Typology of Public Pension Reform and Future of 2004 Pension Reforms in Japan

Typology of Public Pension Reform and Future of 2004 Pension Reforms in Japan

Masato Shizume

Associate Professor

Faculty of Contemporary Social Studies,

Doshisha Women’s College of Liberal Arts

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Ⅰ Introduction

The public pension system in Japan is mainly composed of the Employees’ Pension Plan (EPP), an income-related pension for private-sector employees and the National Pension Plan (NPP), a flat rate pension for all residents, though the benefits are reduced according to the contribution period. In 1941, the government enacted worker’s pension covering all physical laborers except for those in small businesses with fewer than 10 employees. The worker’s pension was composed of three types of benefits: old age benefits, disability benefits, and survivor benefits. Two years later, the name of the plan was changed to EPP, which was expanded to cover office workers, including women, in businesses with five or more employees. After WWⅡ, the system was completely overhauled in 1954.

The new National Pension Plan was then established in 1959 to cover those ineligible for EPP and the Plan for public-sector employees, such as the self-employed, farmers, and housewives. Later, in 1985, the NPP was revised and expanded to become a part of the Basic Pension which covered everyone aged 20 to 59, and in 1991, even students over 20 were included. As a result, NPP benefits are equivalent to Basic Pension benefits. Employees thus receive two forms of pension benefits: old age basic pension benefits and EPP benefits.

As a rule, the public pension reform based on financial re-calculation has been implemented once every five years. Recently, the pension reform of 2004, was preceded by the reforms which took place in 1965, 1969, 1973, 1976, 1980, 1985, 1989, 1994, and 1999, respectively.

The present study represents an attempt to clarify how the public pension system has been evolving through a series of reforms and also to underscore the impact of the 2004 Pension Reform Act.

Ⅱ Development of Public Pension System in Japan

The main public pension reforms of postwar days are as follows.

・Pension Reform Act of 1954

EEP: Flat-rate benefit added to income-related benefit

Transition from full government financing to partially funded financing (gradual PAYG financing since then)

Raising government burden from 10% to 15%

・Pension Reform Act of 1965

EPP: Introducing early retirement system

Establishing Employee Pension Fund, which employer voluntarily would provide, and in which employees could choose lump-sum benefit, annuity, or both, at retirement

Raising government burden from 15% to 20%

・Pension Reform Act of 1969

EPP: Raising standard full pension qualifying period from 20 to 24 years

NPP: Introducing supplement benefits for flat-rate benefits

・Pension Reform Act of 1973

EPP: Revaluation of the past wage by gross wage growth and gross wage indexation every five years

Targeting replacement rates at a certain level (60%)

Raising full-pension qualifying period to 27 years

EPP & NPP: Cost-of-living indexation for benefits when consumer price indices fluctuated over 5%.

・Pension Reform Act of 1976

EPP: Early retirement system amended (benefits levels subject to an earnings test were lifted)

Raising full-pension qualifying period to 28 years

・Pension Reform Act of 1980

Raising full-pension qualifying period to 30 years

・Pension Reform Act of 1985

EPP: Reduction of accrual rate

Raising full-pension qualifying period to 40 years

Gradual rise in pensionable age of women from 55 to 60

NPP: Rearranged as part of the basic pension

Raising full-pension qualifying period from 25 to 40 years

・Pension Reform Act of 1989

EPP: Early retirement system amended (benefits levels subject to an earnings test were lifted)

NPP: Establishing National Pension Fund, a voluntary supplement pension for those covered only by NPP

EPP & NPP: Automatic annual cost-of-living indexation

・Pension Reform Act of 1994

EPP: Changing benefit adjustment from gross wage indexation to net wage indexation

Stepwise increase in normal pension age from 60 to 65 for the basic part of EPP benefits

Early retirement system amended (earnings test was mitigated)

Exemption from contribution for those needing child care

Levying special contribution from bonuses (1%)

・  Pension Reform Act of 1999

EPP: 5% reduction in pension benefits (reduction of accrual rate)

Gradual increase in normal pension age from 60 to 65 for income-related part of EPP benefits

Extending early retirement system coverage from 65 to 70

Contribution based on annual earnings

Exemption from contribution for employers of employees providing child care

NPP: Extending exemption from contribution for low-income person (added a 50% discounted contribution)

EPP & NPP: Abolition of wage indexation for pension benefits

・  Pension Reform Act of 2004

EPP: Extending coverage of early retirement system for those aged 70 and over

Division of benefits if divorced

Extending contribution exemption period from one to 3 years for those needing child-caring

NPP: Extending exemption from contribution for low-income person (added a quarter and three quarters discounted contribution)

EPP & NPP: Macro economy indexation

Before analyzing pension reforms, it is helpful to sketch out the main framework in which the types of reforms are discussed.

