岡山大学経済学会雑誌 42（２），2010，47 〜 76

Welfare Analysis of Progressive Expenditure Taxation in Japan
Akira Okamoto (Okayama University)*Toshihiko Shima (University of Tokyo)
Abstract
This paper aims to establish guidelines for public pension reform in an aging Japan, using a numerical simulation
approach. The paper examines the effects of demographic change and public pension policies on economic
growth and welfare, using a dynamic life-cycle general equilibrium model. It deals with the benchmark case withthe current Japanese pension schedule based on the 2004 reform, and the reform cases in which the whole basic
pension beneﬁt is ﬁnanced by a consumption tax and in which the earnings-related pension is abolished. Moreover,it handles the case in which a progressive expenditure (or consumption) tax is introduced. The simulation results
show that the level of economic welfare is higher under these reforms than under the current pension schedule.
Keywords: Aging population; Public pension reform; Basic pension; Progressive expenditure tax; Life-cycle
general equilibrium simulation model
JEL classiﬁcation: H30; C68

1 Introduction
With a population that is rapidly aging, Japan faces serious public finance problems, particularly when it
comes to tax and social security issues. Structural reforms are urgently needed to accommodate the impending
demographic change. In particular, the sustainability of the public pension system is an important problem inJapan, and thus a reform of the public pension program was implemented in 2004. However, this reform seems
to be far from a radical reform. Hence, it was unable to dispel completely the suspicion with which the people,
especially the young, view the public pension scheme. The necessity for a more drastic reform of the scheme isnow becoming obvious.
This paper aims to establish guidelines for public pension and tax reforms in an aging Japan, using a
numerical simulation approach. This paper examines the effects of different public pension policies on economic
growth and economic welfare in an aging Japan, using a computable, general equilibrium model of overlapping
generations. In the benchmark simulation, the public pension reform scheduled by Japan’s 2004 pension reformis performed. Alternative simulations with another public pension reform are also implemented. The paper deals* Correspondence to: Professor, Faculty of Economics, Okayama University,
Tsushima, Okayama, 700-8530, Japan.
Phone & Fax: +81-86-251-7539 E-mail: okamoto@e.okayama-u.ac.jp−47−

Akira Okamoto and Toshihiko Shima96

with the simulation case in which the whole basic pension is ﬁnanced by a consumption tax or in which theearnings-related pension is abolished. Furthermore, the paper handles the case where a progressive expenditure(or consumption) tax replaces a proportional one.
To analyze the problem, this paper looks at the Japanese tax and social security systems using an extended
life-cycle general equilibrium model. Many papers have studied using this kind of model; for instance, Auerbachand Kotlikoff (1983a, 1983b, 1987), Seidman (1983), Auerbach et al. (1989), Altig et al. (2001), Homma et al.
(1987), Uemura (2001) and Ihori et al. (2006). Nearly all of them, however, have concentrated on analyzing theeffects of an aging population on production and consumption1, and thus on economic growth; but when dealing
with tax and pension reforms it is vital to evaluate not only efﬁciency but also equity.
There are three themes in this paper.
First, the paper incorporates three representative households with different earnings abilities in a dynamic
life-cycle general equilibrium model with an elastic labor supply. This enables us to examine equity issues in
addition to efﬁciency issues. Thus, this paper considers intra- as well as intergenerational equity, which enables
us to present some comprehensive and useful guidelines for public pension reforms. The macroeconomic andwelfare effects of alternative pension policies are evaluated in a transitional process to an aging Japan.
Second, when dealing with alternative pension reforms, the paper addresses the problems that will actuallyarise in a transitional process of the pension and tax reforms. Concretely, in the reform case in which theearnings-related pension is abolished, a transition relief is considered for the generations that have paid
contributions.
Third, we take account of a progressive expenditure (or consumption) tax as a source of revenue on public
pension and tax systems.2 Few studies have dealt with this new type of tax regime to evaluate the effects ofstructural tax reforms. Because there are only a few studies on a progressive expenditure tax, our study has somemerit as a pioneering work. There are two types of progressive consumption taxes: expenditure tax and sales
tax. The former deﬁnition, a direct tax that is levied on consumers, is used in our analysis.
This paper is organized as follows. The next section identiﬁes the basic model employed in the simulation
analysis. Section 3 explains the method of simulation analysis and the assumptions adopted. Section 4 evaluates
the simulation ﬁndings and discusses policy implications. Section 5 summarizes and concludes the paper.

2 Theoretical Framework
The life-cycle growth model employed in this paper 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−48−

Welfare Analysis of Progressive Expenditure Taxation in Japan97

length uncertainty and unintended bequests into the model.
We calibrate the simulation of the Japanese economy by employing population data estimated by the
National Institute of Population and Social Security Research in 2006. The model has 75 different overlapping
generations. Three types of agents are considered: households, ﬁrms, and the government. The basic structuresof households, firms, and the government are first described, and then market equilibrium conditions are
explained.
2.1 Household Behavior
Each household is assumed to consist of a couple of the same age. Each household appears in the economy asa decision-making unit at the age of 21 and lives to a maximum of 95. Younger people than age 21 do not affectthe economy at all. Households face an age-dependent probability of death. Let q tj + 1 | j be the conditional
probability that a household born in year t lives from age j to j+1. Then the probability of a household of age
21, born in year t, surviving until s can be expressed by(1)
The probability q tj + 1 | j is calculated from data estimated by the National Institute of Population and Social

Security Research (2007).

Households are divided into three income classes: low, medium, and high. A single household type represents
each income class. The household that belongs to the same cohort has the same mortality rate and the same
utility function. Unequal labor endowments, however, create different income levels. The utility of eachhousehold depends on the levels of consumption and leisure. The household born in year t works from age 21
to a maximum of RE t, the retirement age. The labor supply is elastic but zero after retirement. Each householdthat maximizes the expected lifetime utility makes lifetime decisions at age 21, concerning the choice between
leisure and labor supply and the allocation of wealth between consumption and savings. The utility function of arepresentative household of income class i, the form of which is assumed to be time-separable, is(2)

where C t,s i and l t,s i represent consumption (or expenditure) and leisure, respectively, for income class i, ofage s, born in year t , φ the share parameter for consumption, δ the adjustment coefﬁcient for discounting
the future, and r the intertemporal elasticity of substitution in the consumption/leisure composite. The
superscript i (=l, m, h) stands for low, medium, and high-income classes, respectively.
The ﬂow budget constraint equation for each household at age s at time t is−49−

Akira Okamoto and Toshihiko Shima

98(3)
where Ast, i represents the amount of assets held by income class i born in year t at the beginning of age s, r t

the interest rate at time t, wt the wage rate per efﬁciency unit of labor at time t, and e s is the age proﬁle ofearnings ability. For income class i, of age s, born in year t, 1− l st, i is the amount of labor supply,is the amount of public pension benefit, and a t,s i is the amount of bequest to be inherited.
is the tax rate on labor income at time t,that on consumption at time t , τ r that on

capital income, and τtp is the contribution rate to the public pension scheme at time t. x i is the weight
coefﬁcient corresponding to the different levels of labor endowments across the three income classes.

