Impact of Population Aging on the Personal Income Tax Base in Japan: * Simulation Analysis of Taxation on Pension Benefits Using Micro Data

Transcription

1 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Impact of Population Aging on the Personal Income Tax Base in Japan: * Simulation Analysis of Taxation on Pension Benefits Using Micro Data Hiroyuki Yashio Associate Professor, Faculty of Economics, Kyoto Sangyo University Keishi Hachisuka Former Researcher, Policy Research Institute, Ministry of Finance Abstract In Japan, the ratio of public pension benefits to overall individual income (earned income and pension benefits) is rising due to population aging. A pay-as-you-go pension system represents a transfer of income from the working-age population to the retired generation. Therefore, in principle, the system itself does not work to reduce the personal income tax base at a macro level. However, because of the effects of generous income deductions alied to public pension benefits, the overall tax base is expected to be significantly eroded. From the viewpoint of this problem, this paper uses micro data to quantitatively evaluate the recent changes in the personal income tax base across Japan. It also conducts a simulation analysis to determine the extent to which tax base erosion can be mitigated by strengthening taxation on pension benefits. The analysis shows that population aging, coupled with economic stagnation, has continued to erode the tax base in recent years, although it has not been aarent due to the tax reforms implemented in 2005 and In the future, the tax base is likely to be eroded further. The National Council on Social Security (2013), for example, proposed strengthening the taxation on pension benefits for high-income earners. However, the analysis found that from the viewpoint of the tax policy, the effect of such a reform on the overall tax base would be extremely limited. Presumably, it is necessary to review the preferential treatment that is widely alied to pension benefits. Keywords: income tax, taxation on pension benefits, tax base, simulation JEL Classification: H24, H55, J18 * This work was suorted by Kyoto Sangyo University Research Grants.

2 520 H Yashio, K Hachisuka / Public Policy Review I. Introduction In Japan, the ratio of public pension benefits to overall individual income (earned income and pension benefits) is rising due to population aging. 1 Thus, this paper analyzes the effect of this observation on the overall Japanese personal income tax (PIT) base. 2 Note that under a pay-as-you-go system, a public pension system is basically an income transfer from the working-age population to the retired generation. Under the Japanese PIT system, on one hand, pension premiums paid by the working-age population are excluded from the tax base, and on the other hand, pension benefits received by the retired generation are essentially included in the tax base. Therefore, in principle, the system itself does not work to reduce the PIT base at a macro level. However, erosion of the tax base will occur for the following reasons. First, in a typical case of the Japanese PIT system, as annual income is low, so is the ratio of the tax base to annual income. By the very fact that income is transferred from the working-age population to the retired generation (i.e., typically from high-income earners to low-income earners), the overall tax base is eroded. Second, and more importantly, in Japan, special income deduction (public pension deduction, kotekinenkinto-kojo in Japanese) is alied to pension benefits. Although the deduction was scaled back in the 2006 tax reform, it is still more generous than that alied to salary workers. Accordingly, as the graying of Japan s population advances, overall income transfer from the working-age population to the retired generation through the public pension system increases. This transfer significantly erodes the tax base of the PIT, and the resulting revenue loss will have a negative impact on the already worrisome fiscal condition of the Japanese government in the long run. From the viewpoint of this problem, we conduct data analysis to examine the following two points. First, we focus on the recent change in the overall PIT base in Japan. From 2000 to 2009, the overall amount of public pension benefits received by the retired generation has increased by more than 10 trillion Japanese yen (JPY). As a result, despite the significant decrease in overall earned income, the entire country s individual income (earned income and pension benefits) has not decreased. However, the PIT base could have been reduced due to the abovementioned income deduction alied to public pension benefits. Conversely, it is likely that the scaling back of the deduction in the 2006 tax reform has curbed the decline of the tax base. Based on such facts, we qualitatively assess the recent change in the entire tax base in Japan. 1 Capital income (interest and capital gain) has been excluded from our analyses since this information was not included in the income survey of the National Living Status Survey. In addition, this income is separately taxed in Japan. 2 The effects of population aging on the tax revenue were analyzed in several foreign countries (Creedy et al. 2010; Conway and Rork 2008; Fisher 2007). However, the results were not necessarily pessimistic since aging in other foreign countries is not as rapid as that in Japan or the tax bases of these countries are far broader than those of Japan. Regarding another type of research, Burman et al. (2014) analyzed the effects of taxation on the social security benefits of the elderly.

