Fiscal Decentralization in Japan


Published on

The Global Urban Economic Dialogue Series, 2012

  • Be the first to comment

  • Be the first to like this

No Downloads
Total views
On SlideShare
From Embeds
Number of Embeds
Embeds 0
No embeds

No notes for slide

Fiscal Decentralization in Japan

  2. 2. FISCAL DECENTRALIZATIONIN JAPANUnited Nations Human Settlements ProgrammeNairobi 2012 Sec1:i
  3. 3. The Global Urban Economic Dialogue SeriesFiscal Decentralisation in JapanFirst published in Nairobi in 2012 by UN-HABITAT.Copyright © United Nations Human Settlements Programme 2012All rights reservedUnited Nations Human Settlements Programme (UN-HABITAT)P. O. Box 30030, 00100 Nairobi GPO KENYATel: 254-020-7623120 (Central Office)www.unhabitat.orgHS/043/12EISBN Number (Series): 978-92-1-132027-5ISBN Number (Volume): 978-92-1-132458-7DisclaimerThe designations employed and the presentation of the material in this publication donot imply the expression of any opinion whatsoever on the part of the Secretariat ofthe United Nations concerning the legal status of any country, territory, city or areaor of its authorities, or concerning the delimitation of its frontiers of boundaries.Views expressed in this publication do not necessarily reflect those of the UnitedNations Human Settlements Programme, the United Nations, or its Member States.Excerpts may be reproduced without authorization, on condition that the source is indicated.Acknowledgements:Director: Naison Mutizwa-MangizaChief Editor and Manager: Xing Quan ZhangPrincipal Author: Nobuki MochidaContributor: Jaana MiochEnglish Editor: Roman RollnickDesign and Layout: Peter Cheseretii
  4. 4. FOREWORD Ur b a n i z a t i o n provision of adequate housing, infrastructure, is one of the education, health, safety, and basic services. most powerful, irreversible forces The Global Urban Economic Dialogue series in the world. It is presented here is a platform for all sectors estimated that 93 of the society to address urban economic percent of the future development and particularly its contribution urban population to addressing housing issues. This work carries growth will occur many new ideas, solutions and innovative in the cities of Asia best practices from some of the world’s and Africa, and to a leading urban thinkers and practitionerslesser extent, Latin America and the Caribbean. from international organisations, national governments, local authorities, the private We live in a new urban era with most of sector, and civil society.humanity now living in towns and cities. This series also gives us an interesting Global poverty is moving into cities, mostly insight and deeper understanding of the widein developing countries, in a process we call range of urban economic development andthe urbanisation of poverty. human settlements development issues. It will serve UN member States well in their quest The world’s slums are growing and growing for better policies and strategies to addressas are the global urban populations. Indeed, increasing global challenges in these areasthis is one of the greatest challenges we face inthe new millennium. The persistent problems of poverty andslums are in large part due to weak urbaneconomies. Urban economic development isfundamental to UN-HABITAT’s mandate.Cities act as engines of national economic Joan Closdevelopment. Strong urban economies Under-Secretary-General of the Unitedare essential for poverty reduction and the Nations, Executive Director, UN-Habitat iii
  5. 5. iv
  7. 7. FISCAL DECENTRALIZATION IN JAPANLISTS OF FIGURES, TABLES AND BOXESLIST OF FIGURESFigure 1 Classification of Local GovernmentsFigure 2 Local Taxes in Prefecture, FY2009Figure 3 Local Taxes in Municipality, FY2009Figure 4 Contribution of LAT to reduce regional disparities, per capita FY2003Figure 5 Degree of Equalization, 1950-2002Figure 6 Main Creditor of Local BorrowingFigure 7 Change in revenue component after ‘Trinity Reform’ (2004-2006)Figure 8 Questionnaire Survey on Amalgamation, 2010LIST OF TABLESTable1 Income and Expenditure of Japan’s Local Governments, FY2008Table 2 Expenditure by Function and Level of Governments, FY2009Table 3 Revenues received by states and local government, FY2010Table 4 Local Debt OutstandingTable 5 Number of SNG designated as ‘early stage fiscal improvement’vi
