reasons. First, it distorts labor supply of married women and causes a loss in efficiency. Evidence shows that the earnings of married, part-time, female workers are heavily concentrated around the 1 million yen level (Abe and Ohtake, 1997; Abe, 2003; Oishi, 2003; Nagase and Nawata 2005; Akabayashi 2006). If married women are reducing their working hours even though the marginal product of their labor exceeds their marginal disutility from it, then the ceiling is introducing distortions in labor supply. (1)

The second criticism is based on equity considerations. Married women who earn less than or equal to 1.03 million yen annually pay no income tax and no Social Security contributions, even though they are eligible for health and public pension benefits through their husbands' coverage. (2) The wife's earnings up to 1.03 million yen are almost tax free, while any other middle-income person earning an additional 1 million yen would be taxed at a marginal rate of at least 19%. (3)

Although the 1.03 million yen ceiling has attracted much attention, little is known about the dynamic consequences of the ceiling. Previous studies examining the effect of the ceiling on part-time labor supply have almost always used a static framework. However, part-time workers in Japan have a relatively strong attachment to work (Ohtake, 2000). In this paper. I use a simple dynamic labor supply model to assess the behavioral consequences of the 1.03 million yen ceiling. (4) The labor supply schedule in a dynamic model has properties that are not present in a static framework, which I call the "spillover effect." The dynamic welfare cost of the ceiling is also discussed.

The rest of the paper is organized as follows. Section II provides a brief summary of the Japanese income and Social Security participation rules and presents empirical evidence on how these rules affect labor supply of married women. Section III presents a dynamic labor supply model, examines the properties of optimal labor supply choices, and discusses the implications of these choices on the welfare cost. Section IV illustrates the results of Section III with a numerical example. Section V concludes.

II. TAX, SOCIAL SECURITY SYSTEMS, AND STYLIZED FACTS

In this section, aspects of the income tax and Social Security systems concerning the labor supply of married women are briefly explained. (5) In Japan, Social Security enrollment rules and firm benefit policies create work disincentives for married women. In addition, two sets of empirical evidence are presented as background to the subsequent analysis.

A. Tax and Social Security Systems

The social insurance participation rules relevant to low-income married women are as follows: when the wife's earnings are below 1. …

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