(Summary Version is here.)

Rebuilding the Public Pension System
which Earns the Confidence of the Citizens

July 21, 1998

(Japan Federation of Economic Organizations)


Japan is now facing the need to undertake major structural reforms so as to switch from its existing "catch-up" systems built on the assumption of rapid economic growth. At the same time its birthrate is falling and its population aging at a faster rate and on a more major scale than any other country has experienced. In addition to undertaking reforms of the tax system and the financial system, in order to achieve an affluent and vigorous society of high longevity in the twenty-first century, we must carry out a fundamental overhaul of our systems of social security, including pensions, medical care, nursing care, and welfare, so as to make them transparent, sustainable systems on which people can rely.
Discussions are now underway concerning reform of the public pension system, a major component of social security, in preparation for the 1999 recalculation of pension finances. All the plans that make up the system are facing major problems. For example, the National Pension plan suffers from high levels of nonpayment and nonparticipation, while the Employees Pension program (the public pension scheme for company employees) is severely underfunded and distributes its burdens inequitably between generations. These problems are heightening people's worries about their old age. We must make it possible for people to spend their old age with peace of mind while maintaining the vigor of the Japanese economy and caring for the truly disadvantaged even in the low-birthrate, high-longevity society of the twenty-first century. In addition to building social systems that will allow the growing numbers of elderly people to be tapped as active workers, we need to promote the improvement of corporate and individual pension plans based on individual self-help efforts and carry out a fundamental reform of the public pension system so that people can enjoy financial stability in the future.

With regard to corporate pensions, Keidanren came out with a position paper in December 1997 titled "Seeking a Fundamental Reform of the Corporate Pension System." In this document, while calling for corporate pensions to be clearly identified as private-sector plans and for measures to secure beneficiaries' rights, we urged that freedom be granted for pension plan design on the basis of labor-management agreements; in particular we called for the introduction of defined-contribution corporate pension plans. We also urged that tax incentives be adopted and that the special corporate tax be abolished.
On the subject of public pensions, Keidanren drew up a document titled "Seeking the Rebuilding of a Transparent and Sustainable Pension System" in December 1996, in which we set forth our fundamental views: (1) The basic-pension portion should be handled on a pay-as-you-go basis. (2) The earnings-related portion should be funded; consideration should be given to the possibility of privatizing this portion and integrating it with corporate pensions in the future.

We have now put together the following set of reform proposals aimed at rebuilding the public pension system into one that people can rely on.

  1. Problems with the Current Public Pension System
    1. Underfunding and the increasing burden on future generations
    2. Because of repeated hikes of benefit levels in the past without the imposition of appropriate contribution levels, the Employees' Pension program has become drastically underfunded. According to figures released by the Ministry of Health and Welfare, the funding shortfall is ¥350 trillion for the earnings-related portion and ¥490 trillion for the system as a whole. As a result, people have become seriously worried about whether they will be able to receive their expected old-age income. The government bears a extremely heavy responsibility for not having disclosed information on this critical situation to the public until recently and for having failed to undertake fundamental reforms. The government should first of all explain the causes of this tremendous funding shortfall to the public in a plain fashion, and it should disclose the detailed bases of its funding calculations, including the precise amounts of the shortfalls and the assumptions and processes used in calculating them.
      Since the present system is effectively being operated on a pay-as-you-go basis, the contribution (premium) rates are greatly affected by demographic changes, such as the declining birthrate and increased longevity. According to an estimate that has been made public, if the Employees' Pension program, a component of the public pension system, is maintained in its present form, the future decline in births and growth of the elderly population will require a doubling of the contribution rate from the present 17.35% to 34.3% by fiscal year 2025. At the time of the previous quinquennial recalculation of pension finances, the estimated contribution rate for FY 2025 was 29.8%, but the revision of population projections a mere three years later (in January 1997) has resulted in an estimated rise of over 4 percentage points. It is quite conceivable that future demographic changes will make additional hikes in the rate necessary. If future generations are forced to bear this sort of excessive burden, the vigor of the Japanese economy is bound to decline steadily, and the public, unable to foresee the level of the burden, will grow increasingly mistrustful of the system.