  8. 8. CHAPTER 1 STATUS OF LOCAL GOVERNMENTCHAPTER 1 STATUS OF LOCAL GOVERNMENT Virtually all countries in the world, whether The chapter states that regulations concerningexplicitly federal or not, exhibit a degree of organization and operations of local publicdecentralization, and to that extent they share entities should be fixed by law in accordancea number of common problems. How much with the principle of local autonomy. Theresponsibility for expenditure programmes new Constitution articulates the government’sshould be given to sub-national governments? responsibility in maintaining the minimumTo what extent should they finance those standard of living and decent life. Especially,responsibilities from own source revenues? the modern development of redistributiveHow far should the central government go policy in Japan is based on the followingin equalizing disparities in sub-national fiscal article 25 of the Constitution:capacities? What controls might be used toensure responsible fiscal conduct, including (1) All people have the right to maintainwith respect to borrowing obligations? While the minimum standards of wholesome andthe answers to these questions are to some cultured living. (2) The state must makeextent country-specific, there are a number efforts to promote and expand social welfare,of underlying principles that can be used to social security and public health services toinform them. Indeed, while this paper is a cover every aspect of the life of the study of the evolution of multi-level fiscal [Article 25]decision-making in Japan, it would contains Normally, the constitution cannot specifymany lessons for other countries of different details of tax and expenditure assignmentcharacteristics. to each level of government. This task is left for laws on local taxation, such as the Local Finance Law in Japan. Among many lawsJurisdictions regarding fiscal issues, the Local Tax Law of Japan’s local autonomy has been guaranteed Japan has been main piece that governs theby the Constitution after the Second World division of taxing powers. The rules specifiedWar. The post-war Constitution of Japan has a in these laws have ensured the stability andchapter on local self government (Article 92). predictability of local budgetary expenditure. 1
  9. 9. FISCAL DECENTRALIZATION IN JAPANFigure 1 Classification of local Governments Local governments Ordinary local authority Prefecture (47) Municipality (1727) Designated city (18) Core city (41) Special city (41) Other municipality (1627) Special local authority Special ward (23) Municipal cooperative Partial association (1393)Source: Ministry of Home Affairs and Communicatio (2011) White Paper on Local Public Finance, table 1 In Japan the government sector is stratified Japan is 39,000, which is considerably ininto several levels, each having responsibility excess of the number found in average OECDfor a particular set of public functions. The countries, except for UK (Shah 2006:28-29).main levels of the Japanese government are the These numbers have been achieved by severalnational, the prefectural, and the municipal waves of mass amalgamation. We often refergovernments. The last two are called ‘local to prefectures and municipalities jointly asgovernments’, while the first is referred to as ‘local public bodies’.the ‘national’ or ‘central’ government. Onthe sub-national level, Japan has a so-called The origin of a modern local governmenttwo-tier system of local governments. Figure system in Japan can be dated to 1890s. In1 shows that the total number of prefecture, about 1890, a highly centralized system was47, has not changed since the prewar period created in Meiji, Japan, which was based on theexcept for the addition of Okinawa. On the German model(Muramatsu and Iqubal 2001).other hand, there are 1727 municipalities, Gradually, political parties mobilized theconsisting of 785 cities, 750 towns and 192 residents, using local councils to enhance localvillages (in March, 2011). The number of democracy and to express local interests to themunicipalities in Japan is much less than in central government in the 1920s. Despite theFrance, Germany, USA, and Canada, but more progress and attempt toward decentralizationthan in United Kingdom and Sweden (Policy in 1920s, wartime mobilization completelyResearch Institute, Ministry of Finance 2002). recentralized the country.Average population per local authorities in2