The tax system consists of labor income, interest income, consumption, and inheritance taxes. Labor income
or consumption (i.e., expenditure) is taxed progressively. The progressive tax schedule is incorporated in thesame manner as in Auerbach and Kotlikoff (1987). If the tax base is z, we choose two parameters labeled
α and β, and set the average tax rate (τ w or τ c) equal to α ＋ 0.5βz for all values of z. The corresponding−−

marginal tax rate (τ w or τ c) is α ＋ βz. Setting β = 0 amounts to proportional taxation. One may make the tax
system more progressive, holding revenue constant, by increasing β and decreasing α simultaneously.
Progressive taxation is applied to the gross wage or the level of consumption on an annual basis for.

households. In the case of progressive labor income taxation, the tax base, z, is the gross wage,

If progressive expenditure (or consumption) taxation is adopted, z is the level of expenditure (or consumption),
Cst, i . The symbols,and, in equation (3) mean that τ w and τ c are functions ofand Cst, i , respectively. The tax systems on interest income and inheritances are proportional.

The public pension program is assumed to be a pay-as-you-go system that is close to the current Japanesesystem. The program consists of the basic pension (i.e., the flat part) and a part proportional to the averageannual income from labor for each household. Variables related to the program are represented by
(4)
where
(5)
ST t is the age at which the household born in year t starts to receive public pension beneﬁt, the averageannual income from labor for each income class is, the basic pension beneﬁt per representative

household is ft , and the weight coefﬁcient of the part proportional to H t, i is θt. Thus,
different earnings abilities across the three income classes. The symbol,of public pension beneﬁt is a function of the age proﬁle of leisure,−50−

reﬂects, signiﬁes that the amount.

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Welfare Analysis of Progressive Expenditure Taxation in Japan

There are accidental bequests caused by uncertainty over the length of life. The bequests, which were held asassets by deceased households, are handed to all households surviving at time t. The inheritance is transferred
within the same income class. When BQsi is the sum of bequests inherited by s-year-old households of income
class i at time t, ast, i is deﬁned by

(6)
where
(7)
N st, i is the number of income class i , of age s, born in year t, and τ h is the tax rate on inheritances ofbequests. The amount of inheritances received is linked to the age proﬁle of assets chosen by each household.

When we consider the utility maximization problem over time for each income class, in addition to the ﬂow
budget constraint represented by equation (3), the following constraint is imposed:(8)This is a constraint that labor supply is nonnegative, and that each household invariably retires after theretirement age RE t.
Let us consider the case in which each household maximizes expected lifetime utility under two constraints.
Each household maximizes equation (2) subject to equations (3) and (8) (see Appendix A). From the utility
maximization problem, the equation expressing evolutions of the consumption/leisure composite over time foreach household is characterized by
(9)
where
(10)
If the initial level, V t,21i , is speciﬁed, the level of each age, Vst, i , can be derived from equation (9). If Vst, i is

speciﬁed, the levels of consumption, Cst, i , and leisure, lst, i , at each age are obtained. The amount of assets

held by each household at each age can be obtained from equation (3). The expected lifetime utility of eachhousehold is derived from equation (2).

The welfare function of each generation, which takes account of different earnings abilities and thus provides
different levels of consumption and leisure, is given by
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Akira Okamoto and Toshihiko Shima(11)
This function is derived from a summation of the expected lifetime utilities at age 21 for the three income
classes. The function is of the “Benthamite type,” but depends greatly on the utility of the low-income class. It
is maximized if all income classes have the same level of the consumption/leisure composite.
Empirical evaluation of each simulation from Case B to E in comparison with the benchmark Case A is madeby the following formulation of RWC t (relative welfare changes by percentage ﬁgures):(12)
where UAt signiﬁes the lifetime utility for the generation born in year t in Case A, and UJt (J = B, C, D, E)

represents the lifetime utility for the generation born in year t in each simulation case. The minus sign wasadded so that improvements in RWC t show positive numerical changes in welfare.
2.2 Firm Behavior
The model has a single production sector that is assumed to behave competitively using capital and labor,

subject to a constant-returns-to-scale production function. Capital is homogeneous and depreciating, while labor
differs only in its efﬁciency. All forms of labor are perfect substitutes. Households in different income classes orof different ages, however, supply different amounts of some standard measure per unit of labor input.
The aggregate production technology is the standard Cobb-Douglas form:(13)
where Yt is the total output (national income), Kt the total capital, Lt the total labor supply measured by the
efﬁciency units, B t the labor augmenting technology, and ε is a share of capital. Using the property subject to a
constant-returns-to-scale production function, we can obtain the following equation:(14)
where δ k is the depreciation rate.
2.3 Government Behavior
The government sector consists of a narrower government sector and a public pension sector. The narrower
government sector collects taxes, and spends them on general government expenditure and a transfer to thepension sector. The budget constraint of the narrower government sector at time t is given by−52−

Welfare Analysis of Progressive Expenditure Taxation in Japan

101
(15)

where Dt is the stock of outstanding debt at the beginning of year t, Gt is general government spending on
goods and services, except for a transfer to the public pension sector, Ft is the total amount of basic pension
beneﬁt, and μt is the ratio of the part covered by general tax revenues to Ft , Tt is the total tax revenue fromlabor income, interest income, consumption, and inheritances.
The budget constraint of the public pension sector at time t is given by(16)
where Qt is an accumulated public pension fund at the beginning of year t, Rt is the total contribution to thepension program, and Pt is the total beneﬁt of the part proportional to the income from labor. Gt , Tt , Ft , Rt ,and Pt are deﬁned by
(17)
(18)
(19)
(20)
(21)
where g is the ratio of government expenditure to national income, ft is the total basic pension to national
income, I is an indicator function, and(22)
LXt and CXt are tax revenues from labor income and consumption, respectively:
(23)

(24)

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102

Aggregate variables can be obtained by a simple summation of the three income classes with the same
weight, because each income group accounts for the same proportion of population. Similarly, aggregate assets
supplied by households, ASt, and aggregate consumption, ACt , are obtained by
(25)
(26)

2.4 Market Equilibrium
Finally, equilibrium conditions for the capital, labor, and goods markets are described.
1 Equilibrium condition for the capital market
Because aggregate assets supplied by households are equal to real capital, we get(27)
2 Equilibrium condition for the labor market
Measured in efﬁciency units, because aggregate labor demand by ﬁrms is equal to aggregate labor supply byhouseholds, we get(28)

3 Equilibrium condition for the goods market
Because aggregate production is equal to the sum of private consumption, private investment, and government
expenditures, we get(29)
An iterative program is performed to obtain the equilibrium values of the above equations.

