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2015 | OriginalPaper | Chapter

2. The Political Economy of Social Security Funding: Why Social VAT Reform?

Author : Hideki Konishi

Published in: The Political Economy of Fiscal Consolidation in Japan

Publisher: Springer Japan

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Abstract

Recently, taxation reforms entailing a “social” valued-added tax (VAT), i.e., a social security reform shifting funding from traditional wage-based taxation to consumption taxation, have been obtaining political support in some developed countries, e.g., Japan, France, Denmark, and Germany. This paper analyzes the political economy of social security funding in an overlapping-generations economy. In particular, we consider how population aging influences the choice of wage or consumption tax financing by focusing on their differential impact on inter- and intragenerational redistribution. Our results show that population aging may drastically alter the political equilibrium: if the population growth rate is higher than the interest rate, wage taxation is the only equilibrium choice, but if it is lower, multiple equilibria are likely to emerge, in which the introduction of consumption taxation emerges as an alternative equilibrium choice.

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In Japan, the concern for intragenerational fairness is also emphasized in the call for consumption tax funding. The reason is that a substantial share of the working population, especially those in their 20s or 30s, are not paying national pension contributions, despite their being mandated.

According to their estimates of net total social expenditure including taxation and private social spending, international differences in the ratio of social expenditure to GDP are less than what we usually observe for gross social expenditure. For example, in terms of gross social expenditure, France, Sweden, and Denmark are the three largest social spenders in the OECD, but in terms of net total social expenditure, Sweden ranks fourth and Denmark ninth.

The social protection programs underlying the figures in Table 2.1 include not only old-age pension programs but also health care, unemployment, housing, and social assistance programs.

See Atkinson and Stiglitz (1980, Ch. 6) for the excise tax effect of corporate income taxes.

Theoretically, when markets are perfectly competitive, the share-out ratios should make no difference in equilibrium prices and resource allocation. This argument, however, seems to be hardly acceptable in practice.

This further implies that under consumption tax financing, workers have to save more for their postretirement consumption to pay for consumption taxes.

In Appendix 3 we relax this assumption following Conde-Ruiz and Galasso (2005) and show that the same equilibrium outcomes are realized in the subgame-perfect equilibria of an infinitely repeated voting game.

Because $ 1-\left(1-{\tau}_w\right)\left(1-{\tau}_c\right) $ is the difference between the before- and after-tax wage rates, multiplying it by the change in the labor supply yields the change in the deadweight loss in the labor supply.

Differentiating (2.11) with respect to n and making use of (2.14) yields $ {\partial}^2{U}_i/ \partial n\partial {\tau}_w=\left[\left(1-{\tau}_c\right){N}_i+{\tau}_cE\right]/ \left(1+n\right)>0 $ when $ {\tau}_w={\tau}_w^y $.

This follows given $ \partial {\tau}_w^y/ \partial {E}_i<0 $ and $ \partial {E}_w/ \partial n=1/ \left[2{\left(1+n\right)}^2f\left({E}_w\right)\right]>0 $.

This observation is similar to that by Razin et al. (2002). They used an overlapping generations model with human capital formation and showed that population aging may lead to a downsizing in the size of the welfare state. They also tested this hypothesis with data for the US and 12 European countries over the period 1965–1992 to obtain a positive empirical result. See also Disney (2007), Simonovits (2007), and Galasso and Profeta (2007), among others, for the controversies that their paper initiated.

If we look at (2.13), the three channels correspond to the changes in the three terms on the right-hand side. Differentiating (2.11) with respect to τ _c, we have

$$ \begin{array}{c}\frac{\partial^2{U}_i}{\partial {\tau}_c\partial {\tau}_w}=-\left(E-{E}_i\right)-\frac{1+n}{\left(1+r\right){\left(1-{\tau}_w\right)}^2{\left(1-{\tau}_c\right)}^2}.\\ {}\end{array} $$

The first term reflects the effect through the first channel, and the second term reflects the net effect through the second and third channels. Given that the decisive worker–voter has E _i < E, both terms are negative.

This observation follows from $ {\partial}^2{V}_j/ \partial {E}_j\partial {\tau}_c=-\left(1+r\right)\left(1-{\tau}_w\right)<0 $ and $ {\partial}^2{V}_j/ \partial {\tau}_c^2<0 $.

This observation follows from $ {\partial}^2{U}_i/ \partial {E}_i\partial {\tau}_c=-\left(1-{\tau}_w\right)<0 $.

See footnote 12.

See, e.g., Persson and Tabellini (2000).

In Japan, the Committee on Health, Welfare, and Labor in the lower house (as well as that in the upper house) has jurisdiction over wage-based social security contributions, while the Committee on Financial Affairs has jurisdiction over consumption taxes.

As shown in Appendix 2, the equilibrium with $ {\tau}_w^e>0 $ and $ {\tau}_c^e>0 $ is unique if it exists.

This ability distribution yields a before-tax wage distribution with quartile dispersion coefficient (3rd quartile – 1st quartile)/(2×median) = 0.23 and decile dispersion coefficient (9th decile – 1st decile)/(2× median) = 0.45. These are close to the corresponding values in the Japanese wage distribution for males aged 40 to 44 years. According to the Basic Survey on Wage Structure 2013, they are 0.23 and 0.48, respectively.

The population growth rates of many developed countries can be found in Statistical Bureau, Ministry of International Affairs and Communications (2013).

Adema W, From P, Ladaique M (2011) Is the European welfare state really more expensive? Indicators on social spending, 1980–2012; and a manual to the OECD Social Expenditure Database (SOCX), OECD social, employment and migration working papers, No. 124. OECD Publishing, Paris

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Title: The Political Economy of Social Security Funding: Why Social VAT Reform?
Author: Hideki Konishi
Publisher: Springer Japan
Book: The Political Economy of Fiscal Consolidation in Japan
Print ISBN: 978-4-431-55126-3

Electronic ISBN: 978-4-431-55127-0

Copyright Year: 2015
DOI: https://doi.org/10.1007/978-4-431-55127-0_2