  10. 10. CHAPTER 1 STATUS OF LOCAL GOVERNMENT The process of developing the local finance of social welfare programme in public pension,system in post-war Japan was initiated by medical care etc. The Second Provisionalthe US. In this regard, we must stress the Administrative Reform Commissionsignificant role of the 1949 Shoup Mission in (SAPARC) assumed the responsibility forshaping the local finance system in post war tackling this issue, and it succeeded toJapan. Thus, the entire intergovernmental fiscal a significant degree in attaining its goalrelations were fully reconstructed, producing through the privatization of large governmentepoch-making changes. However, ideal local cooperation. In contrast to previous decades,finance system achieved by the initiative of US they were now urged to prioritize and downsizeinfluence was of temporary duration: many of public expenditures. The commission alsothe elements were modified soon after their recommended decentralization as a way toenactment. For one thind, the US’s proposed rationalize expenditures and reduce fiscal“layer cake” model, in which the functions of pressures (Muramatsu and Iqbal 2001:16-18).the central government and local governmentsare clearly demarcated, was not to be realized On the other hand, public statement claimas it intended (Mochida 2008). that Japan’s centralised system of government eventually be unable to resolve issues In this way, Japan mixed the pre-war generated by economic globalization and thecentralized system with the decentralized fiscal stress caused by post-bubble economicin a distinct manner. On the whole, the blues. Reflecting these general outcries, theintergovernmental system continued to Murayama government finally enacted Thefeature strong centralized elements. However, Law for the Promotion of Decentralization,local passive attitude were temporarily on May 15, 1995 and Koizumi governmentdropped in response to the urban congestion lauched an ambitious reform of the threeand environmental pollution. In the 1970s, components of local government financialJapan experienced a case of conflict between resources - earmarked grants, local taxes andthe central and local governments. Two factors the local allocation tax – the so called “Trinitydefined this new era of central-local relations: Reform” during 2004-2006. The questionthe mushrooming of residents’ movements, of decentralization and deregulation hasand the increase in opposition control of developed into one of the most contentiouslocal government. Furthermore, local policy political issues in Japan.initiative had reverse impact on nationalpolicy outcomes during this time (Muramatsuand Iqbal 2001:12-15). Japanese local Economic Weightgovernment responded by expanding its roleas policymaker in environment, city planning, In virtually every country, some amount ofwelfare on its own, as well as in its role as an decentralized fiscal decision making is a factagent of the central government. of life. Lower-level jurisdiction- be they state or provinces, prefectures or regions, cities or In the 1980s, however, the Japanese municipapities- are typically given responsibilitygovernment faced a new challenge: fiscal stress. for delivering some of most important publicMassive expansionary fiscal policy after oil services, such as schools, health service andshocks left fiscal deficit in its wake. The second social services. How important are localreason explaining the increase in fiscal deficit governments in Japan? Table 1.1 presents arelates welfare state construction. In the late quantitative approach to this question based on70s, Japan did catch up with the Western level national account data for FY2008. 3
  11. 11. FISCAL DECENTRALIZATION IN JAPANTable 1 Income and expenditures of Japan’s local governments, 2008 Amount (trillion yen) percentage of GDP percentage of general government total expenditure 93.8 19.1% 54.20% final consumption 26.5 5.4% 67.60% social transfer in kind 40.1 8.2% 79.10% social benefits 8.7 1.8% 16.60% investment 12.3 2.5% 74.0% total income 90.8 18.5% 40.40% taxes 40.0 8.1% 46.10% transfers, receivable 28.1 5.7% 60.90% social contribution 20.1 4.1% 35.0% balance 0.8 0.2% - Source: national accounting data Note1:local government is defined as prefectures plus municipalities. 2: including national health insurance and long term-care insurance managed by municipalities. Several important points emerge. First, and cover 30 per cent of local governmentsubnational government income and resources. Fifth, local governments invest 74expenditures represent about 19.1 per cent per cent of general government’s investments.of gross domestic product(GDP) in Japan. Finally, local net lending is small relative toSecond, in expenditure terms, the weight of central governmet net lending, but indebtenesslocal governments is about half that of the is as much as the central government. Relyinggeneral government. Third, local taxes cover on these quantitative data, Japan does notabout 44 of local government expenditures seem to match the standard model of aand represent, therefore, about 8.1 per cent of centralized country at all, where relatively weakGDP. Fourth,as a cosequence, transfers from subnational governments are assigned limitedthe central government to local government expenditure and revenue responsibilities.account for about 5.7 per cent of GDP4