    3. Intergenerational inequity of benefits and burdens
    4. In addition, checking the balance between benefits and burdens, we find pronounced inequity between generations. As estimated in the White Paper on Pensions released by the Health and Welfare Ministry this February, the benefit-to-burden ratio for the Employees' Pension program (with employers' contributions included in the calculation) is 2.21 for participants born in 1944, who are about to start collecting their pensions, but it will only be 0.87 for participants born in 2004, meaning that they will not receive benefits matching their payments. The intergenerational lack of balance between benefits and burdens under the existing system is producing rising mistrust in public pensions among younger people.

    5. Nonpayment and nonparticipation
    6. Approximately one-third of the people who are supposed to be covered under the present National Pension plan are either not paying their contributions or have not signed up for the plan at all. This is making the concept of universal coverage a hollow slogan. In the future, as those who have failed to pay or participate reach benefit-receiving age, the number of pensionless people will rise, and the base of financial stability that the public pension system is supposed to provide for the entire nation may be seriously shaken.
      The annual expenses of paying the basic pension (a component of all the public pension plans) are apportioned among the Employees' Pension program, mutual aid association pensions, and the National Pension plan in accordance with the number of people covered under each of the types of pension. However, the number of people covered under the National Pension plan is taken as the number of people paying contributions; those who are not paying or participating are excluded from the calculation. This means that a portion of the expenses that are supposed to be borne by the National Pension plan are actually being paid by participants in the other programs. This is producing inequity in the burden sharing for the basic pension.

  2. Preconditions for Reform
  3. In order to deal with these problems, the present public pension system must be fundamentally reformed, even though this will cause pain for the general public in the form of increased burdens and lower benefits. But the following items must be implemented thoroughly as absolute preconditions for reform.

    1. Greater disclosure
    2. In December 1997 the Health and Welfare Ministry presented what it called "five options" for pension reform. While we appreciate the improvement, by comparison with the past, in the ministry's stance of seeking opinions broadly from the public, the level of disclosure must still be labeled inadequate. For example, the ministry did not reveal the details of the assumptions or processes behind the calculation of the options. In order to carry out reform of the public pension system, the understanding and support of the people is essential. The ministry should therefore carry out greater disclosure, listening to public opinion after revealing the methods used to derive the various estimates and providing detailed data, including simulations based on assumptions closely conforming to reality for such underlying factors as the birthrate and economic growth rate; it should also make the contents of the deliberations of the government's Pension Council immediately available.
      Also, the White Paper on Pensions makes virtually no mention of the mutual aid association pension plans, such as the one that covers civil servants. Public understanding and support is essential for these plans, just as for the Employees' Pension program, and the ministry should therefore carry out thorough disclosure and make clear the actual state of these plans.

    3. Efficiency and transparency in fund management
    4. As of the end of FY 1996 (March 1997), the government was holding reserves of approximately ¥126 trillion in total for the Employees' Pension and National Pension programs. These funds have been invested in infrastructure improvement projects and guidance policy financing through the organs of the Fiscal Investment and Loan Program. As the operator of these pension programs, the government must exert itself to put their finances on a sound footing, investing the funds as efficiently as possible so as to lighten the burden on the public and to help make up for the funding shortfall. Consideration is now being given to the idea of eliminating the requirement that the funds be deposited with the government's own Trust Fund Bureau and allowing them to be invested independently; there is, however, a need for greater transparency to be achieved and further improvements in efficiency to be sought by making the government's fiduciary responsibility clear and conducting thorough disclosure of information, including the details of asset management.

