Asian Economic and Financial Review

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1 Asian Economic and Financial Review, 203, 3(4):490-5 Asian Economic and Financial Review ournal homepage: hp://aessweb.com/ournal-deail.php?id=5002 CHILD BENEFITS AND WELFARE FOR CURRENT AND FUTURE GENERATIONS: SIMULATION ANALYSES IN AN OVERLAPPING- GENERATIONS MODEL WITH ENDOGENOUS FERTILITY Kazumasa Oguro Associae Professor, Insiue of Economic Research Hiosubashi Universiy, Japan Manabu Shimasawa Senior Researcher, Naional Insiue for Research Advancemen, Japan Junichiro Takahaa Assisan Professor, Dokkyo Universiy, Japan ABSTRACT We consruced an overlapping-generaions model wih endogenous feriliy o analyze he effecs of child benefis and pensions on he welfare of curren and fuure generaions. The following resuls were obained. Firs, in he case wihou pension and acceleraed fiscal reforms, he bes policy o improve he welfare of fuure generaions is o finance he provision of child benefis by capial axaion, followed by issuing governmen deb, consumpion axaion (VAT), and wage axaion, in ha order. Second, deb reducion coupled wih increasing child benefis is preferable o deb reducion alone o reduce public deb for fuure generaions. In paricular, coupling increased child benefis and fiscal reform simulaneously sands ou as he mos desirable opion. Third, from he viewpoin of pension reform, mainaining pension benefis by increasing VAT is beer han cuing benefis coupled wih increasing child benefis for fuure generaions. Keywords: Overlapping-generaions model; child benefi; endogenous feriliy; heorem of zero capial ax 490

2 Asian Economic and Financial Review, 203, 3(4):490-5 INTRODUCTION This paper aims o analyze he effec of child benefis and pensions on he welfare of curren and fuure generaions, by consrucing an overlapping-generaions (OLG) model wih endogenous feriliy. The decline in feriliy rae is a maor concern for he Japanese economy. The reason for his is ha an economy wih a low birh rae and an aging populaion has creaed serious problems in erms of he susainabiliy of fiscal and social securiy sysems, including public pension. In order o mainain susainabiliy, we have several policy choices. The firs is o promoe fiscal reform, e.g., increase consumpion ax. The second is o carry ou social securiy reform, e.g., decrease public pension benefis. The hird is o revise he populaion rends, e.g., increase feriliy rae by expanding child benefis. The Japanese governmen has aemped o work wih he firs and he second policies. However, due o conflicing ineress beween younger and older generaions, obaining an agreemen on he reform by boh generaions is ofen oo difficul for he governmen o achieve. Therefore, he governmen is rying o promoe child benefis expansion as he hird policy. Consequenly, we should consider how o finance child benefis expansion. In general, he financial resource selecion o provide child benefis deermines he ype of welfare effecs on curren and fuure generaions. A his poin, key research resuls on he OLG models wih exogenous versus endogenous feriliy should be compared. For he sandard OLG model represened by Diamond (965) and ohers, i is well esablished ha consumpion axaion (VAT) is he mos effecive mehod o raise financial resources for he welfare of fuure generaions, followed by wage axaion and capial axaion, he second and hird mehods of choice, respecively, given he fuure pah of governmen expendiure. This can be explained as follows. The firs benchmark is he heorem of zero axaion of capial income, derived from (Akinson and Sigliz, 972) he orem of opimal ax. The heorem is bes undersood by considering he OLG model wih wo generaions, working and reired, living concurrenly. A he firs period (working period), each generaion earns wage income by providing labor force, consumes a par of ha income, and saves he remainder. A he second period (reired period), he reired generaion consumes he principal and he ineres derived from ha saving. In his seing, Akinson and Sigliz (976) have proved ha he case in which he consumpion ax of he firs period is differen from ha of he second period is no opimal. In addiion, since hese respecive differing consumpion axes have he axaion propery for he ineres on he savings consumed in In our paper, child benefis cover he oal cos of child rearing and child care, bu we do no disinguish beween benefis in cash (e.g., child benefi) and benefis in kind (e.g., subsidies for using nursery and forreceiving high educaion). Therefore, he analyses in his paper do no esablish ha benefis in cash are more effecive han benefis in kind. 49

