岡山大学経済学会雑誌３
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Introduction of Progressive Expenditure Taxation to Japan
Akira Okamoto＊＊

1. Introduction
Aging of the Japanese population is currently progressing at a rapid rate, and will continue at a speed that noother developed nation has ever experienced. Figure 1 presents the transition of the ratio of people aged 65 andabove to the total population for five advanced countries. The percentage of Japan’s population aged 65 andabove has increased by 8.2% during the 30 years from 1965 to 1995. This proportion is expected to increase
further by another 14.2% during the next 30 years from 1995 to 2025 : this increase in elderly population is of adrastic nature that no other population in the world has ever experienced.
This situation is causing serious problems in Japanese society. Under the current system, the aging populationis placing an increasingly heavy burden of inflating pension and medical care expenses on a shrinking working
population. For instance, because the current Japanese public pension program is operated in a manner that issimilar to a pay−as−you−go scheme, the declining percentage of the working population will have a harmful
effect on economic welfare. Hence, structural reforms, especially tax reforms, to accommodate this drastic
demographic change, have become an urgent policy issue.
The purpose of our analysis is to establish guidelines for structural tax reforms in Japan, a society with an
aging population. We evaluate the alternative tax regimes in terms of efficiency and equity to explore an
optimum tax scheme. Any persuasive analysis on this subject should include the general equilibrium effects ofpolicy choices on endogenous economic variables such as interest rates, wages, and savings. In particular, theproper choice of tax bases is a significant question, because this choice has important implications for the courseof savings and economic growth, the level of economic efficiency, and the distribution of welfare acrossgenerations.
Figure 1 suggests that the aging of the Japanese population will progress rapidly in the coming decades. The
saving rate in Japan will reduce further, and thus Japan may suffer seriously from a lack of savings in the future.
The tax policy to promote capital accumulation will become more and more necessary in an aging Japan.

*

This study is based on Chapters 1, 4, and 9 in Okamoto (2004). The author is grateful for insightful comments and suggestions byProfessors Toshiaki Tachibanaki (Kyoto University), Toshihiro Ihori (The University of Tokyo), and Eiji Tajika (Hitotsubashi
University). The author acknowledges the financial support from the Ministry of Education, Culture, Sports, Science andTechnology in Japan (Grant−in−Aid for Scientific Research (C) (2) No.15530215).

** Correspondence to : Associate Professor, Faculty of Economics, Okayama University, Tsushima, Okayama, 700−8530, Japan.
e−mail : okamoto@e.okayama−u.ac.jp

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2. A Life−Cycle General Equilibrium Simulation ModelIn our analysis, the life−cycle general equilibrium simulation model developed by Auerbach and Kotlikoff(1983) is used to take account of the rapidly aging Japanese population.1 This is because the model is suitable asa basic theoretical framework to examine the impact of demographic changes on various social and economic
variables. The work of Auerbach and Kotlikoff (1987) was published to share this new perspective on themacroeconomic effects of fiscal policies. They have continued to improve the simulation model, and Altig et al.
(2001) undertook an analysis with the latest, large−scale, dynamic model. Several Japanese researchers have

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Figure 1 Transition of the proportion of elderly population for five advanced countries
Figures for Japan obtained from “National Census” and “Japanese Future Demographic Projections” (National Institute of Populationand Social Security Research, January 2002). Figures for other nations from “World Population Prospects : The 2002 Revision”(United Nations).
Source : Current Japanese fiscal conditions and issues to be considered , The Ministry of Finance, Japan (2004)
1 We perform an analysis based on a life−cycle model. The crucial points are whether this model is applicable to Japan, and whether it
can successfully explain its society. See Appendix A for the applicability of the life−cycle hypothesis of saving to Japan.

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also employed the macro model. Homma et al. (1987) were the first to make an analysis using this model.
Iwamoto (1990) incorporated uncertainty regarding the length of individual life and unintended bequests,
consistent with its uncertainty, into a life−cycle general equilibrium model.
The life−cycle growth model employed in our analysis is grounded in the microeconomics of intertemporalchoice, and the macroeconomics of savings and growth. The simulation model has three features. First,
aggregate assets of the economy in each period consist of the assets of different generations that maximize their
lifetime utility. This allows us to rigorously analyze changes in the supply of assets caused by demographic
changes. Second, assets in the capital market, where aggregate assets appear as real capital, affect the productionlevel. Third, it is possible to estimate realistic consumption−savings profiles for the elderly, by incorporating
life−length uncertainty and unintended bequests into the model.