3 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Next, we analyze the effect of a future tax reform on the entire tax base. Some earlier studies have insisted that even after the 2006 tax reform, the deduction alied to pension benefits is still quite large and should be curtailed further (Nishizawa 2011, Yashiro 2013). In particular, it is well-known that the income tax burdens of some rich pensioners (who have ample assets) are somewhat eased due to the deduction. Since the tax base will be eroded further in the future under the current tax system (due to the aging population), we conduct simple simulation analyses from the viewpoint of the extent to which strengthening the taxation on pension benefits can alleviate future erosion of the tax base. Some earlier studies have already investigated the situation of the Japanese PIT base, of which the majority utilized macro data (Morinobu and Maekawa 2001; Morinobu and Nakamoto 2013; Mochizuki et al. 2010; Ueda et al. 2010). However, our study differs in that it uses micro data of individual income (the income survey of the 2001 and 2010 National Living Status Survey (the Ministry of Health, Labor, and Welfare), both of which show the information from the previous year). In the analyses, we simulate each family s (theoretical) taxable income by alying the income tax code for each family s income data and estimating the total tax base throughout the country. Using 2000 and 2009 data, we can see how the entire tax base has changed between the years. In addition, following Yashio s (2013) method, we decompose the change into several components in order to understand why such change has occurred. The disadvantage of using micro data is that the result can lose touch with that gained from macro data. However, by taking advantage of micro data, we can investigate the effect of the tax reform on the entire tax base. Although our results are no more than preliminary calculations, they still indicate some important tax policy implications. Before moving to the next section, we briefly explain our main results. First, according to the analyses, the per-capita PIT base did not change significantly from 2000 to 2009, and erosion of the tax base seemingly has not advanced. Upon closer examination of the results, we can provide different explanations for such outcomes. The reason why erosion of the tax base has not advanced is the tax base expansion of two tax reforms: one in 2005 (reduction in allowance for spouses) and the other in 2006 (reduction in public pension deductions and abolishment of exemptions for the elderly (age 65 and over)). However, if these two tax reforms were not conducted, the per-capita tax base would decrease by more than 10% because of population aging coupled with stagnation of the Japanese economy. In other words, the overall tax base would shrink so much that the effects of the two tax reforms would be totally canceled out. Hence, population aging will definitely continue to have a negative impact on the tax base, and even if the problems have not been entirely aarent, they still remain. Finally, we examine the effects of future tax reforms. As stated earlier, even after the 2006 tax reform, the deduction alied to pension benefits is still generous and there seems to be some room for further reforms. In this respect, the National Council on Social Security (2013), for example, proposed strengthening the taxation on pension benefits for high-income earners. However, our analysis shows that from the viewpoint of the tax policy, the effect of such reforms on the overall tax base would be extremely limited. Presumably, as the graying

4 522 H Yashio, K Hachisuka / Public Policy Review population advances, it is inevitable that the preferential treatment widely alied to pension benefits be reviewed. The rest of this paper is organized as follows. Section 2 examines the current situation of population aging and the PIT system of pension benefits in Japan. Section 3 describes the analysis method and the data, followed by Sections 4 and 5, which explain our analyses results. Finally, Section 6 presents our conclusions. II. Situation of population aging and the PIT system of the retired generation in Japan Before proceeding to the data analyses, we explain how much the ratio of public pension benefits to overall individual income (earned income and pension benefits) is rising, in order to show how population aging is developing in Japan. After that, we briefly describe the Japanese PIT system of the retired generation. Table 1 presents the recent change in the ratio of public pension benefits to individual income at a macro level as well as per-capita earned income (including salary income, business income, and real-estate income), per-capita pension benefits, and per-capita individual income (earned income and pension benefits) in 2000 and We calculated Table 1 by using micro data of individual income. These figures are the values obtained after subtracting the social security premiums (as explained later, pension premiums should have originally been subtracted, but social security premiums [pension premiums and medical care premiums] are subtracted here due to data constraints). As the table shows, per-capita earned income in Japan has decreased by aroximately 8% in nine years. We consider two major reasons for this decrease: the increasing retired generation (due to population aging) and the stagnation of the Japanese economy. However, note that pension premiums subtracted from earned income have been distributed to the Table 1. Situation of per-capita individual income (1,000 JPY) Per-capita earned income A Source: The income survey of the 2001 and 2010 National Living Status Survey.

5 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October retired generation as pension benefits. In fact, the decline in per-capita individual income (earned income and pension benefits) during the nine years was just 1% far less than 8%. If pension benefits were entirely included in the tax base, then the PIT base would not shrink as significantly as individual income. However, the tax base erosion will advance because, as we noted in the Introduction, generous income deduction is alied to public pension benefits in the Japanese tax system. Conversely, the tax reform strengthening the taxation on pension benefits in 2006 may alleviate the problem. Thus, we now review the Japanese PIT system alied to the retired generation. Below is the summary of how to calculate the taxable income of pensioners (65 years and over). For comparison, we also present the case of salary workers. < The case of pensioners > Pension income = pension benefit public pension deduction Taxable income = pension income exemption for the elderly (alied only for those 65 years and over) basic allowance allowance for spouse allowances for dependents allowance for social insurance premiums (1) < The case of salary workers > Salary income = salary salary income deduction Taxable income = salary income basic allowance allowance for spouse allowances for dependents allowance for social insurance premiums (2) Note here that income deductions specially alied to pensioners aged 65 years and over (public pension deduction and exemption for the elderly 3 ) are generous. Salary income deductions (kyuyo-shotoku-kojyo in Japanese) are also alied specially to salary workers, but the deductions alied to pensioners are far more generous (as we will show in detail later). However, such deductions have been curtailed in the 2006 tax reform. Figure 1 presents the situation in detail. The horizontal axis shows the annual amount of pension benefits received by an individual and the vertical one shows the sum of public pension deductions and allowances for the elderly. The figure also separates pensioners under 65 and those 65 years and over since the deductions alied to them differ. Moreover, the figure shows the situation before and after the 2006 tax reform. Finally, salary income deductions are depicted in the figure for comparison. As the figure depicts, while the deductions alied to pensioners under 65 are almost equivalent to those alied to salary workers, the deductions for pensioners 65 years and over are far more generous. Especially, prior to the 2006 tax reform, the minimum amount of deductions was 1,900,000 JPY. For other deductions, such as basic allowances, pension 3 Elderly exemptions were not just for pensioners but for all people 65 years and over. However, since most people 65 years and over are pensioners, we can say that the tax base of the retired generation is eroded.