3 Asian Economic and Financial Review, 203, 3(4):490-5 he reired period, his heorem suggess ha zero axaion of capial income is opimal; i holds in he OLG model wih muli-concurren generaions and exogenous feriliy 2. Similarly, Chamley (986) and Judd (985) also indicae ha zero axaion of capial income in he OLG model wih exogenous feriliy and aking over inheriance among generaions is mos effecive in he long erm. Moreover, on he seady sae, he equaion ( wage ax rae) ( + consumpion ax rae) = holds and consumpion axaion becomes equivalen o wage axaion wih no borrowing consrain and no change in governmen policies. Because of his, a swich in governmen policies from wage-based o consumpion-based axaion, if implemened a a ax rae equivalen o ha described previously, may have no influence on he generaion immediaely afer he policy change, bu he effec during he ransiion period may differ. Taxaion on he reired generaion s consumpion in he early sage of he ransiion period presens less disorion as i works like a lump-sum ax. In oher words, considering ineremporal governmen budge consrains wih he zero-sum feaure of inergeneraional income ransfer, his policy would resul in a ransfer of income from he reired generaion o he working and fuure generaions. An increase in he public deb ends o insigae he crowding-ou effec, which may lead o a resrained accumulaion of capial and a decrease in fuure economic growh. In he same manner, according o Haa and Oguchi (999), among ohers, he pay-as-you-go public pension also carries an implici deb of approximaely 50% of GDP and may inhibi fuure growh. Alhough public pensions ransfer income from he working and fuure generaions o he reired generaion, implemenaion of he above-menioned policies would have he opposie effec, ransferring he income from he reired generaion o he working and fuure generaions, resuling in an increase in capial accumulaion and enhanced fuure growh. From his we can infer ha, in he sandard OLG model wih exogenous feriliy and given he fuure pah of governmen expendiure, consumpion axaion (VAT) would mos ofen be he opimal source of funding for expendiure, followed by wage axaion and capial income axaion, in ha order. However, as he assumpions in he OLG model wih exogenous feriliy are realisically modified, he conclusions drawn such as he heorem of zero axaion of capial income begin o differ. For example, Cremer and Gahvari (995) indicaed ha if he wage income in he second (reired) period is uncerain, i is desirable ha he axaion imposed on he second-period consumpion is higher han ha of he firs (working) period. This means ha capial income axaion is desirable. Similarly, Conesa e al. (2007) sugges ha, when life expecancy and wage income are uncerain, a capial income ax is desirable. Saez (2002) adds ha zero capial axaion is no always opimal, as he desirable savings rae differs wih varying levels of individual skill. Moreover, Weinzierl 2 The reader should remember ha Akinson and Sigliz s (976) parial equilibrium analysis grealy influences he opimal ax rule,while considering he OLG model wih exogenous feriliy based on he evaluaion crieria of he growh process known as he golden rule. 492

4 Asian Economic and Financial Review, 203, 3(4):490-5 (2007) shows ha, when wage income varies wih age and here are heerogeneous demographics, a 5% ax would increase social welfare more han he zero-axaion scenario. In addiion, Hubbard and Judd (986) found ha, when he capial marke is incomplee and here are borrowing consrains, he implemenaion of capial axaion can be usified. As described above, modificaions by Akinson and Sigliz (976) sugges ha here are various usificaions for he implemenaion of capial axaion. However, hese are based on he OLG model wih exogenous feriliy; research on he usificaion of capial axaion, assuming he OLG model wih endogenous feriliy, remains insufficien. Our resuls show ha he child-rearing cos is he key parameer in he OLG model wih endogenous feriliy. For example, zero capial axaion may no longer be considered opimal if he child-rearing cos is an increasing funcion of lifeime income. This can be explained as follows. Firs, zero capial axaion is desirable in he sandard OLG model wih exogenous feriliy; however, in comparison o nonzero capial axaion, boh lifeime income and child-rearing coss increase for fuure generaions. If he posiive effec of increased lifeime wages is overshadowed by a larger negaive effec of increased child-rearing coss, he relaive value of lifeime wages for child-rearing coss decreases due o he lifeime budge consrains of each generaion. In such a case, alhough he implemenaion of capial income axaion is in fac usified, research based on he OLG model wih endogenous feriliy is no being pursued. On he basis of he findings of Oguro e al. (2009), we consruc an OLG model wih muliconcurren generaions and endogenous feriliy, assuming consumpion, wage, capial, and oher axaions as poenial funding sources for increased child benefis, o analyze he effec on he welfare of each generaion. We hen analyze he effec on he welfare of each generaion from he perspecive of fuure social securiy reforms in wo hypoheical cases: reducing pension benefis and using consumpion ax o parially fund pension benefis. According o our simulaion resuls, he welfare for he fuure generaion in he case wih child benefis expansion funded by capial income ax is greaer han in he case wih child benefis expansion funded by consumpion ax. This indicaes ha zero axaion of capial income in he OLG model wih endogenous feriliy is no he mos effecive in he long erm. Our research is organized as follows. In Secion 2, we explain he OLG model wih muli-concurren generaions and endogenous feriliy used in his paper. In Secion 3, we describe he daa, as well as he calibraion and simulaion scenarios used in our research. In Secion 4, we evaluae he simulaion resuls. Finally, in Secion 5, we summarize our resuls and sugges opics for fuure discussion. The Model Srucure In his secion, we describe he demographic and economic srucure of our model. The model used here is a compuable general-equilibrium OLG model wih perfec foresigh agens, muliple periods, and endogenous feriliy. In our model, here is a represenaive individual for each generaion in he household secor. Each individual a age 20 maximizes his/her ineremporal 493