    5. Greater efficiency of operation
    6. The inefficiency of such items as the spending by the Social Insurance Agency on premium collection has become a major issue. For example, the ratio of clerical expenses to income from contributions under the National Pension plan is far higher than under the Employees' Pension program. The goal of achieving a small government also requires a thorough review of the existing clerical systems and the pursuit of greater efficiency so as to cut collection costs.

  4. Basic Thinking on Public Pension Reform
  5. In preparing to conduct reform of the public pension system, we believe that there is a need for a national discussion of the role that public pensions are expected to perform, the concomitant benefits and burdens, and funding methods. The following three points represent the basic thinking of Keidanren in this connection.

    1. Construction of a sustainable system that can withstand changes in society and the economy
    2. The high-longevity society of the twenty-first century must be lively and vigorous, allowing older people to be active workers. For this reason it is important to think in terms of having able-bodied elderly people be among the providers of support rather than drawing a uniform line by age between those providing support and those receiving it. It is also important to think in terms of shifting to a self-help society so as to minimize the burden on the nation as a whole. In order to make the public pension system one that will be sustainable and can win the people's trust in the century ahead, we need to adjust benefits to a level corresponding to the burden that the people will accept, keeping the load on the active population from becoming too heavy; we cannot maintain a system of high benefits and heavy burdens.

    3. Clarification of the role of public pensions, improvement of private pensions
    4. In order to improve people's old-age financial security within the context of the move toward a self-help society, we should rebuild the public pension system into a sustainable one that will fundamentally aim to provide the "national minimum" standard of living; at the same time it is essential that we improve the corporate and individual pension systems that serve as means for people to provide for their own futures. One urgent requirement in terms of increasing the range of choices available is the introduction of defined-contribution corporate pensions. Even if the amount of old-age income guaranteed by the public pension system decreases, lightening the burden on individuals will help assure the system's stability, and with improvement of the corporate and individual pension systems of the private sector, it will become possible for people to assure their old-age income through their own choice and at their own responsibility, thereby sweeping away worries about the future.

    5. Discussion in tandem with fiscal and tax reform
    6. Social insurance premiums now impose a heavy burden on both individuals and corporations; they may be considered a second layer of taxes. It is feared that with the aging of the population, this burden may severely constrain personal and corporate economic activity. It is therefore essential to consider public pension reform not just in the context of the entire social security system but also in tandem with fiscal reform and tax reform. On the fiscal front there is a need to shift to a structure of expenditures appropriate for a high-longevity society, leaving as much as possible up to the private sector; on the tax front there is a need for fundamental reform aimed at sustaining and enhancing economic vigor.
      One benchmark for these reforms is the size of the "national burden" of taxes plus social security charges as a percentage of national income. In order to keep this burden as far below 50% as possible, the hikes in taxes and social insurance premiums for public pensions must be held to an absolute minimum.

  6. Concrete Directions for Public Pension Reform:
    Separation of Basic and Earnings-Related Portions, Reconsideration of Funding
  7. In order to carry out reform of the public pension system in line with the thinking described above, the roles of the basic-pension portion and earnings-related portion should be clarified and their finances and funding methods should be reconsidered in line with their purposes, and the finances of these two portions need to be distinguished clearly from each other.

    1. Reform of the basic-pension portion
    2. The basic-pension portion acts as a form of income redistribution; its objective is to assure a minimum standard of living for the elderly. It should therefore be switched to a pay-as-you-go system funded by taxes. In terms of spreading the burden among the entire public and minimizing the impact on economic vitality, indirect taxes should be used in preference to direct taxes. One concrete possibility would be to collect the necessary amount as a surcharge on the existing consumption tax.#1
      The switch to pay-as-you-go funding based on indirect taxation would take care of some of the problems that have been pointed out with respect to the National Pension program, including (1) the frequency of nonpayment, nonparticipation, and exemption which means that about a third of those covered by the plan are not paying their contributions, and (2) the issue of requiring full-time housewives and students to pay contributions. This change would also alleviate the intergenerational inequity in the balance between burdens and benefits.
      In keeping with the idea of guaranteeing the minimum standard of living, benefit levels for the basic pension should be maintained as at present for the time being. Thereafter they should fundamentally be raised in consideration of inflation and maintenance of the "national minimum".
      #1 As estimated by the Ministry of Health and Welfare,
      the initial surcharge required would be 3.2%.