6 524 H Yashio, K Hachisuka / Public Policy Review Figure 1. Amount of public pension deductions (including exemptions for the elderly) (1,000 JPY) benefits of at least 2,300,000 JPY were excluded from the tax base. 4 However, through the 2006 reform, exemptions for the elderly had been abolished and public pension deductions were reduced. As the figure shows, the minimum amount of these deductions was decreased to 1,200,000 JPY and the deductions alied to pension benefits of more than 3,300,000 JPY had become equivalent to those alied to salary incomes. As such, the 2006 reform was important, but problems still remained. According to the Ministry of Health, Labor, and Welfare, aroximately 90% of pensioners receive less than 3,000,000 JPY in public pension benefits. Thus, we can still state that, in general, more generous deductions are alied to pension benefits compared with the same amount of salary incomes. Considering that salary workers typically pay heavier social insurance premiums, the difference of the burden between pension benefits and salary incomes is not likely to be small. Moreover, it is well known that among pensioners who receive aboveaverage benefits (about 2,200,000 JPY or more), there are many rich people with ample assets due to their previous high-salaried positions (Yashio and Hasegawa, 2009). It is likely that the tax burdens of such individuals are somewhat eased by public pension deductions. Finally, under the current tax system, as the graying population advances, the number of 4 The amount of basic allowance is 380,000 JPY.

7 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October pensioners increases while the entire country s tax base shrinks. The resulting revenue loss will have a negative impact on the already worrisome fiscal condition of the government. Judging from these situations, there aears to be some room for additional tax reforms in the near future, especially in regard to the retired generation. III. The model and the data III-1. The model With the aforementioned in mind, we analyze the recent change in the entire Japanese PIT base by using micro data of individual incomes. We are particularly interested in the effects of population aging, but one of the difficulties is how to separate the change caused by population aging from that caused by other reasons that include stagnation of the Japanese economy and two tax reforms. In the 2005 tax reform, allowances for spouses were reduced to mainly extend the tax base of working families, in addition to the abovementioned 2006 tax reform for the elderly. Considering these facts, we decompose the recent tax base change in Japan into several factors, following Yashio s (2013) method. We describe the method, as well as the data used in the analyses in this section. First, we describe per-capita earned income and per-capita pension benefits for year t (t ww = 2000, 2009) in the entire country as yy tt and yy tt, respectively, and their sum (individual income) as yy tt =yy ww tt +yy ww tt. In this case, yy tt represents earned income after subtracting the pension premiums since such premiums are the main financial resource of yy tt. Next, we consider per-capita taxable income yy tt, which is derived by subtracting various income deductions from yy tt. We divide it into two parts: one derived from earned income yy ttww and the other derived from pension benefits yy tt (i.e., yy tt = yy tt ww + yy tt ). Then, we can express yy t=yy tt ww θθ tt ww +yy tt θθ tt (3) θθ ww tt = yy ttww yy ww tt, θθ tt = yy tt (4) ii where θθ tt (ii = ww, ) represents the ratio of taxable income to earned income or pension benefits. Note that typically, θθ ww tt > θθ tt due to the abovementioned income deduction alied to pension benefits. We can also say θθ 09 > θθ 00 because the tax base of pension benefits was extended in the 2006 tax reform. However, we cannot state that θθ ww 09 > θθ ww 00, despite the tax base expansion of working families in the 2005 tax reform, because, conversely, the average wage is decreasing due to the stagnation of the Japanese economy (a decline in average ww salary generally causes θθ tt to decrease). At this point, we briefly explain how to calculate (3) from the micro data. We can easily ww obtain yy tt and yy tt by summing up and averaging the micro data (after adjusting for sampling bias to reflect the entire country s actual demographic structure). In fact, we have already discussed the recent change in yy ww tt, yy tt, and yy tt in Table 1 (Section 2). After that, we aly the yy tt