5 Asian Economic and Financial Review, 203, 3(4):490-5 uiliy funcion wih consumpion and he number of children. The represenaive compeiive firm has a sandard Cobb Douglas producion echnology and maximizes is profis. In our model, no only he goods marke bu also facor markes are perfecly compeiive. The model has five main building blocks: () household behavior, (2) firm behavior, (3) he public pension, (4) he governmen, and (5) marke equilibrium. Deails of each block follow. Household Behavior There is a represenaive individual for each generaion in he household secor. We assume ha preference forms are he same for all agens in all generaions. Moreover, each individual lives for a fixed number of periods. In each period of he model, he oldes generaion dies and a new one eners. Furher, he represenaive individuals maximize heir ineremporal uiliy funcion wih consumpion and he number of children subec o heir lifeime income. They are also assumed o be raional and wih perfec foresigh. Each generaion eners he labor marke a age 2, bears and brings up heir children a ages 2 o M + 20, reires a age Q, is graned a pension a Q, and dies a age Z. In addiion, each supplies labor inelasically, and he uiliy funcions of he -h generaion born in year are specified as: U n ( ) Z 20 where refers o he weigh beween number of children and consumpion, c, parameer of number of children, he -h period of life, () he preference he pure rae of ime preference, and he reverse of he elasiciy of ineremporal subsiuion of consumpion. The argumens of he uiliy funcion are he number of children ( n ) and he consumpion per period ( c, ). In addiion, we assume ha he number of children ( period of life is he following: n, ) whom he -h generaion bears a he -h n, p n ( where p 0 ( if M 20) and p 0 ( if M 20)), (2) where p refers o he possibiliy ha each generaion bears he children a he -h period of life and his parameer is assumed o be exogenous. Moreover, he echnological progress is assumed o be exogenous and labor embodied. We model age-specific labor produciviy by assuming a hump-shaped age-earnings profile, ha is, a quadraic form of is age, so is age-wage profile e akes he following form: e, 0 and , 2 (3) The ineremporal budge equaion of each generaion is described as follows: 494

6 Asian Economic and Financial Review, 203, 3(4):490-5 M 20 ( c ) 20 g g 20 g ( g 20 RN ) n k k 20, Z 20 ( c 20 ) c, RN k k 20 NW 20 Q 2( w 20 w 20) w 20( ) e Z 20 ( p 20) 20 Q 20 RN RN k k 20 k k 20 q,(4) where / RN refers o he facor of he presen discouned value derived from he gross ineres rae afer ax RN ) ( r r, he rae of reurnr, and he capial ax r in year, and g is he child-rearing cos a he g-h period of life; is he governmen subsidy in year ; c is he consumpion ax rae in year ; premium rae in year ; w is he labor income ax rae in year ; w is he public pension NW is he ne lifeime income of generaion ; w is he wage rae in year ; p is he ax for pension benefi in year ; and q sands for he pension benefi in year. 3 In addiion, he child-rearing cos is assumed o be proporional o ne lifeime income; ha is, g NW /( c ), where g is he consan parameer and c he average rae of g consumpion ax imposed on he -h generaion. Each generaion maximizes is uiliy funcion () under he budge consrain (4). When, he maximizaion procedure differeniaing he household uiliy funcion (2) 2 wih respec o n and, subec o he individual s lifeime budge consrain (4), yields he c, following equaions concerning consumpion per period and number of children. ( ) c,, ( c ) 20 k RN k 20 / n ( ) p, (5) M g g 20 ( c 20) g g k RN k 20 / and / M 20 ( c ) / 20 g ( 20 g g k g 20 RN ) p k 20 / Z 20 ( / ( k ) / c RN 20 k ) 20 / NW 3 In Japan, here are some indirec axes (e.g., alcohol and obacco ax) oher han consumpion ax. We calculaehe indirec ax rae from he oal amoun of indirec ax revenue in he naional accoun. The rae is abou 2%. 5% is he consumpion ax rae and 7% he oher indirec ax rae. Therefore, he effec of he oher indirec ax rae is also considered in our simulaion. However, in he simulaion, we focus on he effec of increased consumpion ax. Hence, we le he consumpion ax only in our paper. c represen 495

7 Asian Economic and Financial Review, 203, 3(4):490-5 If he parameer is sable, hese equaions dicae he following wo relaionships: () as in any life-cycle model, he rade-off beween curren and fuure consumpion is deermined by he raio of he ineres rae and he ime preference rae, and by he degree of risk aversion, and (2) he number of children declines when he child-rearing cos increases or he governmen subsidy decreases. Moreover, from hese equaions, he following forms can be shown: Z 20 C N c, N N n (6) 20, M 20 20, wherec is he aggregaed consumpion in year and N indicaes he ordinal number of he generaion born in year. In addiion, we can also derive he following physical wealh accumulaion equaion: a, a, ( r ( ) 20) R ( ) 20 ( w 20 w 20) w, ( c 20) c, 20 ) g g ( 20) ( c n, and PA N a (7), g Z 20 20, where a, is he physical wealh asse of generaion a he -h period of life and PA is he aggregaed privae asse in year. Firm Behavior The inpu/oupu srucure is represened by he Cobb Douglas producion funcion wih consan reurn o scale. The firm decides he demand for physical capial and effecive labor in order o maximize is profi wih he given facor prices of wage and ren, which are deermined in he perfec compeiive markes. Y AK L, L ( e N (8) K I e, ( ) K Q 20 e, ) 20 wherey is he oupu, sands for capial income share, A is a scale parameer, K is he physical capial sock, and L e, is he effecive labor. We can derive wo facor prices, he rae of reurn r and he wage rae per uni of effecive labor w, by he firs-order condiions for he firm s maximum profi: R r AK Le, ( ), w ( ) AK Le, (0) (9) where is he depreciaion of physical capial. The Public Pension The pension secor grans a pension o he reiring generaions while a pension premium is colleced from he working generaions. P w w L, () e 496