    3. Reform of the earnings-related portion
      1. Purpose of the earnings-related portion
        The earnings-related portion has the purpose of supplementing the basic-pension portion so as to guarantee the retirees a certain percentage of the living standard which they enjoyed in their working ages; it is largely a self-help pension plan under which benefits are proportionate to contributions made during one's working years. It is thus proper for this portion to be funded through accumulated reserves.

      2. Government responsibility for underfunding
        As noted above, in June 1997 the Health and Welfare Ministry announced the existence of funding shortfalls of ¥350 trillion for the earnings-related portion and ¥140 trillion for the basic-pension portion of the Employees' Pension program. The government bears grave responsibility for letting the situation go to the point where the shortfall is on the order of a whole year's gross domestic product and for failing to disclose this information to the public.
        If benefits are kept at present levels, the current and future generations of workers will have to make up for this shortfall. It is the government's duty to offer measures to solve this problem of underfunding in a way that the public can accept.

      3. Directions for reform of the earnings-related portion
        One approach to reform of the earnings-related portion would be

        1. to maintain the existing social insurance framework and shift to a system of funding through reserves, collecting additional contributions from present and future workers, with the aim of eventual privatization.
        In this case present and future workers would have to bear a double burden, paying for their own future benefits and at the same time paying to make up for the underfunding of the past. In order to keep the burden on any particular generation from becoming altogether too heavy, it would be necessary to make the amortization period quite long and thereby minimize the level of the added contributions required; in addition it would probably be inevitable that benefit levels also be lowered within the bounds acceptable to the public.
        The process of amortization would presumably result in the accumulation by the state of a pool of pension assets even larger than at present. There would accordingly be a need to entrust funds for investment with private-sector financial institutions; there would also be a need to secure adequate transparency through thorough disclosure and clarification of the government's fiduciary responsibility.

        Another approach would be for the state to assume responsibility for writing off the funding shortfall for the earnings-related portion and for this portion to be shifted promptly to a system of full funding. Examples of how this might be done in practice include
        1. to terminate the existing Employees' Pension program, split off the funding shortfall of the earnings-related portion, and recommence the entire earnings-related portion on a fully funded basis or as a defined-contribution plan;
        2. to merge a portion of the earnings-related portion at each company with a corporate pension plan and terminate the existing Employees' Pension program.
        In these cases, even if the government assumed responsibility for proposing measures to deal with the need to pay benefits to those whose pensions have already commenced and to eliminate the funding shortfall, the money would ultimately have to come from taxes paid by present and future generations.

        Whichever of these approaches might be taken, the present and future generations will have to bear a double burden. This will be painful for them, but it is something that cannot be avoided in order to achieve sustainability for the pension system. Moves should be undertaken immediately to prepare for a shift to a system of full funding for the earnings-related portion while taking care not to rob the economy of its vitality. It will be essential in this connection to lower the existing benefit rates; even a comparison of these benefits with the income of current workers indicates this necessity. In concrete terms the possible approaches include
        1. to reduce benefits even for those whose pensions have already commenced by cutting the benefit multiple;#2
        2. to immediately end the wage-level adjustment of benefits;
        3. to extend the application of the system of old-age pensions for employed people (providing lower benefits for the working elderly) to those in their late sixties.
        #2 Monthly pensions are calculated as follows:
        Average standard monthly compensation x
        Benefit multiple (7.5/1000 for those born since April 2, 1946) x
        Months of participation x Inflation adjustment x 1/12

      4. Improving old-age financial security with a combination of public and private pensions.
        In order to achieve a vigorous economy and society in the twenty-first century and also allow people to feel peace of mind about their old-age finances, it is essential both to rebuild the public pension system so that it will be sustainable and to improve the private pension systems, such as corporate pensions and individual pensions, with moves like the establishment of tax incentives to support self-help efforts and the introduction of defined-contribution corporate pensions. Only through such moves will it become possible to achieve a combination of public pensions with their stability restored and private pensions based on self-help, thereby sweeping away concerns about the future, offering people a way to provide for their old-age financial security through their own efforts, and allowing them to draw bright plans for their lives.