3 Simulation Analysis
3.1 Method of Simulation
The simulation model presented in the previous section is solved under the hypothesis of perfect foresight byhouseholds that correctly anticipate the interest, wage, tax, and contribution rates. If the tax and public pension
systems are determined, the model can be solved using the Gauss-Seidel method (see Auerbach and Kotlikoff(1987) or Heer and Maußner (2005) for the computation process).
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Welfare Analysis of Progressive Expenditure Taxation in Japan

This paper deals with the Japanese transitional economy, considering the initial steady state in 2008 andthe ﬁnal steady state in 2200. With regard to the generations that are alive in the 2008 initial steady state andcontinue to survive in 2009, we should pay attention to their formation of the expectation for the future. These
generations realize at the point in 2009 that their expectation from 2009 onwards has been wrong. Thus, again in
2009, they maximize their remaining lifetime utility under the hypothesis of perfect foresight.
3.2 Simulation Cases
In the benchmark simulation, the public pension reform scheduled by Japan’s 2004 pension reform isperformed. Alternative simulations with another public pension and tax reform are also considered. We ﬁrstly
deal with the reform case in which the whole basic pension is ﬁnanced by a consumption tax. Then we deal
with the case in which the earnings-related pension is abolished and the public pension system consists of
only the basic pension ﬁnanced by a consumption tax. In this respect, we can interpret that this case means theintegration of public pension and tax systems. Finally, we explore a desirable source of revenue on the integrated
public pension and tax systems. We handle the case in which a progressive expenditure (or consumption) tax is
introduced.
With regard to the setting of the simulation cases, we make the total amount of public pension benefit ineach year ﬁxed across cases to eliminate the effects of different pension size on the simulation results. The total
amount of public pension beneﬁt in each year in Cases B, C, D and E is adjusted to be the same as in Case A:
In Case B the contribution rate in each year is reduced, while in Cases C, D, and E the amount of basic pension
beneﬁt in each year is increased. We consider ﬁve simulation cases (see Figure 1 for diagrams of the public
Figure 1 Diagrams of public pension system in each simulation case

Case A

Earnings-related
pensionBasic pension

Case B

Cases C, D, and E

Earnings-related
pensionBasic pension

A shadow area shows the part ﬁnanced by taxes.

Case A: Benchmark simulation, Case B: Basic pension ﬁnanced by consumption tax
Case C: No earnings-related pension, Case D: Proportional expenditure tax
Case E: Progressive expenditure tax−55−

Basic pension

Akira Okamoto and Toshihiko Shima

104

pension system in each simulation case):
1) Case A (Benchmark simulation)
The public pension schedule by Japan’s 2004 pension reform is implemented up to 2200. The general tax
revenue covers a little more than one third (i.e., 37.3%) of the basic pension in the public pension system in2008.3 From 2009 onwards it is raised to a half according to the pension plan. The rise in the basic pension by
about one sixth is assumed to be ﬁnanced by a consumption tax. The contribution rate to the public pension
scheme is the actual rate of 15.35% in employee pension plans (Kosei Nenkin) in 2008 and increases gradually
towards 2017 (see Table 1 for the contribution rate in each year). From 2017 onwards, the rate is ﬁxed at the18.30% level. The balance of the pension fund undergoes a transition until 2100 along the schedule by the 2004
reform.
2) Case B (Basic pension ﬁnanced by a consumption tax)
In Case A, from 2009 onwards the remaining half of the basic pension is ﬁnanced by a consumption tax.
Thus, from 2009 onwards the overall basic pension beneﬁt is ﬁnanced by a consumption tax.4 The earningsrelated pension remains to be ﬁnanced by contributions. We consider the substitution from contributions (whichmean a proportional labor income tax) to a consumption tax in a half of the basic pension.
3) Case C (No earnings-related pension)
In Case B, the earnings-related pension is completely abolished in 2009. From 2009 onwards, the public
pension system consists of only a basic pension ﬁnanced by a consumption tax.5 In other words, from 2009
onwards the whole public pension beneﬁt is ﬁnanced by a consumption tax and the contribution rates become
zero. A transition relief is considered for the generations that have paid contributions.

Table 1 Contribution rates in the benchmark simulation
Year
2008

Contribution rates (τtp )15.35%

2009

15.704%2010

16.058%2011

16.412%

2012

16.766%201317.12%

2014

17.474%2015

17.828%2016

18.182%2017 —

18.3%

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Welfare Analysis of Progressive Expenditure Taxation in Japan

1054) Case D (Proportional expenditure tax)
In Case C, from 2009 onward a proportional expenditure (or consumption) tax finances the overall tax
revenue. Labor income, capital income, and the inheritance of bequests are not taxed. All tax systems become
proportional, and thus there is not the income redistribution through a tax system.
5) Case E (Progressive expenditure tax)
In Case D, from 2009 onwards a progressive expenditure (or consumption) tax replaces a proportional one.
This reform enables to perform the income redistribution through a tax system.
Case B deals with the substitution from contributions (which mean a proportional labor income tax) to a
proportional consumption tax. In Case B the whole basic pension is ﬁnanced by a consumption tax. In Case C
the earnings-related pension is completely abolished, and the amount of the basic pension is increased. This
increase strengthens income redistribution effects through a public pension scheme.
Cases D and E are extreme cases to explore guidelines for public pension and tax reforms. Case D deals
with the complete shift to a proportional expenditure (or consumption) tax. Case D does not have the functionof income redistribution through a tax system. Due to perform the function of income redistribution, Case E
introduces a progressive expenditure (or consumption) tax (see Appendixes B and C for the concrete method of
the introduction of a progressive expenditure tax).
In Cases C, D, and E, the earnings-related pension system is completely abolished from 2009 onwards.
However, as a transition relief, the generations that have paid contributions until 2008 can receive the earningsrelated pension until they die. The amount of the earnings-related pension benefit is proportional to thecontributions paid. In Cases C, D, and E, the average annual income from labor for income class i born in yeart (t ≤ 1987) is(5)’
In Cases C, D, and E, equation (5)’ replaces equation (5). With regard to the weight coefﬁcient on the averageannual income from labor for each income class, θt , the values in Case B are applied for Cases C, D, and E.
3.3 Speciﬁcation of Parameters
This paper examines the implications of several public pension policies in an aging Japan. We choose
parameter values that are realistic for the economy. Parameter values are assigned with reference to empiricalresearch, such as Braun et al. (2005, 2009), Hayashi and Prescott (2002), and Nishiyama and Smetters (2005).
The parameter values used in the benchmark simulation are given in Table 2.