Ⅲ Institutional change in Public Pension System ― four types of reforms

In the typology of institutional change, it is critical to distinguish the fundamental change which replaces the old system with a new one from the ordinary change which maintains the pre-existing structure. Ordinary change includes programmatic change, path-dependent change, and parametric change (Pierson 1994; Bonoli and Palier 1998; Myles and Quadagno 1997). On the other hand, fundamental change is equivalent to systematic change, innovative change, and paradigmatic change. In fundamental change, the actors’ position in relation to an arrangement is modified, and a new pattern or political equibrium is generated, often with some actors who lose and others who win (Bonoli and Palier 1998). This may shift the locus of authority over policy (Hall 1993).

Hall distinguishes the policy instruments, the levels (or settings) of instruments and the goals to ascertain the process to the fundamental change (Hall 1993). There are three ways to change a policy in social policy making: 1) altering the overarching goals that guide policy in a particular field; 2) choosing policy instruments to attain given goals; and 3) changing the level or settings of policy instruments to attain given goals. With the help of these distinctions, he identifies three distinct kinds of changes in social programs. A first-stage change involves changes in a social policy program’s settings without abolishing the social policy program itself or changing its overarching goals. Examples of changes in the first stage in pension policy include adjustments of benefits and collection as shown in Table 1: accrual rate, methods or times of indexation, pensionable age, and the ratio of contribution between employer and employee. The second stage of change involves the abolishment of a program followed by the introduction of a new social policy program but without changing the overall goals. Examples of changes in the second stage of pension policy include those in benefit structure, benefit calculation, universality, source of fund and financing method as indicated in Table 1: defined benefit or defined contribution, funded scheme or PAYG scheme, contribution or taxation. A third-stage change is of both overarching goals and social policy programs. In pension policy, the goal of income-related pension would assure a certain level of income replacement, and the flat rate pension would serve to maintain a minimum standard of living. So, if a reform is intended to alter these goals and instruments, it means a third stage of change.

First- and second-stage changes can be seen as cases of “normal policymaking,” a process that adjusts policy without changing the overall terms of a given policy paradigm. By contrast, third-stage change is likely to reflect a very different process marked by radical change in the overarching terms of policy discourse associated with a “paradigm shift” (Hall 1993). Whether the overarching goals are altered or not is a crucial issue because the first- and second-stage changes do not involve changes of goals.

A third-stage change is truly far-reaching because it involves changes of both the goals and instruments as mentioned above. However, if overarching goals are altered without changing policy instruments themselves, the policy outcome would be greatly changed. It is the converse of first-stage change. Relatively minor changes like adjusting policy settings may gradually bring about a paradigm shift, when the overarching goals are altered. Such change suits policy makers because the politics of blame avoidance have been important in the pension retrenchment phase (Weaver 1986; Pierson 1994).

In this article, we categorize changes in social policy into four types by combining the change of overarching goals with the change of policy instruments or the levels (settings) of instruments. Four reform types are denoted in Table 2: adjustment reform (equivalent to first-stage change), system replacement reform (equivalent to second-stage change), far-reaching fundamental reform (equivalent to third-stage change), and gradual fundamental reform in which overarching goals are altered without changing policy instruments themselves.

An example of far-reaching reform in the public pension sector is the Swedish pension reform of 1999 (Nordlund 2002). The characteristics of the new Swedish pension system are that a pension finance method is a PAYG, but this system is a defined contribution. Therefore, it is called a notional defined contribution. In this reform, the policy instrument was altered, but the aim was not changed because the reason for reform is to solve the sustainability and inequities of the old system and assure income security for all workers at retirement (Timonen 2001:40; Timonen 2003:191).

An example of far-reaching reform is the Chilean pension reform of 1981. General Pinochet introduced the private pension fund to replace the existing PAYG scheme, in which the government guaranteed a "minimum pension" for affiliates with a 20-year record of paying into the system.