8 Asian Economic and Financial Review, 203, 3(4):490-5 where P sands for he aggregaed pension premium. The aggregaed pension benefis in year is given by he produc of he reiremen-age populaion, he replacemen rae, and he average earnings of each generaion during he working period W. Z Q 9 20 Z 20 B q N W N (2) Q where denoes he replacemen raeand B he aggregaed pension benefi. We explicily model he public pension sysem as a pay-as-you-go scheme. The budge consrain of he pension secor can be shown as follows: P ( sp) (3) B where sp denoes he public subsidy o he pension scheme, financed by governmen expendiure G. Moreover, we assume ha he public pension secor mainains a fixed replacemen rae exogenously. As a resul, in our model, he pension premium rae is endogenously deermined in order o keep he budge consrain (3). The Governmen The governmen secor imposes four ypes of axes: he wage ax, he consumpion ax, he capial ax, and he pension benefi ax. T w w Le, c C c CH r R We keep all ax raes consan. The role of he governmen is o endogenously deermine he rae of he public deb issue as a residual of governmen expendiure and revenue. D G T ( r ) D whereg sands for governmen expendiure in year, T denoes ax revenue in year, and denoes public deb in year. PA p B (4) (5) D Marke Equilibrium Finally, in our closed-economy model, we require a financial marke equilibrium, in which he aggregae value of asses equals he marke value of capial socks plus he value of ousanding governmen bonds: PA K D (6) Daa, Calibraion, and Scenarios In his secion, we describe he ouline of he daa and he parameers of our model, and explain he scenarios of our simulaion. 497

9 Asian Economic and Financial Review, 203, 3(4):490-5 Daa and Calibraion Firs, we presen he values of he main parameers and exogenous variables of he model in Table. The parameer values for he households and firms behaviors are derived from Auerbach and Kolikoff (987) and various early OLG simulaion sudies in Japan. 4 These parameers, such as he echnological and preference parameers excep he weigh parameer, are assumed o be consan. The exogenous variables, such as he macroeconomic, fiscal, and public pension variables, are derived mainly from OECD (2007) and Whiehouse (2007).In addiion, he childbearing possibiliy parameer is derived from he age-specific feriliy rae daa provided by he Naional Insiue of Populaion and Social Securiy Research (2007), and he parameer values of he child-rearing cos and he governmen subsidy are derived from he special research repor on he social cos of rearing children, provided by he Direcor-General for Policies on a Cohesive Sociey, Cabine Office, Japan (2005). Second, by conrolling he weigh parameers during he years , we calibrae our demographic proecion o fi he daa s rend in Populaion by Age (generaion born in ), provided by he Saisics Bureau, Minisry of Inernal Affairs and Communicaions (MIAC), wih he collaboraion of oher minisries and agencies in Japan 5. Fig. repors he acual and compued values of demographic proecions. Noe he close correspondence beween he acual and calculaed values. In addiion, since he model is simulaed over 500 periods from 2007, he base year of our simulaion, we ensure a sufficienly long period for a seady sae o be achieved. In he simulaion, we also keep he ousanding governmen deb o GDP a he same level afer 2035, by conrolling consumpion ax. Table 2 repors he acual values of some key variables in 2007 and he compued values in he model. Furher, i is observed ha he acual values closely correspond o he calculaed values. Scenarios Nex, we presen he simulaion scenarios. The scenarios are classified ino nine caegories (See Table 3). Japan s governmen recenly announced ha he rae of consumpion ax will increase o 0% by he mid-200s. In addiion, Inernaional Moneary Fund (20) has suggesed ha he Japanese governmen should begin a gradual increase in consumpion ax from 5% o 5% over several years, in order o mainain fiscal susainabiliy. Therefore, Scenario assumes he baseline case wih no expansion of child benefis, no reducion of public pension, and consumpion ax 4 See Sadahiro and Shimasawa (200, 2003), Uemura (2002), and Ihori e al. (2006). 5 On he calibraion wih he demographic proecion, we also conrol he weigh parameer in equaion () during he years Concreely, we adap he following operaion. Le N * denoe he populaion of he generaion born in year, provided by MIAC, and N, he populaion of he generaion born in year in equaion (6). The parameer in he uiliy of he generaion born in year increases (decreases), if N +Δ<N * +Δ( N +Δ>N * +Δ, e.g., Δ=25). In addiion, he parameer is fixed afer year