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Akira Okamoto and Toshihiko Shima

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Table 2 Model calibration and data sources for exogenous variables
Parameter description
Share parameter for consumption
Adjustment coefﬁcient for discounting the future

Parameter values

Data sources

φ = 0.5

Nishiyama and Smetters(2005): φ = 0.47

δ = - 0.013

Intertemporal substitution elasticity

γ = 0.3

Altig et al. (2001): γ = 0.25

Capital share in production

ε = 0.362

Hayashi and Prescott (2002)

Depreciation rate

δ k = 0.0759

Braun et al. (2005, 2009)

Parameters on a progressive labor income tax (Case A, B, and C)

α w = 0.0423,
β w = 0.1747

Parameters on a progressive expenditure tax (Case E)

β c = 0.63

Tax rate on capital income (Case A, B, and C)

τ r = 0.48

Hayashi and Prescott (2002)

Tax rate on inheritance (Case A, B, and C)

τ = 0.1

Ihori et al. (2006)h

1 Demography
Actual population data are used from 2008 to 2200 in a transitional process. With regard to population
projections until 2200, we employ the “medium variant” data from the National Institute of Population andSocial Security Research (2007). Because the data gives estimates of the future population only until 2105, thenumber of births and deaths and survival rates after 2105 until 2200 are assumed to be ﬁxed at their 2105 levels.
The percentage of the population of each age in the total population in the simulation equals the value based on
this data. Survival probabilities ( pst ) are also calculated from the data. Our model makes no distinction by sex,
and thus this study uses male–female average values.
2 Age proﬁle of labor efﬁciency
With regard to the age proﬁle of earnings ability, es, the data was obtained from Braun et al. (2005, 2009).
The labor efﬁciency proﬁle is constructed from Japanese data on employment, wages, and weekly hours from1990 to 2000 (see the data appendix in Braun et al. (2005)).
3 Government deﬁcits
The ratio of the outstanding government debt to GDP is assumed to be 107.2% in 2008 in the simulation,
making reference to the Ministry of Finance (2008). We assume that the ratio of the public debt to GDP tends
to decrease gradually from 2008 through 2200, as shown in Figure 2 (which presents the ratio until 2100). The
movement of the decrease is connected with the decrease in the ratio of pension fund to GDP.
4 Taxes and expenditures
The progressive tax system on labor income in 2008 is fixed until 2200. Tax rates on capital income and
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Welfare Analysis of Progressive Expenditure Taxation in Japaninheritance are also held constant at the 2008 levels (namely, 48% and 10%, respectively) through time.6 A
consumption tax is endogenously determined to keep certain tax revenue. Because our model does not introduce
such taxes as corporate and property ones, tax rates on consumption are likely to take higher values than actual
ones. It should be also noted that the consumption tax in our model means an indirect tax.
The ratio of the general government expenditures to national income, g, is held constant at the 2008 level (i.e.,
0.02239) through time. Thus the total government expenditure, G t , depends on the level of national income, Yt.
The ratio of outstanding government debt to GDP, Dt , is exogenously given in our simulation. Therefore, thetax rate on consumption is endogenous in our simulation.
Next, we explain the method of assigning the parameter values that determine the tax progressivity on labor
income, namely, α w and β w. Table 3 shows the data from the Ministry of Finance (2007). This table presents
the effective tax rates of wageworkers on a national income tax and a residence tax for the three income classes,with regard to a couple with two children. The parameter values on labor income are chosen so that the effective
Figure 2 Changes of the ratio of public debt to GDP
Public debt/GDP
1.4

1.2

1

0.8

0.6

0.4

0.2

Year

0
2008

2018

2028

2038

2048

2058

2068

2078

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2098

Table 3 Effective tax rates for national income tax and residence tax of wageworkers
Income class

Total amount of annual
income (million yen)

Weight on laborendowmentsLow

5x l = 0.7143

Total amount of annual taxes: national income Effective tax rates
tax and residence tax (thousand yen)
(%)
195

3.90

Medium

7

x=1

459

6.56

High

10

x h = 1.4286

1,130

11.30

Data given are for a couple with two children.
Source: Ministry of Finance (2008).

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Akira Okamoto and Toshihiko Shima108

tax rate for each income class in 2008 in Case A is close to the estimated value, and that the average tax rate onlabor income is close to the value calculated from this data (i.e., 8.11%).
Finally, we explain the method of assigning the parameter values that determine the tax progressivity on
expenditure, namely, αtc and β c, in Case E. The parameter of the part proportional to the level of consumption,

β c, is exogenously given, and thus the parameter of the constant part, αtc is endogenously determined in eachyear.

5 Public Pension System
The public pension program is assumed to be a pay-as-you-go system that is close to the current Japanesesystem. The public pension beneﬁt consists of a basic pension (i.e., a ﬂat part) and a part proportional to theincome from labor for each income class. Under the current Japanese system, the general tax revenue covers alittle more than one third of the ﬂat part, and contributions cover both the remaining two thirds and the overall
part proportional to the income from labor. The Japanese government aims to raise the ratio from 0.373 in 2008
to a half in 2009.
The ratio of the total amount of basic pension beneﬁt (F t ) to GDP (Y t ), i.e., f, is determined so that theratio in each simulation is the ratio presented in the Ministry of Health, Labor and Welfare (2008) (see Figure
3 for further details of the ratio). Thus, the ratio ( f t ) is exogenously given in each year until 2200. From 2100
onwards the ratio in 2100 is used and constant up to 2200.
In Case A, the public pension reform scheduled by Japan’s 2004 reform is executed until 2105. The ratio of
Figure 3 Changes of the ratio of basic pension to GDP

