B3.5 Technological Progress

Technological progress in private production plays a very important role in economic growth. Thus, very careful attention should be paid to assumptions regarding technological progress. Technological progress here is calculated as the Solow residual. Average annual growth between 1983 and 1992 was 0.1 %; between 1993 and 2002, it was —0.5 %. In our benchmark simulations, technological progress from 2003 is assumed to be zero in order to reflect the reality of the two preceding decades.

B3.6 Simulation Results

The GDP growth rate in our simulation turns negative because of the decrease in the labor force and the zero rate of technological progress. This differs from Broda and Weinstein (2004), who assume positive GDP growth rates. With negative GDP growth, the rate gap can be bigger than 4%, as shown in the last column of Table 7.B1.

Tax burdens will increase to almost 36% in 2050 because of the large gap between the GDP growth rate and the interest rate. The gap results in high tax burdens to finance interest payments on outstanding government debts, even though the government tries to make the primary balance positive from 2010. In the benchmark case, it is assumed that the primary balance is positive by 2010.

The difference in the value of the tax burden between the actual burden and the simulated burden can be explained by the difficulty of achieving a positive primary balance by 2010 with the current tax level.

The trend for the ratio of public pension benefits to GDP, and the ratio of public health insurance benefits to GDP, to increase can be explained by an aging population. The social security burden increases to 23.27 % in 2050 if the current system is maintained.

The simulation result of an increasing trend in public health insurance benefits is also consistent with empirical research. Such benefits are expected to increase their share of GDP by almost 1 percentage point every 10 years, so that the ratio of public health insurance benefits to GDP will be approximately 9.6 % in 2050.

This simulation means that if the government wants to have a positive primary balance in the near future, the future burden will be high, implying that the current financial situation facing the Japanese government in terms of intergenerational conflicts is severe. If the government postpones the start of the reduction of its outstanding debt, the situation will be worse because of the greater interest payments needed to service the significant amount of outstanding debt.

Because of the large gap between the GDP growth rate and the interest rate, and because of an aging population, the national burden measured against GDP will increase to approximately 59 % in 2050 in this benchmark case.

An increase in the contribution rate results in a decrease in disposal income. Thus, a rapid increase in the future contribution rate places a greater burden on future generations if the current modified pay-as-you-go public pension scheme continues. Future generations will be less prosperous because of the increase in the contribution rate.

If an increase in the consumption tax rate induces an increase in private savings, the increase in the consumption tax to finance interest payments incurred by outstanding government debt results in higher GDP in the future; thus, future generations will be better off. Further, an increase in interest payments incurred by outstanding government debt implies an increase in interest income. In addition, an increase in the consumption tax necessarily results in a decrease in disposal income.

Two different scenarios in terms of future outstanding government debt have been studied in Ihori et al. (2005): “high-debt” and “low-debt” scenarios. The high- debt scenario corresponds to a weak consolidation scenario in the sense that the primary balance does not become positive until 2022, and outstanding government debt has a gross value of 450 % of GDP in the final steady state. In the low-debt (strong consolidation) scenario, outstanding government debt is paid back at a relatively early stage. As a result, the primary balance becomes positive in 2006 in this scenario and the steady-state level of outstanding government debt is 150 % of GDP (incidentally, the actual primary balance was negative in 2006). The final level of the outstanding government debt ratio in a steady state differs depending upon when the primary balance becomes positive.

With a weak consolidation policy, the future tax burden is higher than in the benchmark case and the tax burden increases to more than 50%. Under a strong consolidation policy, the burden is higher than the benchmark case until around 2020, but the lowest burden is achieved eventually. A weak consolidation policy is not preferable for future generations because such a policy postpones the burden and places it on them. However, a strong consolidation policy is not preferable for the current generation because it has to carry the burden by paying relatively high taxes.

As explained before, in 2004 the public pension scheme was reformed. The main feature of the reform was to impose a ceiling on the contribution rate in the near future. Thus, instead of maintaining the per capita amount of future benefits, the per capita amount of future contributions is maintained after some further increases. The contribution rate is increased until 2017; however, after this, the rate is fixed at the 2017 level and the per capita amount of benefits is adjusted.

In our benchmark simulation, the amount of per capita benefits is assumed to be fixed at the 2002 level in the future; however, the total amount of benefits increases as the population ages.

Finally, in order to investigate the effect of the 2004 reform, the replacement rate is used as a control variable to maintain the future level of the contribution rate. According to our simulation, in 2050 the reform is shown to have successfully reduced the expected social security burden ratio from 23.27 to 15.02 %.

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