3. Progressive Expenditure Taxation
We take account of progressive expenditure (or consumption) taxation.2 Few studies have dealt with this new
type of tax regime to evaluate the effects of structural tax reforms. Because there are only a few studies on
progressive expenditure taxation, our study has some merit as a pioneering work. There are two types ofprogressive consumption taxes : expenditure tax and sales tax. The former definition, a direct tax that is leviedon consumers, is used in our analysis.

4. Summary and Conclusions
Okamoto (2004) has investigated the macroeconomic and welfare effects of structural tax and public pension
reforms in Japan, a society with an aging population. A life−cycle general equilibrium simulation model
developed by Auerbach and Kotlikoff (1983) was employed to take account of the rapidly aging Japanese
population. That study has also compared various alternative tax regimes in terms of efficiency and equity to
explore an optimum tax policy (see Okamoto (2004) for the details of the model, the method of simulation
analysis, and the assumptions adopted).
The simulation results in Okamoto (2004) suggest that capital stock will decline with an aging population.
Two possible reasons are as follows : the first is that in an aging society, there are many cohorts that dissave
their assets based on a life−cycle motive ; the second is that payroll tax (i. e., contribution rate) rises sharply.
The results also show that progressive expenditure taxation stimulates much more capital accumulation thanprogressive labor income taxation. Therefore, it is ultimately desirable to shift from progressive labor income
taxation to progressive expenditure taxation. The switchover from an income−based to a consumption−based tax
system should be executed gradually in an aging Japan.

2 See Seidman (1997) for the details of a progressive consumption tax.

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Our simulation results suggest, quantitatively, that a shift to progressive expenditure taxation can overcome
the large welfare loss that would occur under the current tax system as Japan ages (see Okamoto (2005b) for
further details). When progressive expenditure taxation is adopted as the nucleus tax regime, its combination
with an inheritance tax is preferable in terms of efficiency and equity.
With regard to the structural reforms in the current Japanese system, the contributions to the public pension
scheme in a pay−as−you−go system should be replaced by general taxes, in particular by a progressive
expenditure tax. Such possible integration of tax and social security systems is desirable in terms of efficiency
and equity. We should promote the partial integration of tax and public pension systems as a transition process,substitute a consumption tax for the contributions, and implement a gradual shift toward perfect integration.
Therefore, we recommend the introduction of progressive expenditure taxation with the complete integration of
tax and social security systems (see Okamoto and Tachibanaki (2002) for further details).

5. Introduction of Progressive Expenditure Taxation
The simulation results in Okamoto (2005a) quantitatively suggest that a progressive expenditure tax
substantially stimulates capital accumulation, and efficiently reduces within−cohort income inequality. To
introduce a progressive expenditure tax, it is necessary that the tax office can grasp the total amount ofexpenditure for each individual or household. At present, computer technology is making remarkably rapid
progress and over time will be able to provide a better environment for the introduction of a progressive
expenditure tax in Japan. Thus, the possibility of introducing the tax regime should steadily increase.
The justification for introducing a taxpayer identification number system is presently being actively discussed
in Japan. This system has already been adopted in the United States, Canada, and in Scandinavian countries. In
this system, each taxpayer has an identification number (a tax number or a social security number) that enables a
tax agency to monitor the total amounts of income and assets. Not only would this system help the introductionof a progressive expenditure tax, it is also necessary to efficiently and equitably provide public services for theelderly. Thus, it may not be long before a progressive expenditure tax is introduced in Japan.
Nowadays, the number and variety of financial transactions that occur by Internet trading are progressing on a
global scale. Hence, it is becoming more and more difficult to precisely monitor personal income. Levying a tax
on expenditure, an ultimate purpose of economic activity, may solve this problem. Irrespective of a means toearn income, a tax office may be able to collect taxes efficiently and equitably by taxation on expenditure.3
The amount of income of salaried workers can be precisely monitored by withholding tax at the income
source. On the other hand, it is said that for self−employed persons or farm households, the ability to monitor
income is substantially lower because of tax payment by self−assessment. An expenditure tax is likely to
mitigate this state of unfairness between workers of different fields. Moreover, the introduction of tax

3 Kaldor (1955) claims that the implicit taxation of individuals with vast inherited wealth via an expenditure tax is a final goal.