Basic pension/GDP
0.045
0.04
0.035
0.03
0.025
0.02
0.015
0.01
0.005
0
2008

Year
2018

2028

2038

2048

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2058

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2078

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109

Welfare Analysis of Progressive Expenditure Taxation in Japanthe public pension fund to GDP in 2008 is 31.6%, namely the ratio suggested by the Ministry of Health, Laborand Welfare (2008). The public pension fund will be gradually diminishing up to 2200, as shown in Figure 4(which presents the ratio until 2100).
The contribution rate, the public pension fund, and the basic pension beneﬁt per household are exogenous ineach year. Thus, the weight coefﬁcient (θ t ) on the earnings-related pension is endogenous in each year. When
the whole basic pension is ﬁnanced by a consumption tax in Case B, the contribution rate (τtp ) is exogenously
decreased. The contribution rates in Case B are reduced or the ratios of the total amount of basic pension beneﬁt

to GDP are increased in Cases C, D, and E, so that the total amount of public pension beneﬁt in each year is thesame as in Case A.
The age at which households start to receive public pension beneﬁts, ST t, is different across generations,because it has been modified by several public pension reforms in Japan. The starting age, ST t, for eachgeneration in the simulation is shown in Table 4. The compulsory retirement age, RE t, is the starting age of
Figure 4 Changes of the ratio of pension fund to GDP

Pension fund/GDP
0.4
0.35
0.3
0.25
0.2
0.15
0.1
0.05
0
2008

2018

2028

2038

2048

2058

2068

2078

2088

2098

Table 4 The starting age for receiving public pension beneﬁts
The year when the generation was born

Starting age for receiving public pension beneﬁts (STt )— 195460

1955 — 1957

61

1958 — 1959

62

1960 — 1961

63

1962 — 1965

64

1966 —

65

−61−

Year

Akira Okamoto and Toshihiko Shima

110

public pension beneﬁts, ST t, minus one.
6 Differences in Earnings Abilities
Next, we explain the method of assigning the weight given to labor endowments for the three income classes.
In our model, the three representative households, namely, low, medium, and high-income classes, have different
earnings abilities. Table 3 shows that each income class, which accounts for one third of the total population,corresponds to the representative household earning 5, 7, or 10 million yen, respectively, on an annual base. The
weight on labor endowments for each income class corresponds to the ratio of its amount of earned income. The
medium-income class is used as a yardstick, that is, x m = 1 ; x l and x h are assigned to reﬂect different earnings
abilities across the three income classes.
7 Share Parameter on Consumption in Utility
We assign the value of the share parameter on consumption in the utility function, with reference to Auerbachand Kotlikoff (1987) and Altig et al. (2001). We choose the value such that, on average, the medium-income
class devotes approximately 40% of the available time endowment (of 16 hours per day) to labor during
working years (roughly ages 21-61) in 2008 in Case A.
8 Technological Progress
The technological progress of private production plays a significant role because it greatly affects the
economic growth. Thus, careful attention should be paid to the assumption on technological progress. The
growth rate of labor augmenting technology is assumed to be zero in our simulation, reflecting Japan’s
experience for the last two decades, as in Ihori et al. (2006),

4 Simulation Results
Table 5 presents the simulation results on the initial steady state in 2008. In 2009, alternative public pension
and tax reforms are implemented in all simulation cases. The generations that are alive in the 2008 initial steadystate and continue to survive in 2009, realize in 2009 that their expectation from 2009 onwards has been wrong.
Hence, again in 2009, they maximize their remaining lifetime utility under the hypothesis of perfect foresight.
We evaluate their utility by their ex post lifetime utility at age 21.
4.1 Findings and Policy Implications
Table 6 presents the simulation results on the benchmark case and four public pension and tax reforms, whichcorresponds to Case A and Cases B, C, D, and E, respectively. This table shows variables of interest for fourtransition years─2009, 2020, 2050, and 2100─meant to illustrate short-run, medium-run, and long-run effects.
Some variables are indexed with a value of 1.000 for each year in benchmark simulation (i.e., Case A).
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Welfare Analysis of Progressive Expenditure Taxation in Japan

Case A: Benchmark simulation
In Case A, the public pension reform scheduled by the 2004 reform plan is implemented.
The ratio of the part ﬁnanced by taxes to the basic pension, μ t, is raised from 37.3% in 2008 to 50% in 2009.
The source of revenue is a consumption tax. The contribution rates gradually increase as shown in Table 1.
The public pension fund tends to gradually decrease as shown in Figure 4. In short-run, the interest rate once
increases from 2.8% in 2009 to 6.7% in 2020. However, afterwards the interest rate tends to decrease, andultimately drops to 1.7% in 2100. A possible reason for this is that we have more capital than labor, as Japanages. In the short-run, the indirect tax rate increases from 11.6% in 2009 to 12.7% in 2020. The rate increases up
to 20.6% in 2050, but it gets settled to 15.0% in the long-run.
Case B: Basic pension ﬁnanced by consumption tax
In Case B, from 2009 onwards the overall basic pension is ﬁnanced by a consumption tax. The contribution
rate in each year in Case B is reduced so that the total amount of public pension beneﬁt in each year in Case B is
the same as in Case A. Thus, we can understand that Case B deals with the substitution from contributions (whichmean a proportional labor income tax) to a proportional consumption tax. The substitution promotes capital
accumulation. Table 6 suggests that the level of capital stock increases in the conversion from Case A to B. In
the switch from Case A to B, the capital stock increases by 3.8% in 2020 and by 4.9% in 2100. The labor supply
also increases slightly by 0.9% in 2020 and by 0.3% in 2100. As a result, the national income increases by 1.9%
in 2020 and by 2.0% in 2100.
Figure 5 presents the welfare changes for each generation in switching from Case A to B. The welfare forthe generation born in from 1972 onwards is improved. In the long run it is improved by 0.8%. However,with regard to the generations born in from 1938 to 1971, the welfare is deteriorated. A possible reason for
Table 5 Simulation results in the initial steady state in 2008
Parameter description

Parameter values

Tax rate on labor income,

0.082aTax rate on consumption, τc

0.167

Ratio of part ﬁnanced by taxes to the basic pension, μ0.373 bContribution rate, τp

0.1535bInterest rate, r

0.026

Wage rate, w

1.313

Capital stock, K

6.798

Labor supply, L

0.925

National income, Y

1.903

Capital-income ratio, K/Y

3.571

Weight coefﬁcient on earnings-related pension, θ

0.1916a The tax rate is progressive, and an average rate is presented.
b The variable is exogenous.