  12. 12. CHAPTER 2 LOCAL GOVERNMENT FUNCTIONSCHAPTER 2 LOCAL GOVERNMENT FUNCTIONSEXPENDITURE BY FUNCTION spending on infrastructure has declined somewhat since the mid-1990s, but remains The efficiency arguments for decentralizing high by the standards of the Organisation forthe provision of public services and targeted Economic Co-operation and Developmenttransfers are fairly strong: decentralization will (OECD). Third, a significant portion of localenable public services, even those of national governments spending are not for public goodimportance, to be tailored to local preference. but for quasi-private goods, what are referring toThe issue is the allocation of function between as ‘public services’(Boadway, Shah 2009:138).different level of governments. Which Large-scale expenditure programmes involvingfunctions should the lower-level jurisdictions education, health, social security, welfare andbe responsible? Table 2 present expenditure housing are of this function at different level of governmentsin Japan. A standard classification of Given the essentially private nature ofgovernment expenditure by function in the these services, one cannot rely on traditionalIMF’s Government Finance Statistics Yearbook efficiency-type market failure argumentsframework is not available for Japan’s local to justify public responsibility for theirgovernments. Table 2 compiles such data on provision. Instead, the public sector assumesthe basis of expenditure categories used in responsibility for providing public servicesJapanese budgetary statistics. This table only largely for redistributive reasons. Publicillustrates an approximate order of magnitude services are delivered to household on anof central and local expenditures shares. individual basis. The case for decentralization rest on the argument that this delivery is Several important points emerge. First, the more efficiently accomplished if it is theweight of local government’s total spending responsibility of a lower level of governments.exceed that of central government since However, there is tention between the desireFY1953. Second, local governments play a to decentralize fiscal responsibility and thebig role in infrastructure (roads, parks, bridge, desire to maintain central control.port and harbours etc.), compared withother industrial coutries. Local governments 5
  13. 13. FISCAL DECENTRALIZATION IN JAPANTable 2 Expenditure by function and level of government, FY2009 (JPY billions) gross expenditure transfers net expenditure total expenditure Central3 Local (B) from from Central Local Central Local (A) Central Local (A) - (C) (B) - (D) % % (C) (D) General public sevice, 5,074 16,516 1,769 0 3,305 16,516 17% 83% Public order, and Safety Defence 4,831 0 32 0 4,799 0 100% 0% Education 5,869 16,418 2,877 0 2,992 16,418 15% 85% Health, welfare1 30,424 27,835 8,791 0 21,633 27,835 44% 56% Industry 9,100 7,735 441 0 8,659 7,735 53% 47% Infrastructure 9,433 14,642 2,914 1,283 6,519 13,359 33% 67% Debt service 18,444 12,884 11 0 18,433 12,884 59% 41% Local finance 2 17,766 0 17,578 0 188 0 100% 0% Other 4,757 76 4 0 4,752 75 98% 2% Total 105,698 96,106 34,417 1,283 71,280 94,822 43% 57% Notes: 1. excluding pension, health insurance, 2. Local Allocation Tax, 3. general account plus special accounts other than social security Source: Ministry of Home Affairs and Communication(2011), White paper on Local Public Finance, table32.EXPENDITURE RESPONSIBILITY POLICE AND FIRE SERVICE In most nations with multiple levels of Prefectures are responsible for setting upgovernment, some mechanisms are in place police organization (Police Act 36). It is notby which national governments can influence delegated from the central government. Ithow lower-level gevernments design their could be seen as ‘local police’ on the surface.programme. In Japan, the law allows the However, at the center of Japan’s police systemcentral government to influence lower-level is the National Police Agency, which is undergovernment spending decisions through the National Public Safety Commission,conditions imposed on transfer from central an extra-ministerial bureau of the Cabinetgovernments. The 1949 Shoup Mission’s Office. The prefectural police headquartersproposed “layer cake” model, in which the are directed and supervised by the Nationalfunctions of the central government and Police Agency. Prefectural top official beinglocal governments are clearly demarcated, ranking higher than Chief Superintendentwas not to be realized as is. It is difficult to is national government employee. In realty,identify a policy area in which only one level the prefectural police is mixture of nationalof government is involved. The activities and police and local police. Municipalities arefinances of the central and local government responsible for fire fighting (Fire Service Acthave gradually become intertwined. The most 6). National government and prefectures doimportant step away from layer cake model not assume responsibility for it, then have nowas the amendment of Local Finance Law regular authority over 1952, which established so-called “cost-sharing grants.”6