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progressivity to the total amount of expenditure may be desirable in terms of equity, because the range of tax
base of expenditure would be wider than that of income.
Okamoto (2004) suggests that a progressive expenditure tax is ultimately an ideal tax regime in terms ofefficiency and equity. However, a sudden move from the current Japanese tax system (that depends mainly on a
progressive income tax) to a progressive expenditure tax, would generate a substantial transition cost. With
regard to a short−term policy, we should rely more on a consumption tax as a transition process, and execute a
gradual shift towards a progressive expenditure tax.
The main purpose of this study is to let many academic researchers or policy makers aware of this new typeof tax regime (i. e., a progressive expenditure tax) and its merits. We believe that even if a progressive
expenditure tax is not actually introduced in Japan, the policy implication obtained in our analysis will still bemeaningful and effective. Even in the case of implementing structural reform along the lines of the current
Japanese tax system, knowledge of this new type of tax schedule will prove to be useful.

6. How Can Progressive Expenditure Taxation Be Implemented?
Finally, we present the concrete measures of carrying out progressive expenditure taxation. Conceptually, it iseasy to introduce progressive expenditure taxation. The feasibility of implementing progressive expenditure
taxation, however, contains a serious problem in the real world : that is to measure and grasp the figures of eachindividual’s expenditure. For its implementation, it is necessary to grasp the total amount of annual expenditure
for each household. This implies that a tax authority has to grasp the whole picture of consumption activities ofeach individual in detail. How can we measure a tax base that is defined by expenditure? We propose that it isfeasible to measure it with the method that follows.
There is a relation that states income is equal to consumption (or expenditure) plus savings. If the amounts ofboth income and savings are available for each individual, the balance is equal to the amount of expenditure.
The income figure is efficiently obtained using the current Japanese system of withholding taxes at the income
source. The savings figure can be obtained through the self−assessment system. It should be emphasized that theself−assessment of savings is the exact opposite to that of income in terms of an individual incentive. The more
an individual declares savings, the lower tax rates on expenditure the individual has. This is entirely in contrast
to the case of the self−assessment of income.
The savings figure can be consolidated using an electronic financial system. All financial institutions arerequested to report the total amount of financial assets held by each individual with an individual tax number (ora social security number) to a tax office. Thus, the tax office is able to grasp the overall wealth of eachindividual. Of course, this feasibility depends solely on the development of a computer−based financial system.
The introduction of progressive expenditure taxation is our recommendation in the long−term perspective.

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Appendix A : The Applicability of the Life−Cycle Hypothesis of Saving to Japan
We perform an analysis based on a life−cycle model. The crucial question is whether this model is applicable
to Japan, and whether it can successfully explain the society.
For example, Horioka et al. (2000) suggest two empirical results. One is that bequest motives in Japan are
weak on an absolute scale, and are also relatively weaker than those in the United States. The majority ofbequests in Japan consist of unintended bequests and strategic bequest motives. The former are caused by!"our analysis focuses on this bequest motive. The latter signify that

uncertainty regarding the length of life

parents use their wealth (which changes into bequests when they die) as a means of urging their children to lookafter them.4
The other is that many of the aged in Japan finance their living expenses by dissaving, and both parents andchildren are inclined to take selfish actions. These empirical results indicate that the applicability of a life−cycle
model to Japan is fairly high, and even higher than that in the United States. Hence, the findings of Horioka etal. (2000) are likely to support the fact that our study, based on a life−cycle model, provides a reasonably good
description of the actual Japanese situation.
The life−cycle hypothesis of saving suggests that as the population ages, the aggregate household saving rate
diminishes, because of a decrease in the ratio of younger households in their accumulation phase to older
households in their dissaving phase. Thus, when discussing the applicability of the life−cycle hypothesis toJapan, it may be useful to point out the fact that the aggregate household saving rate tends to gradually decreasein Japan.
Figure 2 presents the transition of the aggregate household saving rate from 1985 to 2001 for four advanced
countries. The aggregate household saving rate in Japan shows a tendency to decrease as the population ages
(see Figure 1). This rate dropped further to 6.2% in 2002, the lowest value in the past. Certainly, this decline
may come, in part, from the prolonged recession during the 1990s. However, this decline can also be partly
explained by the life−cycle hypothesis of saving.
Figure 3 shows the transition of the ratio of the households aged 65 and above without occupations to the total
households from 1995 to 2002, and of their saving rate in Japan. The proportion of these elderly households
continues to increase, and it reached 22% in 2002. Their saving rate has a tendency to diminish, and it dropped
to −26% in 2002.