10 Asian Economic and Financial Review, 203, 3(4):490-5 reform (an increase in consumpion ax o 0% from 205 o 2024 and o 5% from 2025 o 2034).Scenarios 2 o 5 assume 00% increase in child benefi afer 205. Then, he addiional financial resource in Scenario 2 is covered by he increase in consumpion ax, in Scenario 3 by he increase in wage ax, in Scenario 4 by he increase in capial ax, and in Scenario 5 by he increase in governmen bond revenue. On he oher hand, Scenarios 6 and 7 are hose of he public pension reform. Scenario 6 assumes 50% reducion of he aggregaed pension premium by increasing he consumpion ax afer 205. Scenario 7 assumes 0% reducion of he public pension benefi and 00% increase in child benefi afer 205.Finally, Scenarios 8 and 9 are hose of he acceleraed fiscal reform. Scenario 8 assumes no expansion of child benefis bu an increase in consumpion ax o 5% (consumpion ax reform) from 205. Scenario 9 is he policy mix of Scenario 2 (permanen expansion) and Scenario 8. SIMULATION RESULTS In his secion, we will describe he simulaion resuls repored in Table 4 and Figs. 2 o 6. Demographic Proecion and Macroeconomic Variables Firs, we describe he demographic proecion. Fig. 2 shows he populaion proecion of fuure generaions born in he period The proecion in Scenario closely corresponds o he official esimaion provided by henaional Insiue of Populaion and Social Securiy Research (2008). In conras o Scenario, Scenarios 2 o 5 (00% permanen child benefis increases) and 9 (acceleraed fiscal reform and 00% permanen child benefis increase) depic a populaion increase in he generaion born afer 205. On he oher hand, Scenarios 6 (50% reducion of he aggregaed pension premium by increasing consumpion ax), 7 (0% reducion of he public pension benefi and 00% permanen child benefis increase), and 8 (acceleraed fiscal reform) show a populaion decrease in he generaion born afer 205. In Scenario 5 (child benefis expansion financed by governmen deb), he populaion of he generaion born in 2030 is he highes, increasing by 26,000.The populaion under Scenario 3 (child benefis financed by increasing wage ax) shows an increase of 77,000; followed by he populaion under Scenario 2 (consumpion-ax-funded child benefis) wih an increase of 73,000; he populaion under Scenario 4 (capial-ax-funded child benefis) wih an increase of 69,000; and, finally, he populaion under Scenario 9 (acceleraed fiscal reform and 00% permanen child benefis increase) wih an increase of 05,000. Scenario 6 (half of he pension premium covered by consumpion ax) demonsraes a decrease of 9,000; Scenario 7 (0% reducion of he public pension benefi and 00% permanen child benefis increase), a decrease of 47,000; and Scenario 8 (only acceleraed fiscal reform), a decrease of 30,

11 Asian Economic and Financial Review, 203, 3(4):490-5 Fig. 4 shows he oal feriliy rae (TFR) from 995 o The proecions in Scenario closely correspond o he official esimaion provided by he Naional Insiue of Populaion and Social Securiy Research (2007). Fig. 2 shows a TFR proecion for all scenarios. For example, Scenario 5 shows he highes TFR wih.55, followed by Scenario 3 wih.48, in 2030.Fig. 3 shows a proecion of he reired populaion raio from 200 o The proecion in Scenario closely corresponds o he official esimaion provided by he Naional Insiue of Populaion and Social Securiy Research (2007). In comparison o Scenario, he 2030 reired populaion raio in Scenarios 2 o 5, wih permanen child benefi increases, decreases beween 0.33% of a poin and 0.42% of a poin. Similarly, he raio in Scenario 9 decreases by 0.22% of a poin, no a highly significan difference. Furher, he 2050 reired populaion raio in Scenarios 2 o 5, wih permanen child benefi increases, decreases beween 2.5% of a poin and 2.0% of a poin, compared o he oher scenarios. Regardless of he long-erm improvemens, in he shor erm, i seems unlikely ha he reired populaion rae will decrease o any significan degree in response o child-rearing benefis. Nex, we simply explain he proecion from a macroeconomic perspecive. As our model employs a life-cycle hypohesis, he savings rae is highly influenced by he aging populaion. Looking a he ransiion of macroeconomic variables shown in Table 4, all scenarios show a decrease in he savings rae beween 200 and 2050, compared o he 2007 rae of 4.72%. However, in comparison o Scenario, Scenarios 2 (child benefis expansion financed by consumpion ax, and permanen child benefis increases), 4 (funded by capial income ax), 5 (funded by governmen deb), and 6 (50% reducion of he aggregaed pension premium by increasing consumpion ax) show a rise in he savings rae in Furher, Scenarios 2 o 9 show a rise in he savings rae in 2050, as compared o Scenario.Finally, he facor price shows a sable ransiion in all scenarios, flucuaing beween he ineres raes of 2.43% (wage rae) and 3.99% (93.38% o 0.37%). In general, increased child benefis lead o more birhs, creaing a greaer workforce. However, an expanded workforce will lower he capial-labor raio, possibly increasing he ineres rae while simulaneously resraining he wage rae. Table 4 shows Scenarios 2 o 5 (permanen child benefis increases) reflecing a lower capial-labor raio for 2030 han ha of Scenario, along wih lower GDP and GDP per employee. On he oher hand, pension and fiscal reforms, as implemened in Scenarios 6 hrough 9, resul in a higher capial-labor raio, GDP, and GDP per employee. Fiscal Variables A pension sysem reform reducing benefis by 0% or acceleraed fiscal reform o increase consumpion axaion o 5% from 205 will sabilize he fuure fiscal balance and he value of ousanding governmen bonds o GDP. Given he above, he proecions in Table 4 and Fig. 5 ogeher yield ha in comparison o Scenario, deb per employee in 2030 improves in Scenario 7 (pension benefis cu by 0% and child benefis expansion) and in Scenarios 8 and 9 (acceleraed fiscal reform). In urn, as Table 4 indicaes, he ousanding governmen deb o GDP in