8 526 H Yashio, K Hachisuka / Public Policy Review 2000 and 2009 tax code to each individual s income data, in order to calculate the individual (theoretical) tax base, and then sum up and average them to obtain yy ttww and yy tt. However, there is a small problem in calculating yy ttww and yy tt because, in the case of an individual who has both earned income and pension benefits, they are first aggregated and then the income deductions (such as basic allowances) are subtracted to calculate the taxable income. Thus, we cannot clearly divide the taxable income into two separate parts of earned income and pension benefits. In such a case, we divide the (theoretical) taxable income into two parts according to the ratio of earned income and pension benefits. Next, by subtracting (3) of year 2000 from that of year 2009 and manipulating it in a simple manner, we can obtain (6). Each term in (6) can be easily calculated using the aforementioned yy tt yy ww tt, yy tt, yy t, yy ttww, yy tt (t = 2000,2009). 5 yy 09,00 = (yy 09 θθ 09 +yy 09 θθ 09) (yy00 θθ 00 +yy 00 θθ 00) (5) = yy 09,00 θθ 00 + yy 09,00 (θθ 00 θθ 00 ) + yy 09 θθ 09,00 +yy 09 θθ 09,00 (6) In (6), the change in per-capita taxable income from 2000 to 2009 ( yy 09,00 ) on the lefthand side is decomposed into four terms on the right-hand side: the first term is the change in per-capita individual income ( yy 09,00 ), the second is the change in per-capita pension benefits ( yy 09,00 ), the third is the change in the ratio of taxable income to earned income ( θθ ww 09,00 ), and the fourth is the change in the ratio of taxable income to pension benefits ww ( θθ 09,00 ). Note that in (6), the weight is multiplied in each term, for example, θθ 00 in the first term. We discuss the economic implication of (6) in more detail as follows. The first term of (6) means that, as per-capita individual income increases ( yy 09,00 > 0), per-capita taxable income also increases ( yy 09,00 > 0). In fact, as shown in Table 1, per-capita individual income has slightly decreased over nine years, which will make the left-hand side slightly negative. However, one more point here is that, as expressed in the weight θθ ww 00, the ratio of taxable income is maintained at that of 2000 in the term. Thus, the effects of the tax base expansion by the 2005 and 2006 tax reforms are not included in the term. ii Next, the third and fourth terms are the effects of changes in θθ tt (ii = ww, tt = 2000, 2009); ww as the ratio of taxable income to earned income or pension benefits increases ( θθ 09,00 > 0 or θθ 09,00 > 0), per-capita taxable income also increases ( yy 09,00 > 0). However, we come up with two major reasons for these terms: the aforementioned two tax reforms and the decline in the average salary due to the stagnation of the Japanese economy. In order to separate these two elements, we further divide the third and fourth terms into two parts each, as seen in (7). 5 We can easily obtain (6) by adding (yy ww 09 θθ ww 00 +yy 09 θθ 00 ) (yy ww 09 θθ ww 00 +yy 09 θθ 00 ) to the righthand side of (5) and rearranging the terms using yy tt =yy ww tt +yy tt (tt = 2000, 2009).

9 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October yy 09,00 = yy 09,00 θθ ww 00 + yy 09,00 +(yy 09 θθ 09,09(00) + yy 09 θθ 09(00),00 (θθ 00 θθ ww 00 ) + (yy ww ww 09 θθ 09,09(00) + yy ww ww 09 θθ 09(00),00 ) ) (7) ii ii ii In (7), θθ 09,09(00) =θθ 09 θθ 09(00) ii ii, θθ 09(00),00 =θθ 09(00) ii θθ 00 (ii = ww, ). Here, ww ww θθ 09(00) = yy 09(00) yy 09 ww, θθ 09(00) = yy 09(00) yy 09 (8) represents the ratio of the (theoretical) taxable income to earned income or pension benefits when we aly the 2000 tax code to the 2009 micro data. The methods for calculating ww yy 09(00) and yy 09(00) are basically the same as those for calculating yy 09 ww and yy 09, but the tax code for 2000 has been used instead of that for Although the third and fourth terms in (7) (both are enclosed in parentheses) may aear complicated, their economic implications are relatively simple. In this case, we simply ii ii separate θθ 09,00 (ii = ww, ) into two elements. The former parts ( θθ 09,09(00) ii = ww, ) are the effects of the tax base expansion by the 2005 and 2006 tax reforms. 6 We expect ii θθ 09,09(00) > 0 (ii = ww, ), which makes the left-hand side positive ( yy 09,00 > 0 ). ii Conversely, the latter parts ( θθ 09(00),00 ii = ww, ) are the effects of the change in income ww distribution during the nine-year period. We expect θθ 09(00),00 < 0 because the average salary is declining due to the recent stagnation of the Japanese economy (in the typical case of the Japanese PIT system, as the average salary is low, so is the taxable income ratio (θθ ww tt )), which makes the left-hand side negative ( yy 09,00 < 0). 7 Finally, we move to the second term of (6) (or (7)), which measures the effect of population aging on the taxable income. Note here that the weight of the term is negative (θθ 00 θθ ww 00 < 0), which means that the tax base of pension benefits is more eroded than that of earned income. Accordingly, as per-capita pension benefits increase ( yy 09,00 > 0 ), percapita taxable income decreases ( yy 09,00 < 0). That is, as the graying population advances, the erosion of the tax base advances. We should especially pay attention to the point where the individual income yy tt (earned income and pension benefits) was already controlled in the first term. Therefore, even if the individual income does not change ( yy 09,00 = 0), as pension benefits increase, the taxable income decreases. As shown in Table 1, although per-capita individual income did not 6 We measured the effects of the tax reforms on the tax base (the former parts of the third and fourth terms) by alying the 2000 and 2009 tax codes to the 2009 income data. The 2005 tax reform (reduction of allowances for spouses) has some effect on θθ 09 because such allowances are alied to everyone with dependent spouses. Similarly, the 2006 tax reform, which abolished elderly exemptions, has some effect on θθ ww 09 because such exemptions are alied to anyone 65 years of age and over. However, since the effects have turned out to be minimal, we do not separately show the effects of the two tax reforms here. 7 We measured the effects of the change in income distribution on the tax base (the latter part of the third and fourth terms) by alying the 2000 tax code to both the 2000 and 2009 income data.

