Academic journal article The Economic and Labour Relations Review : ELRR

Social Security Pensions in Japan: A Balance Sheet Approach

Academic journal article The Economic and Labour Relations Review : ELRR

Social Security Pensions in Japan: A Balance Sheet Approach

Article excerpt

1. Introduction

Japan already has the oldest population in the world. It has built a generous social security pension program. In 2001 the income statement of this program moved into deficit and its balance sheet has continued to suffer from huge excess liabilities. This has been accompanied by a growing distrust of the government's commitment on public pensions and increased concern about the incentive-compatibility problem. The 2004 reforms went some way towards addressing these issues.

This paper uses a balance sheet approach to describe the current financial performance of social security pensions in Japan, and analyses the impact of the recent reform measures. The balance sheet approach was first used about 700 years ago in Italy and since then has become one of the two major accounting tools. However, it has been underutilized for public policy analysis. Benefits of the balance sheet approach are threefold. First, it describes the current financial status in stock terms by presenting assets and liabilities with their compositions. Second, it implies how smoothly future financing will be carried out, and third, it makes clear the impacts of alternative policy measures on future financing.

The paper begins with a brief sketch of the Japanese social security pension program and summarizes Japan's major pension problems. It then explains the 2004 pension reforms and uses the balance sheet approach to analyse the implications for the Japanese economy. The paper concludes with a discussion of future policy options.

2. Japanese Pension Provisions Before the 2004 Reforms

Since 1980. Japan has undertaken piecemeal pension reforms every 5 years or so to address the stresses caused by anticipated demographic and economic factors. This has resulted in a step-by-step reduction in the generous pension benefits, an increase of the normal pensionable age from 60 to 65, and an increase in the pension contribution rate. Yet, in 2004, the pension provisions still remained generous and the system seemed likely to face serious financial difficulties in the future.

Japan currently has a two-tier benefit system. All sectors of the population receive the first-tier, flat rate basic benefit. The second-tier earnings- related benefit applies only to employees. (1) The system operates largely like a pay-as-you-go defined benefit program.

The fiat-rate basic pension covers all residents aged 20 to 60. The full old-age pension is payable after 40 years of contributions, provided the contributions were made before 60 years of age. The maximum monthly pension of 06.200 yen (in 2004 prices) per person is payable from age 65. (2) This benefit is indexed annually to reflect changes in the consumer price index (CPI). The pension may be claimed at any age between 60 and 70 years and is subject to actuarial reduction if claimed before age 65, or actuarial increase if claimed after 65 years.

Earnings-related benefits are given to all employees. The accrual rate for the earnings-related component of old-age benefits is 0.5481 per cent per year; 40 years' contributions will thus earn 28.5 per cent of career average monthly real earnings. (3) The career-average monthly earnings are calculated over the employee's entire period of coverage, adjusted by a net-wage index factor, and converted to the current earnings level. The full earnings-related pension is normally payable from age 65 to an employee who is fully retired. (4) An earnings test is applied to those who are not fully retired. The current replacement rate (including basic benefits) for take-home pay or net income is about 60 per cent for a typical male retiree (with an average salary earned during 40 years of coverage) and his dependent wife. This translates to a monthly benefit of about 233,000 yen in 2004.

Equal percentage contributions are required from employees and their employers. The contributions are based on annual standard earnings including bonuses. …

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