12 Asian Economic and Financial Review, 203, 3(4):490-5 shows more improvemen in Scenarios 7 o 9 han in Scenario. In paricular, he public deb-o- GDP raio afer 2035 is proeced a roughly 3% in Scenario, 28% in Scenario 7, 26% in Scenario 8, and 272% in Scenario 9.On he oher hand, Scenarios 2 (child benefis expansion financed by increase in consumpion ax), 3 (increase in wage ax), 4 (increase in capial income ax), and 5 (child benefis expansion financed by governmen deb) are worse in erms of deb per employee in comparison o Scenario ; Scenarios 2 o 4 show increased ineres due o he lower capial-labor raio and Scenario 5 shows increased public deb due o he lower capial-labor raio and he issue of governmen bonds o fund child benefis. Therefore, he public deb-o-gdp raio afer 2035 is proeced a roughly 327% in Scenarios 2, 320% in Scenario 3, 335% in Scenario 4, and 372% in Scenario 5.The ax changes in Table 4 also show ha he funding required for increased child benefis ranges from 2.2% o 3.44% in Scenario 2 (consumpion ax funding), 2.40% o 3.2% in Scenario 3 (wage ax funding), and 5.36% o 7.65% in Scenario 4 (capial income ax funding). Welfare Finally, we describe he welfare esimaion for each generaion (welfare wih equivalen variaion). Fig. 6 shows he welfare in Scenarios o 9 wih welfare of he generaion born in 930 sandardized as. As he birhrae dwindles and he aging populaion grows, he pay-as-you-go pension premium increases. In addiion, an increased governmen-issued deb o GDP inhibis invesmen of privae asses in producion and lowers fuure economic growh. As a resul, he welfare of he working and fuure generaions decreases in comparison o ha of he generaion born in 930.However, all scenarios (excep Scenarios and 6) have a downward convex shape, wih he lowes welfare occurring in 2020 for Scenarios 2 o 4, in 205 for Scenario 5, in 2065 for Scenario 7, in 2060 for Scenario 8, and in 2025 for Scenario 9. This basically suggess ha he negaive effec of he declining birhrae and he aging populaion is miigaed by expanding he child benefis ha increases he birhrae, or public pension and acceleraed fiscal reforms ha decrease he pension premium and public deb o GDP. We can also see ha in comparison o Scenario, he welfare of he generaions born afer 975, 990, or 995 improves in Scenarios 6 o 9, while he welfare of he generaions born afer 2020 or 2025 improves in Scenarios 2 o 5. The reason for his is as follows. Generally, child benefis expansion reduces he relaive price of he number of children o consumpion for each generaion and increases he number of dependens (i.e., children). Then, in Scenarios 2 o 5, he oal cos of child-rearing rises for he working generaion in he early sage of child benefis expansion. Therefore, he welfare of he generaion becomes lower han ha in Scenarios, 6, and 8. Scenarios 7 and 9 also have he negaive effec of child benefis expansion. However, hese scenarios include he effec of public pension and acceleraed fiscal reforms. For his reason, he welfare of he generaion born in he period 995 o 2020 is higher in Scenarios 7 and 9, as compared o in Scenarios 2 o 5. This indicaes ha he posiive effec of public pension and acceleraed fiscal reforms is much larger han he negaive 50