10 528 H Yashio, K Hachisuka / Public Policy Review Table 2. Explanations of each term in (7) ? decrease much over the nine-year period, the ratio of pension benefits to it rose sharply, which could have caused significant tax base erosion. Also note that the effect of the tax reform is not included here since the ratio of the taxable income is maintained to that of 2000 (that is, θθ 00 θθ ww 00 ) in the term. As mentioned earlier, these effects are expressed in the third and fourth terms. Thus, we later use these terms, coupled with the second term, in order to measure the extent to which the tax reform has alleviated the tax base erosion by population aging. 8 Table 2 includes an overview and the expected sign of each term in (7). III-2 The data and the calculation method Due to space constraints, this discussion will be limited to a brief summary. The data used in this study are from the 2001 and 2010 income surveys of the National Living Status Survey (Ministry of Health, Labor and Welfare), which describes the income of individual families in Japan. In this case, the information actually regards the previous years, i.e., years 2000 and As shown in Table 3, the numbers of families used in the analyses are 28,538 in 2000 and 21,829 in We first sum up and average the micro data to calculate yy tt yy ww tt, yy tt, yy t, yy ttww, yy tt (t = ww 2000, 2009), yy 09(00), and yy 09(00). We use these values to decompose the change in per-capita taxable income over the nine-year period ) into six (four plus two) elements, as ( yy 09,00 explained in the previous section. There are two points to be discussed regarding the calculation method. The first is how to calculate the individual taxable income. The National Living Status Survey includes 8 Although the second term of (6) (or (7)) measures tax base erosion, based on the differences between θθ ww 00 and θθ 00, it is well known that in Japan, ww θθ00 is rather small (due to salary income deductions) compared with other countries (OECD 2011). We do not focus on this problem here, but how to reform the PIT system of earned income is also an important issue.

11 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Table 3. Overview of the income survey of the National Living Status Survey Source: The income survey of the 2001 and 2010 National Living Status Survey. information about the family structure and the income of each family member. Thus, we can calculate the individual (theoretical) taxable income by alying the PIT code to each family s information. The summary of the Japanese PIT code has already been shown in (1) and (2). However, as stated earlier, since the tax reforms were conducted in 2005 and 2006, different tax codes are used in 2000 and The second is how to sum up the micro data. It is problematic to simply sum up and average the data as is, since the demographic composition of the data can be somewhat different from the actual one. Therefore, before summing up the data, we use the results of the national population census to adjust the data s sampling rate. Since the adjustment method is the same as Yada s (2010) method, we omit the explanation here. IV. The analyses IV-1 Change in the PIT base between 2000 and 2009 Our goal is to analyze the recent change in the PIT base by decomposing it into several factors using (7). Before such analysis, in order to understand the results intuitively, we discuss the calculation results of yy tt, yy t, yy ttww, yy tt (t = 2000, 2009), ww yy 09(00), and yy 09(00) in Table 4. First, we again present yy tt as per-capita individual income (earned income and pension benefits) in the table. As previously shown in Table 1, yy tt did not significantly decrease in the nine-year period (1.1% decline). However, note that the ratio of pension benefits to individual income (that is, yy tt yy tt ) has risen sharply due to population aging coupled with the stagnation of the economy (which is not depicted in Table 4). Thus, significant tax base erosion could have occurred. At this point, we focus on the situation of yy t, per-capita taxable income. As shown in

12 530 H Yashio, K Hachisuka / Public Policy Review Table 4. Calculation results of yy tt, yy t, θθ ww tt, θθ ww tt, θθ 09(00), θθ 09(00) Source: Income survey of the 2001 and 2010 National Living Status Survey. Table 4, it has also decreased, but the rate of decrease was only 2.4%, which is roughly equivalent to 1.1%. That is, aarent erosion of the tax base has not occurred over the nineyear period. However, it is premature to judge that population aging did not cause serious problems since the effects of the tax base expansion by the tax reforms are also included in these results. In fact, Table 4 indicates that the two tax reforms had certain effects on the tax base. First, θθ tt, the ratio of taxable income to pension benefits, increased from 8.4% in 2000 to 18.3% in That is, more than 90% of pension benefits were excluded from the tax base in 2000, but the situation partly improved by the 2006 tax reform. However, more than 80% of the benefits were still excluded from the tax base even after the reform, and θθ 09 is far less than θθ ww 09. Conversely, θθ ww tt, the ratio of taxable income to earned income, did not change much over the nine-year period (from 46.1% to 45.7%). However, after decomposing it into two parts, we find that a decline in average salary (due to the economic slump) made it decrease from 46.1% (θθ ww ww 00 ) to 42.8% (θθ 09(00) ), while the tax reforms in 2005 made it increase from 42.8% ww (θθ 09(00) ) to 45.7% (θθ ww 09 ). As such, the two tax reforms were likely to have some impact on the taxable income, although, as mentioned earlier, yy t (per-capita taxable income) slightly decreased. Thus, it is conceivable that the effects of these tax reforms have been canceled out by those of population aging coupled with the stagnating economy. Based on the aforementioned results, we move to Table 5, which shows the decomposition of per-capita taxable income over the nine-year period by (7). The findings obtained are what