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Akira Okamoto and Toshihiko Shima

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Table 6 Simulation results on public pension reforms
Case

2009

2020

2050

2100

A

1.000

1.000

1.000

1.000

B

1.002

1.019

1.021

1.020

C

1.052

1.124

1.114

1.146

D

1.087

1.280

1.256

1.319

E

1.020

1.190

1.196

1.246

A

1.000

1.000

1.000

1.000

B

0.996

1.038

1.050

1.049

C

1.047

1.237

1.266

1.372

D

1.070

1.630

1.576

1.788

E

1.052

1.535

1.555

1.738

A

1.000

1.000

1.000

1.000

B

1.005

1.009

1.006

1.003

C

1.055

1.064

1.037

1.035

D

1.096

1.115

1.104

1.109

E

1.002

1.029

1.031

1.031

A

1.000

1.000

1.000

1.000

B

0.997

1.010

1.016

1.017

C

1.295

1.141

1.499

1.531

D

0.991

1.147

1.137

1.189

E

1.018

1.156

1.160

1.208

A

0.028

0.067

0.015

0.017

B

0.028

0.064

0.013

0.014

C

0.028

0.054

0.004

0.002

D

0.029

0.036

0.000

0.000

E

0.024

0.035

0.000

0.000

A

0.116

0.127

0.206

0.150

Indirect tax rate

B

0.135

0.143

0.239

0.175

(Tax rate on consumption)

C

0.126

0.237

0.407

0.380

D

0.269

0.380

0.531

0.491

E

0.109

0.383

0.537

0.500

National

Income (Yt )aCapitalStock (Kt )aLabor supply (Lt )aWage rate (Wt )aInterest rate (rt )c( τt )

ab

Indexed with a value of 1.000 for each year in Case A.

Case A: Benchmark simulation, Case B: Basic pension ﬁnanced by consumption tax
Case C: No earnings-related pension, Case D: Proportional expenditure tax
Case E: Progressive expenditure taxb

The tax rate is progressive, and the rate presented is an average rate in each year.

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Welfare Analysis of Progressive Expenditure Taxation in Japan

this is that the tax rate on consumption is higher in Case B than in Case A: For example, the rate is 12.7% in
Case A and 14.3% in Case B in 2020. A change from a labor income tax to a consumption tax creates income
transfers among generations during the transition. At the onset of policy reform, the elderly who had alreadypaid their labor income tax have to pay an additional consumption tax. Because these generations suffer from adouble burden, the transition to a consumption tax is not Pareto improving. The conclusion that recommends a
consumption tax will be required to provide further justiﬁcation, that is, to suggest measures to avoid a double
burden during the transition. One of the solutions to this problem may be to consider the transfer from the future
generations that are substantially improved to the generations that suffer from a double burden, through public
debts.
Figure 6 presents the changes in the utility for each income class in switching from Case A to B. The ﬁguresuggests that the pension reform in Case B has a similar effect on the three income classes.
Case C: No earnings-related pension
In Case B the earnings-related pension is completely abolished in 2009, which produces Case C. From2009 onwards, the public pension system consists of only the basic pension ﬁnanced by a consumption tax.
In other words, from 2009 onwards the whole public pension beneﬁt is ﬁnanced by a consumption tax and thecontribution rates become zero. The amount of basic pension beneﬁt in each year in Case C is increased sothat the total amount of public pension beneﬁt in each year in Case C is the same as in Case A. An increase in
the basic pension in Case C strengthens the income redistribution effect through a public pension scheme.
A transition relief is considered for the generations that are alive in the 2008 initial steady state andFigure 5 Changes in welfare for each generation in Cases B, C, D, and E

Changes in welfare
20

Case B
Case C
Case D
Case E

15
10
5
0
1913

1933

1953

1973

1993

2013

2033

2053

2073

2093

Year of birth-5-10Case B: Basic pension ﬁnanced by consumption tax, Case C: No earnings-related pension
Case D: Proportional expenditure tax, Case E: Progressive expenditure tax−65−

Akira Okamoto and Toshihiko Shima

114

continue to survive in 2009. The generations that have paid contributions until 2008 can receive the earningsrelated pension until they die. The amount of the earnings-related pension beneﬁt is proportional to the paid
contributions. The weight coefﬁcients given on the earnings-related pension, θ t , are the same as in Case B.
This pension reform substantially stimulates capital accumulation. Table 6 shows that the level of capital stock
substantially increases in the conversion from Case A to C. In the switch from Case A to C, the capital stockincreases by 23.7% in 2020 and by 37.2% in 2100. A possible reason for this is that in Case C a consumption
tax completely replaces a contribution rate, and thus a whole pension beneﬁt is ﬁnanced by a consumption tax.
A consumption tax enhances more capital accumulation than a contribution rate (which means a labor incometax). The labor supply also increases by 6.4% in 2020 and by 3.5% in 2100. Consequently, the national income
increases by 12.4% in 2020 and by 14.6% in 2100. Therefore, the simulation results predict long-run increases
in output when the public pension system consists of only the basic pension, which is ﬁnanced by a consumption
tax.
Figure 5 presents the welfare changes for each generation in switching from Case A to C. The welfare forthe generations born in from 1978 onwards is substantially improved. In the long run it is improved by 5.6%.
However, with regard to the generations born in from 1955 to 1977, the welfare is deteriorated. Especially,
the welfare for the generations born in around 1965 is deteriorated by approximately 5%. It is certain that thewelfare of many generations is ultimately more improved in Case C than in Case B, but the welfare for the
Figure 6 Changes in utility for each income class in Case B

Changes in utility
2.5
Low income class
Medium income classHigh income class

2

1.5

1

0.5

0
1913

1933

1953

1973

1993

2013

-0.5

-1
Case B: Basic pension ﬁnanced by consumption tax

−66−

2033

2053

2073

2093

Year of birth

115

Welfare Analysis of Progressive Expenditure Taxation in Japangenerations born in around 1965 is more badly hurt in the transition process of the reform in Case C.
A possible reason for this is that the tax rate on consumption is much higher in Case C than in Case B: For
instance, the rate is 14.3% in Case B and 23.7% in Case C in 2020. A change from a labor income tax to a
consumption tax generates income transfers among generations during the transition. At the onset of policy
reform, the elderly who had already paid their labor income tax have to pay an additional consumption tax.
Thus, these generations suffer from a double burden.
Figure 5 shows that, in the switch from Case A to C, the welfare for the generations born in from 1915 to1954 is also improved. One of the reasons for this would be that this paper takes account of a transition relief for
the generations that have paid contributions.
Figure 7 presents the changes in the utility for each income class in switching from Case A to C. The
ﬁgure suggests that the pension reform has a different effect among the three income classes. The degree of
improvement of the utility is greater for the low income class, while for the high income class it is smaller.
In the long run, the utility for the low income class is improved by 8.6%, but for the high income class it isameliorated by only 1.1%. The utility for the low income class turns to be improved for the generations bornin from 1975 onwards, while that for the high income class turns to be improved for those born in from 1984
onwards. A possible reason for this is that the basic pension is substantially increased in Case C, and thus itstrengthens the income redistribution effect through a public pension scheme.
Figure 7 Changes in utility for each income class in Case C