13 Asian Economic and Financial Review, 203, 3(4):490-5 effec of child-rearing cos on he welfare of he generaion. In addiion, among Scenarios 2 o 5, he welfare of he generaions born in he period 955 o 980 is lowes in Scenario 2 (child benefis expansion financed by consumpion ax). An addiional ax on he reired generaion s consumpion in he early sage afer he child benefis expansion of Scenario 2 presens less disorion as i works as a lump-sum ax. This indicaes ha child benefis expansion funded by consumpion ax resuls in an inergeneraional income ransfer from he reired o he younger generaion. On he oher hand, he welfare for he generaion born in 2075 is he highes in Scenario 9 (acceleraed fiscal reform and child benefis expansion). The nex highes figure is for Scenario 4 (child benefis expansion financed by capial income ax), followed by Scenario 5 (financed by governmen deb), Scenario 2 (financed by consumpion ax), and Scenario 3 (financed by wage ax), in ha order. All hese scenarios have child benefis expansion. The sixh highes figure is ha for Scenario 6 (mainains half of he pension premium hrough VAT), followed by Scenario 7 (pension benefis cu by 0% and child benefis expansion), Scenario 8 (acceleraed fiscal reform), and, finally, Scenario, ranking ninh (baseline). All hese scenarios (excep Scenario 7) do no have child benefis expansion. Generally, public pension and acceleraed fiscal reforms have he pressure of rising capial-labor raio in he long period. In our model, while increased capial-labor raio improves lifeime wage, i also increases child-rearing cos. Then, if he posiive effec of improved lifeime wage is overshadowed by he negaive effec of increased child-rearing cos, he welfare of fuure generaions does no improve. The above order of he welfare for he generaion born in 2075 indicaes his mechanism, excep for in Scenario 9. On he oher hand, child benefis expansion leads o more birhs, creaing a greaer workforce, and has he pressure of reducing capial-labor raio in he long run. This miigaes he negaive effec of increased child-rearing cos. In addiion, in our model, each generaion obains he welfare gain from more birhs. Therefore, he welfare for he generaion born in 2075 is higher in Scenarios 2 o 5 and 9, as compared o in oher scenarios 6.Placing he highes imporance on he welfare of fuure generaions, Scenario 9 (acceleraed fiscal reform and child benefis expansion) sands ou as he mos desirable opion. Conclusion and Fuure Issues In his paper, we presened an OLG model wih muli-concurren generaions and endogenous feriliy o analyze he effecs of increased child benefis and reduced pension benefis on he welfare of he working and fuure generaions. The following resuls were obained hrough he analysis. Firs, we considered increased child benefis wihou pension and acceleraed fiscal 6 In Scenario 7, he effec of public pension reform on capial-labor raio is greaer han he effec of child benefis expansion on he same. Therefore, he welfare for he generaion born in 2075 is lower in his scenario, as compared o in Scenarios 2 o 5 and

14 Asian Economic and Financial Review, 203, 3(4):490-5 reforms. Among Scenarios 2 o 5, he welfare of fuure generaions improved mos hrough child benefis funded by capial income ax. This indicaes ha he bes policy is o cover child benefis via capial income axaion, followed by governmen bonds, VAT, and wage axaion, in ha order. We also looked a he exising mehod of acceleraed fiscal reform. In his case, raher han fiscal reform alone, coupling increased child benefis and fiscal reform simulaneously improves he welfare of fuure generaions more. In paricular, according o our simulaion, i sands ou as he mos desirable opion. Public pension reform was also examined. We found ha using consumpion ax o parially fund he pension premium, raher han cuing pension benefis coupled wih increasing child benefis, yields a higher welfare for fuure generaions. Finally, we would like o address some relevan opics for fuure research. The firs key sep is o analyze he opimum axaion for he OLG model wih endogenous feriliy. In his paper, we mainly examine funding for increased child benefis based on consumpion, wage, and capial income axes, and how hose axes would affec he welfare of he working and fuure generaions. However, raher han focusing only on child benefi financing, we should explore opimal ax srucures when exising governmenal expendiures oher han child rearing and pension benefis (such as educaion and medical care) are added as parameers. This will be a maor poin for fuure discussions. The second key issue is how o handle heerogeneiy wihin generaions. To simplify he analysis, we disregarded such consideraions in his sudy. However, if he heerogeneiy facor is added o he simulaion, we mus expec changes in he macroeconomic effecs of child benefis, including he fuure ransiion of populaion demographics. Then, we mus be able o analyze he effec of child benefis expansion, public pension, and fiscal reforms on he inrageneraional equiy for he represenaive households wih differen earnings abiliies. This will also be a maor poin for fuure discussions. The hird issue is o develop he model furher o include endogenous labor supply. For simplified analysis, we assumed inelasic labor supply and disregarded he ime selecion of each generaion beween childbirh or child rearing and labor supply. However, in he real world, his ime selecion is crucial and should be incorporaed ino fuure sudies. The fourh issue is o analyze he effec of public healh insurance. In aging Japan, public healh insurance is as imporan as public pension. Thus, an incorporaion of he medical cos would be expeced o make our analysis more comprehensive. This will also be a maor poin for fuure discussions. Finally, he fifh issue is o analyze he robusness of he simulaion resuls. The resuls may depend on specificaions of he model and parameers. If we change he model and incorporae he above issues (e.g., heerogeneiy wihin generaions, endogenous labor supply, and public healh insurance) in he model, here exiss he possibiliy ha our resuls change. In addiion, we calibrae he parameers of our model o he macro daa of Japan. However, if we calibrae i o ha of oher counries, he resuls may change. These wo issues are lef for fuure discussions. We also need o analyze he impac of he following on governmenal policies: () lower pension premiums and higher pension benefis for households wih more children o 503