13 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Table 5. Decomposition of the PIT base change from 2000 to 2009 by factors ? Source: Income survey of the 2001 and 2010 National Living Status Survey. we expected. First, population aging and the decline in the average salary due to the economic slump have significantly eroded the tax base. As shown in Table 5, tax base erosion caused by population aging was 4.5% (the second term) and that caused by the stagnating economy was 6.5% (the latter part of the third term). In summary, the tax base has shrunk by as much as 11%. The result is interesting since we find that the first term of the table ( yy 09,00 ) caused only a 1.3% decline in the tax base. That is, although individual income did not change significantly, only taxable income has shrunk by more than 10%. However, most of this tax base erosion has been recovered by the 2005 and 2006 tax reforms. According to Table 5, the effect of strengthening the taxation on pension benefits was +4.8% (the former part of the fourth term) and that on earned income was +5.6% (the former part of the third term). Hence, the tax base has been expanded by 10.4% in total, which has canceled out the abovementioned tax base erosion. As a result, the tax base has not aarently shrunk in total. Next, we discuss the change in the tax revenue (the sum of the PIT [national tax] and the individual inhabitant tax [regional tax]) over the nine years in the lower part of Table 5. We can analyze per-capita tax revenue by first alying the table of tax rates 9 to each individual s 9 Although the table of tax rates has been reformed in 2007 (the tax reform for shifting tax revenues from the national to regional level), the aggregate tax rates (the PIT and the individual inhabitant tax) have not changed. Thus, we did not reflect this reform in the analyses.

14 532 H Yashio, K Hachisuka / Public Policy Review (theoretical) tax base, in order to calculate the tax amounts, and then sum up and average them. As shown in Table 5, per-capita tax revenue decreased by 5.4%, which is rather large compared with 2.4%, the abovementioned rate of yy t. This is because the number of highincome earners is decreasing due to the sluggish economy, which is, under the Japanese progressive tax rate structure, likely to cause further tax revenue losses. However, we should again remember that the effects of the two tax reforms are included. If the reforms had not been conducted, per-capita tax revenue would have decreased by as much as 14.1% (we can calculate this by alying the 2000 tax code to the 2009 micro data, although this is not depicted in Table 5). In fact, since revenue losses have been recovered by the tax reforms, actual revenue losses remained at 5.4%. IV-2 Situation of pensioners tax burdens Although tax base erosion has not aarently advanced, problems continue to exist, especially regarding population aging. As the aging of the population advances, income redistribution from the working generation to the retired generation through the public pension system increases, which will cause further tax base erosion under the current tax system because θθ 09 is only 18.3% even after the tax reform. Consequent revenue loss will have a negative impact on the already worrisome fiscal condition of the Japanese government in the long run. From the viewpoint of this problem, we simulate the effects of the future tax reform in the next section. Before that, we discuss one more point: the current situation of pensioners tax burdens. Through Figure 1 and Table 4, we have already shown that more generous deductions are alied to public pensions (θθ 09 is only 18%). Here, we show that their tax burdens are actually eased more than those of salary workers who belong to the same revenue class. This is additional evidence that the taxation of pension benefits should be strengthened further. The situation is depicted in Table 6, which was calculated using 2009 micro data. In the table, we compare the situation of income deductions and tax burdens between pension benefits and salaries by household revenue class. From the table, we can tell, at a glance, that the tax base of pensioners is more eroded, and as a result, their tax burdens are eased more than those of salary workers, who receive the same amount of revenue. In most of the revenue classes, tax burdens of pensioners are more relieved by 1% or 2%. Considering that salary workers typically bear heavier social security premiums (which is not depicted in Table 6), the difference in the burdens between salary workers and pensioners depicted in the table can be significant. Moreover, it is well known that among pensioners who receive above-average benefits (aroximately 2,190,000 JPY or more), there are many rich people with ample assets due to their previous high-salaried positions. Conversely, many low-income salary workers depicted in the table are likely to be young temporary workers and their tax-paying capacities are simply not enough. Therefore, further tax reforms are necessary, not only to prevent significant tax base erosion from occurring in the future but also to ensure the overall fairness of tax burdens.

15 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Table 6. Situation of household income deductions and tax burdens by revenue class Revenue class of household salary(1,000 JPY) Average salary (1,000 JPY) 0~1,000 1,000~ 2,000~ 3,000~ 4,000~ salary(%) benefits(1,000 JPY) Average public pension benefits (1,000 JPY) 0~1,000 1,000~ 2,000~ 3,000~ 4,000~ (%) Source: Income survey of the 2010 National Living Status Survey. V. Simulation analyses on the effects of future population aging and tax reforms V-1 Effects of future population aging on the PIT base Here, we take advantage of the model used in the previous section in order to investigate the following two points. The first is the extent to which population aging in the future will erode the PIT base, and the second is the extent to which the future tax reform of strengthening the taxation of pension benefits can alleviate such tax base erosion. We analyze the first point in this subsection, and the second point in the next. First, we analyze the effect of the future population aging on the PIT base. Our method is simple. We again depict (7) as yy 09,00 = yy 09,00 θθ ww 00 + yy 09,00 (θθ 00 θθ ww 00 ) + (yy ww ww 09 θθ 09,09(00) + yy ww ww 09 θθ 09(00),00 ) +(yy 09 θθ 09,09(00) + yy 09 θθ 09(00),00 ) (7) We already computed the value of each term in (7) in the previous section. In what follows, we basically use these values, but arrange only one point. Again, we calculate yy 09,00, after we make yy 09 increase and ww yy09 decrease, while keeping yy 09 unchanged. That is, we calculate yy 09,00 under the situation in which income transfer from the working