An example of gradual fundamental reform is the UK pension reform by Thatcher in 1985. The government started contracting out the State Earnings Related Pension (SERPs) and had the state pay part of the National Insurance contributions into a private fund. Those who decided to contract out would receive an extra 2% rebate above and beyond that strictly necessary to make their pension the equivalent of the SERPs. The Government also created a new private portable pension, while providing tax relief for paying into the system. As a result, income-related pension was mainly replaced with private pension. Although the SERPs was inherited by the State Second Pension (S2P) in 2002, not only the Basic State Pension and Minimum Income Guarantee, but also the S2P aimed to alleviate poverty at the time (Ring and McKinnon 2002).

Using the typology of reforms, one can predict the outcome of the reforms. We analyze the nature of the pension reforms in the following, based on this frame of reference.

Table 1 Contents of Policy Instruments

Benefit / Structure / Calculation / Universality / Adjustment
Flat rate or Earnings related / Defined benefit or Notional defined contribution / Means (income)-tested or not，Family or Individual unit benefit，occupational unit or not，applicable or not / Accrual rate，Calculation base(based on best(final) earnings, or average earnings when calculating)，Methods or times of indexation，pensionable age，Benefit of early or delayed pension，Taxation on benefit，Maximum or minimum earnings for benefit purpose
Financing / Source / Method / Levy
General taxes or Social security contribution / PAYG or Funding / Type of contribution flat rate, fixed or income-related. Ratio of contribution between employer and employee，Government grants，Qualifying condition (period of contribution)，Maximum or Minimum earnings to be paid in, Contribution based (e.g., with or without bonuses).

Table 2 Typology of Institutional Changes

Change of overarching goal
No / Yes
Change of levels or settings of policy instruments / Adjustment reform
(first-stage change) / Gradual fundamental reform
Change of policy instruments / System replacement reform
(second-stage change) / Far-reaching fundamental reform
(third-stage change)

Ⅳ Pension Reform in EPP and NPP

Demographic ageing would be the primary factor in institutional change in public pension. It is demonstrated that there are correlations between the income replacement levels of EPP and the populations of aged persons 15-64 (r=0.86; p<.01) and between the increase of the income replacement of EPP and the increase of the population of aged 0-14 (r=0.78; p<.05), although the correlations between the levels or increase in the income replacement of EPP and other demographic factors are not statistically significant. Other demographic factors include: population of aged 0-14, 65+, increase of population of 15-64, 65+, aged 65+ / aged 15-64 ratio, and aged 65+ / aged 0-14 ratio1). The level of income replacement of EPP would be upgraded, if many workers pay in. There would be a great increase in income replacement of EPP, when the numbers of children paying in increase in the future. Public pension levels have been changed by many preceding reforms. What is the nature of these and the present ongoing reforms?

1. Typology of Pension Reforms before 2004

(1) History of EPP Pension Reforms

The 1973 pension system reform in EPP was a landmark change. When the EPP was launched, the structure was a single-layer, remuneration-based proportional pension system. In the postwar revisions of 1954, the EPP was restructured into a two-layer system, with a fixed rate part (the first tier) and a remuneration-based proportional part (second tier). The benefit of the fixed part was based on the livelihood aid of public assistant for the aged 60 and over, which covered standard living expenses, irrespective of how the person paid into the system. On the other hand, the benefit of a remuneration-based proportional part was designed to assure 10% remuneration for the full pension which required 20 years of paying in. The EPP benefit had been the same as the NPP benefit from the 1954 reform until the 1969 reform, showing improvement of the benefit payment level called “10,000 yen pension” or “20,000 yen pension” during this time. The EPP aimed to preserve the minimum standard of living as well as the NPP until the 1969 reform because the NPP has been targeted to sustain the minimum standard of living since it was introduced in 1959.

In the 1973 reform, the newly determined model pension, fixed the pension benefit level at around 60% of active generation’s average monthly salary. Some instruments such as the price indexation system and reevaluation of salary were introduced to achieve this goal. According to the price indexation system, if the National Consumer Price Index changes over 5% on an annual average basis changes, the amount of pension shall be revised from the following April. The reevaluation of salary is used to calculate the benefit of a remuneration-based proportional part. When the amount of pension benefit is determined, the average monthly remuneration is revaluated and a prescribed multiplier is used to take into account increases in earning levels during the period concerned. The rate of reevaluation is revised once every five years (Health and Welfare Association 1973:19). The benefit level of EPP has been increasing since then and targeting a certain level of income replacement. Therefore, gradual fundamental reform was implemented by the 1973 reform because the goal of EPP was changed from guaranteeing the minimum standard of living to assuring a certain level of income replacement without altering the basic EPP programs.