  14. 14. CHAPTER 2 LOCAL GOVERNMENT FUNCTIONSEDUCATION higher rate of return in the latter (OECD 2005:113-114). All three levels of governments arevery much involved in education. The There are three sources of financing forbasic division of labor is that municipal public investment: budget income; the FILPgovernments are responsible for developing programmes; and earmarked taxes. Fiscaland maintaining the physical stock of capital equalization grants and specific purpose(namely, the school buildings), prefectural grants constitute budget income. The specificgovernments are responsible for labor (namely, purpose grants are not only earmarked tofor recruiting, monitoring, promoting, and specific areas (e.g. public works) but theypaying for teacher’s salary), whereas the central are made conditional on local governmentsgovernment is responsible for setting service complying with strict and detailed operationalstandard and curriculum. standards. Mihaljek (1997) noted that in the case of public construction work in general, Specific grants are made conditional on even the brands of construction material andlocal governments complying with strict parts were sometimes specified by the centraland detailed operational standards. For one government.thing, salaries of teachers in Japan are bornby the central government and prefectural In addition, some programme, especiallygovernments with 50: 50 sharing ratio. roads, has been financed directly by earmarkedSince allocation of teachers and the number taxes since 1954. Taking road constructionof students per class are clearly spelled out as an example, earmarked taxes such as thein the national law, local governments face motor vehicle tonnage tax, local road transferdifficulties in hiring teachers of English. For tax, light-oil delivery tax, and automobileanother, under the law on State Subsidies on acquisition tax are the main local revenueExpenditure on Facilities for Compulsory sources. Earmarked taxes could enhanceEducation, half of the construction costs efficiency if properly designed by makingof school building are paid by the central beneficiaries pay part of the cost, but is wouldgovernment if the recipients comply with result in resource misallocation if the level ofrather strict conditions, such as floor size, investment is determined by such tax revenues.availability of various rooms, equipment and Actually, these earmarked taxes were abolisheddistance from the students’ home. in FY2009 in view of resource misallocation problems.INFRASTRUCTURE Public investment in terms of GDP ratio HEALTH INSURANCEis about twice as much as OECD average. Local governments manage the two typeLocal governments have played major role in of social insurance: public health insuranceinfrastructure investments, accounting for 73 and long-term care insurance. The Nationalper cent of general government’s investment. Health Insurance (Kokumin kenkohoken) isPublic investments at lower-level governments a system of regional based health insuranceincludes infrastructure, such as road, river managed by municipalities. It was establishedmanagement and sewers. But it is heavily in 1939 to cover the self-employed, farmers,used as a policy instrument for economic workers of smaller firms and their families asstabilization and redistribution of income the insured, accounting for about one-third ofamong regions in Japan. Per-capita public the total population. After being restructuredinvestment in low-income prefectures is twice in 1958, the NHI has played a fundamentalthat of high-income prefectures, despite much role in providing universal medical insurance 7