Changes in utility
15

10

5

0
1913 1933

1953 1973 19932013 2033 2053

2073 2093

Low income class
Medium income classHigh income class-5-10
Case C: No earnings-related pension−67−

Year of birthAkira Okamoto and Toshihiko Shima

116
Case D: Proportional expenditure tax

Finally, we explore a desirable source of revenue on the integrated public pension and tax systems. In CaseC, from 2009 onward a proportional expenditure (or consumption) tax ﬁnances the overall tax revenue, whichyields Case D. Labor income, capital income, and inheritance of bequests are not taxed. All tax systems become
proportional, and thus there is not the income redistribution through a tax system.
Table 6 shows that the complete shift to a proportional expenditure (or consumption) tax substantiallyenhances both capital accumulation and labor supply, resulting in a high level of national income. In switchingfrom Case A to D, the capital stock dramatically increases by 63.0% in 2020 and by 78.8% in 2100. The labor
supply also increases by 11.5% in 2020 and by 10.9% in 2100. As a result, the national income substantially
increases by 28.0% in 2020 and by 31.9% in 2100. Therefore, when the ratio of tax revenue from consumption
to total tax revenue is high, capital accumulation is substantially promoted. The tax reform in Case D generates
favorable results with regard to efﬁciency.
Figure 5 presents the welfare changes for each generation in switching from Case A to D. The welfare
for the generations born in from 1970 onwards is higher in Case D than in Case C. However, with regard to
the generations born in from 1950 to 1975, the welfare is deteriorated compared to Case A. Especially, thegenerations born in around 1960s are badly worse off in Case D than in Case C.
Figure 8 presents the changes in the utility for each income class in switching from Case A to D. This ﬁguresuggests that, with regard to the generations born in from 1971 onwards, the utility is improved for the highFigure 8 Changes in utility for each income class in Case D

Welfare index
20

15

10

5

0
1913

Year of birth
1933

1953

1973

-5

1993

2013

2033

2053

2073

Low income class
Medium income classHigh income class-10
Case D: Proportional expenditure tax

−68−

2093

117

Welfare Analysis of Progressive Expenditure Taxation in Japan

income class more than for the low and medium income classes. Due to the absence of income redistribution
through a tax system in Case D, the low income class is relatively worse off, while the high income class isrelatively better off. Thus, the tax reform in Case D does not create favorable results with regard to equity.
Case E: Progressive expenditure tax
Because of the absence of the function of income redistribution through a tax system, Case D could
not produce favorable results with regard to equity. To solve the problem, a progressive expenditure (orconsumption) tax is introduced in Case D, which yields Case E. Case E examines the effects of the introductionof a progressive expenditure tax on efﬁciency and equity.
Table 6 shows that, with regard to efﬁciency, Case E is slightly inferior to Case D. The levels of the capitalstock, labor supply, and national income are lower in Case E than in Case D. In switching from Case A to E,
the capital stock substantially increases by 53.5% in 2020 and by 73.8% in 2100. However, the labor supply
increases by only 2.9% in 2020 and by only 3.1% in 2100. As a result, the national income increases by 19.0%
in 2020 and by 24.6% in 2100.
Figure 5 presents the welfare changes for each generation in switching from Case A to E. With regard to
the generations born in from 1972 onwards, Case E with a progressive expenditure tax attains the highest
level of welfare among all reform cases presented in this paper. In addition, in switching from Case A to E, thegenerations born in around 1960s are worse off in Case E less than in Case D in the transition process of the

Figure 9 Changes in utility for each income class in Case E

Welfare index
25
20
15
10

5
0
1913

1933

1953

1973

1993

2013

-5

2033

2053

2073

2093

Low income class
Medium income classHigh income class-10
Case E: Progressive expenditure tax−69−

Year of birthAkira Okamoto and Toshihiko Shima

118
reform.

Figure 9 presents the changes in the utility for each income class in switching from Case A to E. Thisﬁgure shows that, with regard to all generations born in from 1913 to 2100, the utility is improved for the low
income class more than for the medium income class. And, the utility is improved for the high income classless than for the medium income class with regard to all generations. This result suggests that the introductionof a progressive expenditure tax provides strong income redistribution, which enhances the welfare of thegenerations.
Therefore, the simulation results show that the introduction of a progressive expenditure tax not only may
promote economic growth substantially but also may mitigate intragenerational inequality efﬁciently, resulting
in a high economic welfare.

5 Conclusions
This paper examined guidelines for public pension and tax reforms in an aging Japan, using a dynamic lifecycle general equilibrium simulation model with different labor endowments. The paper examined the effects
of demographic change and public pension and tax policies on economic growth and welfare. It evaluatedthe benchmark case scheduled by the 2004 reform, the case in which the whole basic pension is financed
by a consumption tax, the case in which the earnings-related pension is abolished, and the case in which a
progressive expenditure tax is introduced as a source of revenue on public pension and tax systems. Whendealing with the pension reform case in which the earnings-related pension is abolished, this paper takes accountof a transition relief for the generations that have paid contributions.
The simulation results predict long-run increases in output when the public pension system consists of only
the basic pension, which is ﬁnanced by a consumption tax. This is because the substitution from contributions(which mean a proportional labor income tax) to a proportional consumption tax greatly stimulates capital
accumulation. Furthermore, the results show that the introduction of a progressive expenditure (or consumption)
tax not only may promote economic growth substantially but also may mitigate intragenerational inequality
efﬁciently.
It is certain that these reforms substantially enhance the welfare of many generations, but badly deteriorate thewelfare for the generations born in around 1960s in the transition process of the reforms. A change from a labor
income tax to a consumption tax creates income transfers among generations during the transition. At the onsetof policy reform, the elderly who had already paid their labor income tax have to pay an additional consumption
tax. Because these generations suffer from a double burden, the transition to a consumption tax is not Pareto
improving. Although the shift to a consumption tax may ultimately improve the welfare for many (especially,
future) generations, the conclusion that recommends a consumption tax will be required to provide further
justiﬁcation, that is, to suggest measures to avoid a double burden during the transition. One of the solutions tothis problem may be to consider the transfer from the future generations that are substantially better off to the−70−Welfare Analysis of Progressive Expenditure Taxation in Japan119

generations that suffer from a double burden, through public debts.
Appendix A: Utility maximization problem
The utility maximization problem over time for each income class in Section 2 is regarded as the
maximization of U t, i in equation (2) subject to equations (3) and (8). Let the Lagrange function be(A1)
where λst, i and ηst, i represent the Lagrange multiplier for equations (3) and (8), respectively.