16 534 H Yashio, K Hachisuka / Public Policy Review generation to the retired generation through the pension system advances further. This is assuming that other factors such as economic situation and the tax system are all unchanged. This assumption is surely too restrictive, but the results indicate the benchmark case where population aging develops further in the future. Considering that the ratio of public pension benefits to individual income (yy 09 yy 09 ) has risen by aroximately five percentage points () over the nine-year period (from 12.8% in 2000 to 17.9% in ), we analyze three cases where the ratio further rises by 5, 7.5, and 10 from 2009 (i.e., yy 09 yy 09 is 22.9%, 25.4%, and 27.9%, respectively). The three cases are referred to as Case A, Case B, and Case C. We show the results in Table 7, which decomposes the change into six (four + two) factors, as Table 5 did in the previous section. We mainly discuss the results of Case B (yy 09 yy 09 is 25.4%) below. According to the table, the tax base is eroded further and decreases by 7.3% from The most outstanding point is that the second term, the effect of population aging, becomes especially large ( 11.2%). Conversely, we should also focus on the effect of the 2006 tax reform (the former part of the fourth term) in which the value of the term increases from +4.8% in 2009 to Table 7. Effect of an increase in pension benefits to individual income on the PIT base (percentage changes since year 2000) ( ) Source: Income survey of the 2001 and 2010 National Living Status Survey. 10 We can calculate these values from Table /1908=12.8% and 359/1887=17.9%.

17 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October %. That is, as the graying population advances, the number of pensioners increases, 11 and therefore, the effect of strengthening the taxation of pension benefits automatically enlarges. However, it cannot prevent the overall tax base erosion. Next, we show the change in per-capita tax revenue in the lower part of the table. In order to calculate this change, we take advantage of the ratio of tax burden to earned income or pension benefits in 2009 (which was calculated in the previous section), coupled with the values of yy tt and yytt ww in the abovementioned three cases. Here, we focus on Case B, in which per-capita tax revenue drops by as much as 10.7% from 2000 and more than 5% from Note that we are assuming here that yy tt, per-capita individual income, does not change from yy 09 ; that is, the value of the first term has been maintained at 1.3). If yy tt decreases as population aging advances, then further revenue loss would occur. Therefore, we should not consider the results to be small or unimportant. 12 V 2 Simulation analyses of the tax reforms Alternatively, we discussed in the previous section that there aears to be some room for further strengthening the taxation of pension benefits in the near future. Therefore, we conduct the following simulation analyses to determine the extent to which the future tax reform can alleviate such tax base erosion. In regard to the calculation method, we first aly our tax reform plan to the original 2009 micro data in order to calculate the taxable income ratio to pension benefits. We express it with θθ 09(reform1), if we name the reform plan as reform 1. Then, by alying θθ 09(reform1) in place of θθ 09 to the results of the aforementioned three cases, we can estimate the extent to which the tax reform alleviates the future tax base erosion caused by population aging. Based on the likewise idea, we can calculate per-capita tax burdens that reflect our tax reform plan. 13 At this point, we briefly explain our tax reform plans. We analyze the three plans, that is, reform 1, reform 2 and reform 3, all of which aim to strengthen the tax of pension benefits by curtailing public pension deductions. First, reform 1 limits the amount of public pension deduction to 1,200,000 yen (Figure 2). The National Council on Social Security 11 We can understand this by the fact that the weight of the former part of the fourth term is yy 09. As population aging advances, yy 09 increases, which automatically enlarges the term. 12 We calculated the tax burden as follows. First, we separated per-capita tax burden in 2009 into one part derived from earned income and the other derived from pension benefits, that is, TTTTTT 09 =TTTTTT ww 09 + TTTTTT PP 09. Here, we can rewrite the formula as TTTTTT 09 = yy 09 yy 09 yy 09 with the value of Case A, B, and C, we calculated per- yy 09 yy 09 TTTTTT 09. Then, changing yy 09 ww and yy 09 yy 09 yy 09 yy 09 capita tax burden when population aging advances. ww TTTTTT ww 09 yy 09 yyww In the case of reform 1, we calculated per-capita tax burden by substituting TTTTTT 09 yy in the formula depicted in Footnote with TTTTTT 09(rrrrrrrrrrrr1) yy 09

18 536 H Yashio, K Hachisuka / Public Policy Review Figure 2. Three tax reform plans used in the analyses (1,000 JPY) Note: For simplicity, we have not depicted the deductions alied for pensioners under 65 in the figure. However, for those 65 years and over in our three reform plans, the uer limits of the deductions are set at 1,200,000, 900,000, and 700,000, respectively. (2013) recently proposed strengthening the taxation on pension benefits for high-income earners, and reform 1 realizes such an idea. That is, reform 1 strengthens the taxation of pension benefits more than 3,300,000 JPY, which is far beyond the amount of pension benefits received by average retired families in Japan (2,190,000 JPY; see Table 6). Conversely, reform 2 limits the amount of public pension deductions to 900,000 JPY, while reform 3 limits them to 700,000 yen. Both reforms aim to strengthen the taxation (on broad income ranges) of public pension benefits but still aly the deductions that exceed the minimum amount of salary income deductions (650,000 JPY). As a result, low-income pensioners are still excluded from PIT taxation even after the reforms. Before moving to the simulation results, we preliminarily discuss the economic implications of the analyses. The impacts of our three reform plans differ significantly. In particular, the effect of reform 1 on the entire tax base is extremely small since the households impacting the tax reform are limited to a handful of retired, uer-income class families. Under reform 1, the entire country s tax base continues to shrink as earlier and the tax revenue significantly decreases from 2000, as the graying population advances. In contrast, under reforms 2 and 3, the taxation of a wide range of retired families is strengthened, which leads to expansion of the entire country s tax base. The revenue losses caused by population aging may not be fully recovered, but they can be alleviated to a considerable degree. Moreover, the inequality of tax burdens between pensioners and salary workers, as discussed in the previous section, are corrected. As such, a tax reform like reform 1, in which the taxations for only high-income earners are strengthened does not have a real impact on the tax base. As population aging advances, it is inevitable to review the preferential treatment that is