  15. 15. FISCAL DECENTRALIZATION IN JAPANin Japan. Since the NHI covers relatively WELFARE ASSISTANCElow-income earners and has no employer Public Assistance for the Poor (Seikatsu-fund, one-half of its insurance benefits must Hogo) is major means-tested in-cash benefitbe subsidized by the national government. available to households, whose income fallsSince municipalities have discretions over the below the minimum standard of living. Thepremium schedule, the premiums for the NHI minimum cost of living set by the centraldiffers across municipalities, even though government is compared with applicant’spatients of comparable characteristics receive income, and if income does not meet thiscomparable medical services at identical out- standard, the difference is compensated byof-pocket expenses. in-cash benefits. Minimum standard of living depends on a number of factors includingLONG-TERM CARE INSURANCE household size, ages of household members, and location of residence. Caseworkers As Japan is rapidly aging, the number of are responsible for conducting surveys ofelders who need care is expected to grow. applicants’ income and assets (means-test) andThe long-term care insurance system (Kaigo- certifying them as being eligible for benefits.hoken), which was introduced in 2000, is The applicants are required to full utilize orintended to insure against expenditures for the exhaust their resources available. Because oflong-term care. Today, the number of persons the recession after Lehman’s fall, the numberinsured and beneficiaries of the programme of recipients hits a post war record: 2 million.reaches 69 million and 3.9 million respectively. The central government takes on three-fourthsInsurers are municipalities. The LTCI covers of the total cost through grants, whereasthose who are aged 65 or older (Type 1) and local governments born remaining one-those who are aged 40 to 64 (Type 2). Insured fourth by general revenue sources. Regionalpersons belonging to Type 1 are qualified as differences in take-up rate are large; however,beneficiaries. The municipalities determine the it reflects economic and social factors such asappropriate category based on the applicant’s unemployment rate, number of elderly, andneed and then notify the applicant of its divorce rate which are beyond the control ofdecision. There are three source of financing local governments themselves.for long-term care insurance: out-of-pocketexpense, premium and budget income. Usersare responsible for paying 10 per cent ofcost. Half of the rest resources is financed bypremiums paid by insured persons. Remaining50 per cent of cost is funded by transferfrom the central government (25 per cent),prefectural governments (12.5 per cent), andmunicipalities (12.5 per cent).8
  16. 16. CHAPTER 3 LOCAL OWN REVENUESCHAPTER 3 LOCAL OWN REVENUESGENERAL MATTERS the distribution of personal income and consumption tax is relatively even across Japan’s local governments collect about 8.1 localities. Second, it can also make cyclicalper cent of GDP in taxes( see, table 1). There fluctuation more smooth. Corporate incomeare about a dozen local taxes. Before discussing tax varies greatly in response to businessin turn the most important of these local taxes, cycles, however revenues from consumptionwe must consider a few general issues. and property tax are more stable (OECD, 2005; Mochida, 2001).SHARED TAX BASES Third, the system of tax base being dispersed Different level of governments have access can make tax burden proportional to residents’to same tax bases. There are few ‘shared taxes’ income. Taxes on consumption tax andin the sense of taxes shared between the central property for residences is relatively regressivegovernments and sub-national governments. to income, but it is mitigated by income taxWhat are ‘shared’ here are not tax proceeds with progressive rate structure. Boadway,but tax bases. Both central government and Hobson and Mochida( 2001) verified thatlocal governments tax on personal income, residence-based local taxes are in proportionalcorporate income and consumption. Consider, to income. However, dispersed tax bases is farfor instance, value added tax (shohi-zei). Let us from simple. The number of different taxes isassume that tax base, here final consumption, too large, and the taxes levied is not a kindis 100 of JPY. The central government will that can be readily understood by tax on a rate of 4 per cent, prefectures on a The link between tax paid and public servicesrate of 1 per cent. Then, consumer will pay received is less visible for the local residents in4 JPY to the central government and 1JPY to Japan (Mochida and Lotz, 1999).the prefecture at the cash register. In practice,however, there are probably few taxpayerswho know which governments are receiving TAXING POWER OF LOCALthe local component of VAT they pay. This GOVERNMENTSapproach does not induce accountability. Broadly speaking, local government can As a result of shared tax bases, local taxes enjoy freedom in tax matters. The lowerdisperse its bases widely across income, jurisdictions