Fiscal sustainability in Japan: What things to tackle
Japan leads the advanced economies in the speed and magnitude of demographic ageing and gets the highest debt-to-output ratio. Rising social insurance expenditures are projected to far outpace revenues also to create a fiscal burden. This column presents sobering projections for Japanese government debt in the lack of reform, but argues a mix of policies, including policies to encourage greater labour participation by women also to enhance productivity, could achieve sustainability.
Japan is ageing fast. Its dependency ratio, thought as the ratio of the populace aged 65 and above to the populace aged 20-64, was 48% in 2015. It really is predicted to go up to 80% by the first 2050s also to stay at around 80% through the second half of the century.
Expenditures for age-related social insurance programmes – such as for example pensions, public healthcare, and long-term care insurance – are projected to go up significantly, far outpacing the projected revenues and insurance premia collected as how big is the working age population continues to shrink rapidly. Previous research discovered that a major upsurge in taxation, in the region of 30-50% of total consumption, will be had a need to finance the demographic transition without the reform (e.g. Braun and Joines 2015, Kitao 2015, Hansen and Imrohoroglu 2013); otherwise, debt will reach an unsustainable level in the not too distant future (e.g. Doi, et al 2011, Hoshi and Ito 2014).
In two papers (Imrohoroglu et al. 2016, 2018), we simulate future paths of individuals’ life-time income, consumption, and saving and calculate projections of future government budget balances and debt. As in Storesletten (2003), we create a life-cycle model with complete markets to measure the impact of demographic ageing and different scenarios involving fiscal responses and economic assumptions that affect fiscal sustainability in Japan. In understanding the magnitude and consequences of demographic ageing, we allow annual deficits to be put into the prevailing government debt, abstracting from the chance of default or inability to issue additional bonds.
Most of all, we treat information on the social insurance system in Japan – including public pension, medical health insurance and long-term care insurance programmes – separately from other government expenditure and revenue items. We include detailed payment arrangements, in addition to the system of co-pay and premium payments that differ by age, employment type, and individual earnings. It really is quantitatively vital that you incorporate the finances of the insurance when in predicting the near future paths of fiscal variables in Japan.
Projected demographic ageing in Japan means that, without the reform or changes in the labour market, annual budget deficits will reach 10% of GDP by 2040 and 18% by 2070. The web debt-to-GDP ratio would reach the unprecedented and unrealistic degree of 230% by 2040 and 630% by 2070. As shown in Figure 1, four components – expenditures for public pensions, medical health insurance, long-term care (LTC) programmes, and debt servicing – would contribute equally to the rising deficits and debt, with the interest payments rising quicker as more debt is accumulated.
Figure 1 Resources of net borrowing (% of GDP)
So, what things to tackle?
Fiscal sustainability is impossible without reform. Additionally it is very difficult to attain sustainability with an individual tool. However, we find a mix of policy reforms and changes in the labour market and productivity would solve the problem.
In particular, a rise in female employment (with wage increases and employment regularisation) would make a significant difference. More female participation and increased earnings wouldn’t normally only increase tax revenues but also the budgets of most three social insurance programmes. A significant obstacle may be the work disincentive and what’s essentially a severe penalty for more women working that’s embedded in today’s social insurance coverage and tax system. Efforts by policymakers to improve these mechanisms also to move around in the direction of not discouraging more participation and achieving growth will be needed for long-run fiscal soundness. We note, however, these changes require significant structural reforms and will only be implemented with a long-term and credible commitment.
Increasing the consumption tax rate from the existing 8% to 10% in 2019 would reduce fiscal pressures in the short run. An additional increase to an even that is much like other advanced economies would help alleviate significantly the accumulation of debt over time.
Achieving fiscal sustainability is difficult however, not impossible. For example, a combined mix of policies such as for example raising the full retirement to 67, reducing pension benefits, raising the co-pays in public areas medical expenditures and long-term care spending to 20%, increasing women’s earnings and employment characteristics to complement those of men, and raising the consumption tax rate to 15% would achieve fiscal sustainability and result in significant fiscal consolidation with a lesser debt-to-GDP ratio in 2050 than in 2020.
Braun, A R and D H Joines (2015), “The Implications of a Graying Japan for Government Policy”, Journal of Economic Dynamics and Control 57: 1-23.
Doi, T, T Hoshi and T Okimoto (2011), “Japanese Government Debt and Sustainability of Fiscal Policy”, Journal of japan and International Economies 25(4): 414-433.
Hansen, G D and S Imrohoroglu (2016), “Fiscal Reform and Government Debt in Japan: A Neoclassical Perspective”, Overview of Economic Dynamics 21: 201-224.
Hoshi, T and T Ito (2014) “Defying Gravity: Can japan Sovereign Debt Continue steadily to Increase with out a Crisis?”, Economic Policy 29: 5-44.
Imrohoroglu, S, S Kitao and T Yamada (2016), “Achieving Fiscal Balance in Japan”, International Economic Review 57(1): 117-154.
Imrohoroglu, S, S Kitao and T Yamada (2018), “Fiscal Sustainability in Japan: What things to Tackle”, RIETI Discussion Paper 18-E-064.
Kitao, S (2015) “Fiscal Cost of Demographic Transition in Japan”, Journal of Economic Dynamics and Control 54: 37-58.
Storesletten, K (2003), “Fiscal implications of immigration – a net present value calculation”, Scandinavian Journal of Economics 105(3): 487-506.