4 Bernheim et al. (1985) addressed strategic bequest motives.

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Figure 2 Transition of the aggregate household saving rate for four advanced countries
Figures for Japan obtained from Annual Report on National Accounts (Economic and Social Research Institute, Cabinet Office,
Government of Japan). Figures for other nations from OECD Economic Outlook No.73.
Source : http : //www5.cao.go.jp/keizai3/2003/1120getsurei/image5.pdf, Cabinet Office, Japan (2003)

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Figure 3 Transition of the ratio of the aged households without occupations and of their saving rate
Figures from Annual Report on the Family Income and Expenditure Survey : Income and Expenditure (Two−or−more−person
Households), Statistics Bureau, Ministry of Public Management, Home Affairs, Posts and Telecommunications, Japan.
Source : http : //www5.cao.go.jp/keizai3/2003/1120getsurei/image5.pdf, Cabinet Office, Japan (2003)

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References
Altig, D., Auerbach, A. J., Kotlikoff, L. J., Smetters, K. A., and Walliser, J. (2001) “Simulating fundamental tax reform in the UnitedStates,” American Economic Review 91 (3) : 574−595.
Auerbach, A. J. and Kotlikoff, L. J. (1983) “National savings, economic welfare, and the structure of taxation,” In : Feldstein, M. (ed),Behavioral simulation methods in tax policy analysis, Chicago : University of Chicago Press, 459−498.
Auerbach, A. J. and Kotlikoff, L. J. (1987) Dynamic fiscal policy, Cambridge : Cambridge University Press.
Bernheim, B. D., Shleifer, A., and Summers, L. H. (1985), “The strategic bequest motive,” Journal of Political Economy 93 (6) :1045−1076.
Homma, M., Atoda, N., Iwamoto, Y., and Ohtake, F. (1987) “Pension : Aging society and pension plan,” In : Hamada, K., Horiuchi,A., and Kuroda, M. (eds), Macroeconomic analysis of the Japanese economy, Tokyo University Shuppankai, 149−175 (inJapanese).
Horioka, C. Y., Nishikawa, M., Iwamoto, S., and Kouno, T. (2000) “The importance and properties of bequest motives, and theireffects on the behavior of parents and children,” Paper presented at the Annual Meeting of the Japanese Economic Association,
Osaka Prefecture University (in Japanese).
Iwamoto, Y. (1990) “Pension plan and bequest behavior,” Quarterly Journal of Social Security Research 25 (4) : 388−411 (inJapanese).
Kaldor, N. (1955) An expenditure tax, London : George Allen and Unwin.
Okamoto, A. (2004) Tax policy for aging societies : Lessons from Japan, Springer.
Okamoto, A. (2005a) “Simulating fundamental tax reforms in an aging Japan,” Economic Systems Research 17 (in press).
Okamoto, A. (2005b) “Simulating progressive expenditure taxation in an aging Japan,” Journal of Policy Modeling 27 (in press).
Okamoto, A. and Tachibanaki, T. (2002) “Integration of tax and social security systems : On the financing methods of a public
pension scheme in a pay−as−you−go system,” In : Ihori, T. and Tachibanaki, T. (eds), Social security reform in advanced
countries : Evaluating pension finance, London and New York : Routledge, 132−160.
Seidman, L. (1997) The USA tax : A progressive consumption tax, Cambridge, MA : MIT Press.
Data
Cabinet Office (2003) http : //www5.cao.go.jp/keizai3/2003/1120getsurei/image5.pdf, Japan.
The Ministry of Finance (2004) Current Japanese fiscal conditions and issues to be considered , Japan.

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Introduction of Progressive Expenditure Taxation to Japan
Akira Okamoto

With a population that is aging faster than any other in the world, Japan faces serious public financeproblems, particularly when it comes to tax and social security issues. The structural reforms are urgently
needed to accommodate the impending demographic change. We look at the Japanese tax and social security
systems through a life−cycle general equilibrium simulation model. We aim to establish guidelines for fiscal
reform in Japan’s graying society and use such advanced modeling techniques to permit the calculation of theeffects of alternative tax policies on capital accumulation and economic welfare. We also examine the impact ofprogressive expenditure taxation, coming to the novel conclusion that this form of taxation may hold the key toovercoming the large welfare loss Japan faces as its society ages under the current tax system. Furthermore, we
present the concrete measures of implementing progressive expenditure taxation.

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