  8. Review of Pension Taxation
  9. Alongside the reform of the public pension system, another important consideration is to review the system of pension taxation. At present, contributions under the public pension system are tax-free because they are covered by social insurance deductions; benefits are also tax-free in practice because recipients are eligible for both public-pension deductions and old-age deductions.
    In terms of intergenerational equity, the deduction that applies only to public-pension income should be reduced. In addition, in line with such considerations as the improvement of private pensions based on self-help, there is a need to achieve thorough implementation of a system that makes contributions and investment earnings tax-free and benefits taxable.

  10. Other Issues
    1. Adjustment for overlapping
    2. Since April 1, 1998, a system has been in operation to adjust overlapping payments of unemployment benefits and Employees' Pension benefits. With the ongoing trend toward lower birthrates and higher longevity, the quest for improved efficiency in the social security system as a whole requires measures to adjust for overlapping between pensions and other social security benefits.

    3. Other problems with the Employees' Pension program
    4. As noted above, we believe that fundamental reform of the public pension system should include a switch to pay-as-you-go funding from indirect taxation for the basic-pension portion and to fully funded reserves for the earnings-related portion. If, however, the present Employees' Pension setup remains in place, the following improvements are called for:

      1. Contributions from full-time housewives, improvement of survivors' pensions
        If the basic-pension system is shifted to funding from indirect taxes, the issue of requiring full-time housewives to contribute would no longer be a point of argument. This is fundamentally a question of whether pensions are to be considered at the level of the family unit or of the individual; it also involves the question of the proper shape of the tax system. In addition it is also related to the appraisal of work done in the home by housewives; since it is not simply an issue of the pension system, it needs to be considered with caution.
        However, the survivors' pension system presents a problem of inequity between full-time housewives and employed wives who participate in the Employees Pension program. At present, if a wife who has been employed becomes eligible for a survivor's pension (because her husband has died), she must forgo either part or all of her own old-age pension. There is a need to modify the system so that such women will be able to receive a certain portion of the survivors' pension to which they have become eligible while continuing to collect their own old-age pensions under the Employees' Pension program.

      2. Calculations based on total income
        Under the existing Employees' Pension program, contributions and benefits are calculated on the basis of "standard monthly remuneration," which is derived from the participant's monthly pay. It has been proposed that this arrangement be replaced with one in which calculations would be based on total annual pay, which would be neutral with respect to the distribution of payments between monthly pay and bonuses. But there is also concern that this change would produce instability in pension system finances, inasmuch as bonus levels are greatly affected by corporate business results. The proposed change should be considered with caution from a broad range of perspectives.

    5. Indirect taxes and adjustment for inflation
    6. The existing consumer price index includes indirect taxes, and so when pensions are adjusted for inflation, increases in such taxes are reflected in pension benefits. But inasmuch as the burden of indirect taxes is supposed to be borne by the nation as a whole, these taxes should not be included in the calculation of prices that is the basis for adjustment of pension amounts.

    7. Prompt conclusion of international pension portability treaties
    8. As the internationalization of the Japanese economy progresses, the number of Japanese people working overseas is increasing. Having negotiated a treaty on international pension portability with Germany, the government is now starting talks with Britain. In addition to working for rapid progress toward a treaty with Britain, the government should promptly commence negotiations with the United States, which is home to the largest number of overseas Japanese residents.

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