19 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October widely alied to pension benefits by conducting such tax reforms as reform 2 or 3. This is the policy implication of our analyses. Next, we briefly show our calculation results. As discussed earlier, the ratio of taxable income to pension benefit after the reforms, θθ 09(reform1) is just 0.189, which is not a significant change from 0.184, the value of 2009 (θθ 09). On the other hand, under reform 2 and 3, the ratios rise sharply to (θθ 09(reform2) ) and (θθ 09(reform3) ). These values simply indicate the extent to which the impacts of reform 2 and 3 on the entire tax base differ from that of reform 1. At this point, we move to Table 8, which shows the effects of the three tax reform plans on the overall tax base by the abovementioned three population aging scenarios (Case A, B, and C). The table shows the changes in yy t (the left-hand side of (7)) and the effects of strengthening the taxation of pension benefits (the former part of the fourth term of (7)). All values in the table are percentage changes since the year Here, we again show Case B, where the pension benefits ratio to individual income is 25.4%. As previously discussed, the effects of the three reform plans are significantly different. Reform 1 does not have a real impact on the tax base, and like before, the overall tax base shrinks as population aging advances. Conversely, reform 2 and 3 drastically alleviate such tax base erosion. Especially under reform 3, the tax base increases even after population aging advances. What is important to note here is the former part of the fourth term, that is, the effect of strengthening the taxation of pension benefits. As the graying population advances, the tax reform effects enlarge to more than 10% and prevent tax base erosion from significantly occurring. We also show the change in per-capita revenue in the table. The prospect of the revenue looks grim, as per-capita revenue decreases by 2.7% from 2000 even under reform 3. However, it increases from that of 2009 (already 5.4 since 2000) and a chunk of revenue losses is recovered by the reform. On the other hand, under reform 1, per-capita revenue does not change from that under the 2009 tax code, and the revenue of more than 10% is lost from 2000 due to population aging. Another important result is depicted in Table 9, which shows the situations of the pension deduction ratio and the ratio of tax burden to pension benefits, which reflect our three tax reform plans by household revenue class. We again show the situation of salary workers for comparison. Under reform 1, the families impacting the tax reform are limited to just the top 10% of income class pensioners. Most pensioners are not influenced by the reform, and therefore, the inequality of tax burdens between pensioners and salary workers (discussed in section IV) hardly improves. In contrast, the effect of reform 2 reaches a wide income range of pensioners, which helps correct the inequality of the tax burdens between pensioners and salary workers. Under reform 3, the tax burdens of pensioners become somewhat heavier than those of salary workers because other income deductions (such as allowances for dependents and social insurance premiums) are typically alied to salary workers. However, the amounts of public pension deductions alied to pensioners are equivalent to those of salary income deductions alied to salary workers in the same revenue classes.

20 538 H Yashio, K Hachisuka / Public Policy Review Table 8. Effects of strengthening the taxation of pension benefits on the PIT base as population aging advances (percentage changes since year 2000) Tax system on year 2009 (the result of Table 7) Reform 1(The uer limit of public pension deduction is set at 1,200,000) Reform 2(The uer limit of public pension deduction is set at 900,000JPY) Reform 3(The uer limit of public pension deduction is set at 700,000JPY) Source: Income survey of the 2001 and 2010 National Living Status Survey.

21 Policy Research Institute, Ministry of Finance, Japan, Public Policy Review, Vol.10, No.3, October Table 9. Impact of strengthening the taxation of pension benefits on the ratios of income deduction and tax burden by household revenue class 0~1,000 1,000~ 2,000~ 3,000~ 4,000~ (1,000 JPY) (%) Tax system on year 2009 (Result of Table 6) 0~1,000 1,000~ 2,000~ 3,000~ 4,000~ benefits(1,000 JPY) benefits(%) Reform 1(The uer limit of public pension deduction is set at 1,200,000) benefits(%) Reform 2(The uer limit of public pension deduction is set at 900,000JPY) benefits(%) Reform 3(The uer limit of public pension deduction is set at 700,000JPY) benefits(%) Source: Income survey of the 2010 National Living Status Survey. Finally, note that even under reform 3, the tax burdens of retired, low-income class families are still nearly zero. As such, by leaving the minimum amount of public pension deductions, we can correct the current inequality of tax burdens between pensioners and salary workers without increasing the tax burdens of low-income class families. VI. Conclusion We analyzed the effects of population aging and the tax reform of pension benefits on the overall PIT base in Japan, using micro data. Our main results are as follows. First, after examining the change in the entire country s PIT base from 2000 to 2009, tax base erosion seemingly did not advance. However, population aging, coupled with the economic slump, continued to have negative impacts on the tax base, and it is likely to shrink even further in the future. Strengthening the taxation on only rich retired families, which the National