set their own tax rate either asconsumption and property. This is apparent surtax on national tax revenues or to applyfrom table3.2. It contrasts sharply with single to the national base, and a higher level oflocal tax system established in UK and Nordic government does sets upper and lower lmitscountries etc. This system of tax base being on the rate chosen. In fact, tax revenue sharedispersed has some advantages. First, to some with full or partial discretion on tax rateextent it can alleviate regional disparity (Policy setting amounts to more than 80 per centResearch Institute, Ministry of Finance, (Blochlinger, Rabesona 2009; OECD 1999)2002). Distribution of corporate income . The share of piggy-backing taxes in termstaxes is skewed toward urban areas,while of revenues is higher than OECD average. 9
  17. 17. FISCAL DECENTRALIZATION IN JAPANHowever, local governments do not make good with capital of more than JPY 100 millionuse of these flexibility. The rate of some local will be altered to include both a value addedtaxes are neary uniform across the countries. component and a capital component. ThePersonal inhabitant tax, local consumption tax value added tax bases is the sum of wages,and property taxes are in fact tax sharing. net interest paid, net rents paid, and taxable income (profit) and the capital base consists of There are a few progress in enhancement paid in capital plus capital surplus. The largerof taxing power of subnational governments. corporations subject to this new tax continueFirst, flexibility of tax rate has been enhanced to be subject to local business tax based onby the removal of the ceiling (upper limit) on their taxable income (profit), but at a reducedthe municipal inhabitant taxes on individuals rate (maximum of 7.2 per cent, comparedin 1998 and of the maximum property tax rate with the normal maximum of 9.6 per cent forin April 2004. Generally speaking, Japanese the local enterprise tax). In addition, however,local governments’ discretionary taxing power these larger corporations will now be taxedare higer than in Austratia, Germany, Italy and, at rate of 0.48 per cent on value added anduntil recently, Belgium and Spain. Second, an additional 0.2 per cent on capital. Thetax autonomy of local governments has been purpose of this new system was essentially tofurther enhanced by the 2000 Amended reduce the sensibility of local tax revenues toLocal Taxation Act which enable them to economic fluctuations, thereby insulating localinvent and create ‘supra-legal taxes’ (i.e. taxes finace from the effects of Japan’s continuingnot stipulated by national laws, but local reccesions.ordinance) after consultation with Ministry ofInternal Affairs and Communications. Manysubnational governments introduce new taxes, Figure 2 Local taxes in Prefectures, FY2009including some on nuclear and industrialwaste, hotel stays, fishing, holiday house etc.However, several tax experts point problem inhabitant property light oil tax 2% acquisitionof ‘supra-legal taxes’. These taxes often fall on delivery tax 3%non-residents or can be shifted on non-voting tax 6%company and revenues are in many cases low, automobile others 3%while obtaining the consent of local residents tax 11%is time-consuming task.INDIVIDUAL LOCAL TAXES local VAT Prefecture tax 17% 14.6 trillion yenLOCAL BUSINESS TAX Local business tax (Jigyo zei) has been themost important prefecture tax in Japan, andit still is, despite recent reform in its tax bases.Figure 2 shows that they constitute 30 per inhabitant enterprise tax 38%cent of prefectural tax revenues. Until 2004, tax 20%local business tax has been imposed on income(profit) of firms and deducted from national Source: Ministry of Home Affairs and Communica-corporate income taxes. Beginning in April tions (2011) White paper on local public finance,2004, the local tax imposed on corporations figure29.10
  18. 18. CHAPTER 3 LOCAL OWN REVENUES Advocates of this new tax support the idea Because local comsumption tax relys collectionof the ‘benefit principle’. To the extent that on national tax administration and has noparticular local public service directly benefits flexibility on tax rate setting, it looks like taxbusiness, those firms should pay tax on its value sharing. Local Tax Raw stipulates that tax rateadded which reflects business activities. This of local comsumption tax is automatically pegidea goes back to Shoup Recommendation in to 25 per cent of national VAT rate. Prefectures1949. In the case of Japan, Hayashim (2008) are discouraged to from increasing tax rate,estimates that on average close to 16 per cent hoping that the central government will pay aof