Decomposition Approach Applied on the Effects of Taxes and Social Insurance Premiums on Income Distribution: Contributions to the Size of the Middle Class in Japan

Japan's middle class in recent years is declining in a similar way to the middle classes of other developed countries. However, since the tax system can reduce income disparity, it can affect the size of the middle class. This study employs household microdata from 1989-2014 to examine how taxes and social insurance premiums affect the size of the middle class in Japan. Further, the evolution of the effects of taxes and insurance premiums involves changes in the tax and social insurance systems (system reform effects) and income distribution or demographics (non-system reform effects). Therefore, this study decomposes the effects of taxes and social insurance premiums into system and non-system reform effects to capture the true contribution of the former. The research found that taxes and social insurance premiums mitigate the reduction of the middle-class share, while the system reform effect did not contribute to the change in this share. Thus, fundamentally reforming the tax systems for a greater effect to enhance the size of the middle class is necessary.