t, iThe ﬁrst-order conditions on consumption Cst, i , leisure lst, i , and assets As+1
for s = 21, 22, ..., 95 can be

expressed by

(A2)

(A3)
(A4)
(A5)
(A6)
(A7)
The combination of equations (A2) and (A4) produces equations (9) and (10). If the initial value, V t,21i , isspecified, the value of each age, V t,s i , can be derived from equation (9). If V si is specified, the values ofconsumption, C si , and leisure, l si , at each age are obtained in the method that follows.

For S=21, 22, ..., RH i, the combination of equations (A2) and (A3) yields the following expression:

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120

Akira Okamoto and Toshihiko Shima(A8)

If the value of lst, i is given under ηst, i = 0, the value of Cst, i can be obtained using a numerical method, andthen the value of Vst, i can be derived from equation (10). The value of lst, i is chosen so that the value of Vst, it, iobtained in the simulation is the closest to that calculated by evolution from V21
through equation (9). If thevalue of lst, i chosen is unity or higher, the value of Cst, i is obtained from equation (10) under lst, i =1. If it isless than unity, the value of Cst, i is derived from equation (A8).

For s = RE t+1, RE t + 2, ..., 95, the condition of lst, i = 1 leads to the following equation:(10)’

The value of Cst, i is chosen to satisfy this equation.
Appendix B: Introduction of Progressive Expenditure Taxation
The simulation results suggest that a progressive expenditure tax is ultimately an ideal tax regime in terms of
efﬁciency 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.
Nowadays, the number and variety of ﬁnancial transactions that occur by Internet trading are progressing ona 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.
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 progressivity to thetotal 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.
Finally, the main purpose of this study is to let many academic researchers or policy makers aware of thisnew type of 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
be meaningful and effective. Even in the case of implementing structural reform along the lines of the current−72−

Welfare Analysis of Progressive Expenditure Taxation in Japan

121

Japanese tax system, knowledge of this new type of tax schedule will prove to be useful.
Appendix C: How Can Progressive Expenditure Taxation Be Implemented?
The simulation results in this paper quantitatively suggest that a progressive expenditure tax substantiallystimulates capital accumulation, and efﬁciently reduces within-cohort income inequality. We present the concretemeasures of carrying out progressive expenditure taxation. Conceptually, it is easy to introduce progressive
expenditure taxation. The feasibility of implementing progressive expenditure taxation, however, contains aserious problem in the real world: that is to measure and grasp the ﬁgures of each individual’s expenditure. For
its implementation, it is necessary to grasp the total amount of annual expenditure for each household. Thisimplies that a tax authority has to grasp the whole picture of consumption activities of each individual in detail.
How can we measure a tax base that is deﬁned by expenditure? We propose that it is feasible to measure it withthe method that follows.
There is a relation that states income is equal to consumption (or expenditure) plus savings. If the amountsof both 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 the
self-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(or a 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.
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.

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Akira Okamoto and Toshihiko Shima

122

Notes
1 Altig et al. (2001) dealt with differences of lifetime earnings ability by incorporating 12 lifetime-income
groups into a life-cycle model. Furthermore, Okamoto (2005b) introduced numerous representative
households with continuous income distribution in each cohort. On the other hand, Uemura (2001) and Ihori
et al. (2006) analyze using a life-cycle model with a single representative household.
2 See Seidman (1997) and Okamoto (2004, 2005a) for the details of a progressive expenditure (orconsumption) tax. Kaldor (1955) claims that the implicit taxation of individuals with vast inherited wealth via
an expenditure tax is a ﬁnal goal.
3 Okamoto and Tachibanaki (2002) also included the ﬂat basic pension in the public pension program. In thatstudy, general tax revenue covered one third of the basic pension in the benchmark simulation, and the rateof tax transfer was raised from one third to a half (i.e., there is a rise in the basic pension by one sixth). That
study examined the effects of an increase in the tax transfer on efﬁciency and equity.
4 With regard to simulation cases except for the benchmark, strictly speaking, the total amount of basic pension
or that of public pension is not ﬁnanced completely by a consumption tax. This is because there exists the part
originally covered by the general tax revenue, namely, a little more than one third of basic pension currently
ﬁnanced by general taxes. However, we can interpret that, in those cases, this part of basic pension is ﬁnanced
not by the general tax revenue but by a consumption tax. Therefore, we can regard that the whole basic
pension or the overall public pension is ﬁnanced by a consumption tax in those cases.
5 According to Okamoto (2010), which analyzes in the steady state, if we consider a public pension programwith the same scale as the current Japanese program, the highest level of social welfare is attained whena public pension system consists of only a basic pension and is ﬁnanced by a consumption tax. Thus, weconsider the case in which the overall public pension consists of only a basic pension and is ﬁnanced by aconsumption tax, namely, Case C.
6 The tax rate on capital income is assigned the same value as in Braun et al. (2005, 2009). The tax rate on
bequests is assigned making reference to Ihori et al. (2006).

Acknowledgements
An earlier version of this paper was presented at the 64th Congress of the International Institute of Public
Finance (IIPF) in the Netherlands in August 2008, and at the 2008 Annual Meeting of the Japan Fiscal Science
Association (Nihon Zaisei Gakkai) in Kyoto in October. The authors are grateful for insightful comments andsuggestions by Professors Pietro Rizza (Banca d’Italia), Toshihiro Ihori (University of Tokyo), and specially
Tomoyuki Nakajima (Kyoto University). The authors also thank Professor R. Anton Braun (University ofTokyo) for his kind permission to use the data in Braun et al. (2005). The ﬁrst author also acknowledges theﬁnancial support from the Ministry of Education, Culture, Sports, Science and Technology in Japan (Grant-in-Aid−74−

Welfare Analysis of Progressive Expenditure Taxation in Japan123

for Scientiﬁc Research (C) No.19530276).
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