15 Asian Economic and Financial Review, 203, 3(4):490-5 endogenize he exernaliy of pay-as-you-go public pensions and (2) an aiude of regarding children as invesmens, no as consumpion. Finally, enhancing he framework of analysis, for example, expanding i from a closed- o an open-economy model and incorporaing uncerainies, will cerainly simulae furher research. REFERENCES Akinson, A.B. and J.E. Sigliz, 972. The srucure of indirec axaion and economic efficiency. Journal of Public Economics, : Akinson, A.B. and J.E. Sigliz, 976. The design of ax srucure: Direc versus indirec axaion. Journal of Public Economics 6(-2): Auerbach, A.J. and L.J. Kolikoff, 987. Dynamic fiscal policy. Cambridge: Cambridge Universiy Press. Chamley, C., 986. Opimal axaion of capial income in general equilibrium wih infinie lives. Economerica, 54(3): Conesa, J.C., S. Kiao and D. Krueger, Taxing capial? No a bad idea afer all! Nber. Cremer, H. and F. Gahvari, 995. Uncerainy, opimal axaion and he direc versus indirec ax conroversy. Economic Journal, 05: Diamond, P.A., 965. Naional deb in a neoclassical growh model. American Economic Review, 55(5): Haa, T. and Y. Oguchi, 999. The heory of public pension reform: Transform o funding sysem. Nikkei Publishing, Inc. [in Japanese]. Hubbard, R.G. and K.L. Judd, 986. Liquidiy consrains, fiscal policy, and consumpion. Brookings Papers on Economic Aciviy, : -59. Inernaional Moneary Fund, 20. Raising he consumpion ax in apan: Why, when, how? Available from IMF Saff Discussion Noe No. 20/3. Judd, K.L., 985. Redisribuive axaion in a simple perfec foresigh model. Journal of Public Economics, 28(): Naional Insiue of Populaion and Social Securiy Research, Populaion saisics of apan [in Japanese]. Naional Insiue of Populaion and Social Securiy Research, Available from Populaion Proecions for Japan: Oguro, K., J. Takahaa and M. Shimasawa, Child benefi and fiscal burden: Olg model wih endogenous feriliy. IPSS Discussion Paper Series 2009-E0. Saez, E., The desirabiliy of commodiy axaion under non-linear income axaion and heerogeneous ases. Journal of Public Economics, 83(2):

16 Asian Economic and Financial Review, 203, 3(4):490-5 Weinzierl, M., The surprising power of age-dependen axes. Available from hp:// Whiehouse, E., Pensions panorama: Reiremen-income sysems in 53 counries. The World Bank. PARAMETER Uiliy funcion Table-.Parameer values of he model Time preference rae 0.0 Ineremporal elasiciy of subsiuion / VALUE Weigh parameer beween number of children and 0.84 * consumpion Producion funcion Technology progress Capial share in producion 0.3 Physical capial depreciaion 0.05 Tax policy parameers Wage ax w 20.0% Capial ax r 20.0% Consumpion ax c 5.0% Pension benefi ax p 0.0% Pension policy parameers Naional subsidy o pension sp 25.0% Replacemen raio 50.0% Oher parameers Child-rearing cos o ne lifeime income Childbearing possibiliy o % 6 o % o % 6 o % o 5 3.0% 6 o 0 7.4% o 5 7.0% 6 o 20 Governmen subsidy o child-rearing cos 0. Age-wage profile 0 2 g= g = p 2.6%

17 Asian Economic and Financial Review, 203, 3(4):490-5 Age limi for childbearing M 40 Age of reiremen Q 65 Average life expecancy Z 85 * This parameer is fixed afer year Table-2.Year 2007 of he baseline scenario OFFICIAL MODEL Naional Income (% of GDP) Privae consumpion Governmen purchases of goods and services Saving rae 74.% 8.8% 2.0% 24.3% 3.% 4.7% Governmen Indicaors Pension premium o wage Gross public deb (% of GDP) Primary balance (% of GDP) 4.9% 4.9% 70.6% 72.4% -2.4% -4.3% Tax revenues (% of GDP) 8.4% 9.8% Oher Indicaors Capial oupu raio Ineres rae % 2.6% Source: OECD Economic Oulook No. 84, 2008, and Annual Repor on Naional Accouns, he Japanese SNA saisics (Cabine Office). Table-3. Scenarios 506

18 Asian Economic and Financial Review, 203, 3(4):490-5 * In each simulaion scenario, we keep he ousanding governmen deb o GDP afer 2035 a he same level, by conrolling consumpion ax. Table 4. Simulaion resuls Table-4. Simulaion resuls (coninued) 507

19 Asian Economic and Financial Review, 203, 3(4):490-5 Table-4. Simulaion resuls (coninued) Fig-.Demographic proecion of each generaion 508

20 Asian Economic and Financial Review, 203, 3(4):490-5 Fig-2.Simulaion resuls: demographic proecion of fuure generaions Fig-3.Simulaion resuls: reired populaion raio 509

21 Asian Economic and Financial Review, 203, 3(4):490-5 Fig. 4.Simulaion resuls: oal feriliy rae Fig. 5.Simulaion resuls: deb per employee 50

22 Asian Economic and Financial Review, 203, 3(4):490-5 Fig. 6.Simulaion resuls: welfare wih equivalen variaion Addiional Informaion Simulaion resuls: welfare wih equivalen variaion Addiional informaion Simulaion resuls: welfare wih equivalen variaion (coninued) 5