prefecture expenditures benefits commercial high political price for implementing tax hike.and industrial activities. This study concludes In contrast, local consumption tax has severalthat the taxes imposed business constitute advantage. It has essentially low sensibilitya higher share than benefits received by to economic fluctuations, thereby insulatingbusiness. However, the original proposal was local finace to some extent from the effectsfaced strong opposition from business to of Japan’s continuing reccesions. In addition,paying taxes when firms had no profit. Official distribution of tax revenue across the countrytax statistics reveal that 1.7 million out of 2.5 is more even, compared with other taxes suchmillion corporations report no profits. As a as local business tax, inhabitant tax (Mochida,result of political backlash agaist pro-forma Horiba and Mochizuki 2010).based local business tax, the scope of tax baseon value added has been substantially eroded.Mochida (2008) estimates that only 1.1 per INHABITANT TAXcent of total corporations (i.e. 29,000 out of Inhabitant tax is a basic local tax on2.5million corporations) actually pay taxes on personal income for both municipalities andvalue added. prefectures as figure 3 indicates. In 2009, tax revenue from individual prefectural inhabitant tax was 2,378 trillion yen, and tax revenueLOCAL CONSUMPITION TAX from personal municipal inhabitant tax was Local comsumption tax is relatively new 5,583 trillion yen. Taken together, inhabitantprefectural tax. But it has been third largest taxes make up approximately 36 per cent oftax in prefectural budgets since 1997 as figure municipal tax and 38 per cent of prefecture2 demonstrates. Local comsumption tax tax essentially local surtax on national VAT.Central government imposes VAT at rate of The inhabitant tax comprises three elements:4 per cent and local government at uniform an income base (tax rates of 10 per cent)rate of 1 per cent. Local component of VAT levied on the previous fiscal year’s income, ais collected by prefectures on origin basis. lump-sum base, and tax on interest, dividends,After collecting taxes, each prefecture transfers capital gains. The minimum amount ofit among them in proportion to the amount taxable income is set lower than that of theof final consumption, thereby attributing the national income tax. Each month, a taxpayerlocal VAT to prefectures on destination basis. pays income tax and personal inhabitant taxEach prefecture, however, allocates half of tax to their employer through tax withholdingreceived to its municipalities in proportion to at the source. The employer then delivers thethe number of population and employees. personal inhabitant tax to the municipality in which the employee resides. Opponents saw main problems of localcomsumption tax to be lack of accountability. 11
  19. 19. FISCAL DECENTRALIZATION IN JAPAN The tax is imposed on capital value insteadFigure 3 Local taxes in Municipalities, of on annual rental value at present. One FY2009 advantage is that the tax be extended to include all depreciable assets of business enterprises, others 3% that is, machinery, vats, ovens, and so on, city planning tax 6% instead of being restricted to land buildings. Such assets cannot well be included in the tax personal rolls on an annual rental basis. If they were inhabitant valued on a capital basis and the land and tax 36% buildings were continued on a rental basis, it would be necessary to distinguish between structures that are buildings (real estate) and Municipality tax those that are not between ‘immovables’ and 20.5 trillion yen ‘movables’. This is often a difficult distinction to draw, and the difficulty is indeed one reason why property tax includes all depreciable assets in the tax base. property tax 42% The other advantage is linked with the business consideration for revaluation of business cigarette tax 4% inhabitant assets. To avoid gross overvaluation by tax taxpayers seeking to increase depreciation and decrease capital gains under the income taxes, it is desirable that the tax system contain automatic checks. One of these checks issource: Ministry of Home Affairs and Communica- obtained by requiring that the value set fortion(2011) White paper on local public finance, purposes of the land and house tax shall not befigure30. less than the value recognized for revaluation under the income tax, minus subsequent depreciation. To obtain this check, the land and house tax must be imposed on capital value, not on real value.PROPERTY TAX Although the assessment of this tax is local, Entire responsibility for the property tax rest a uniform system of assessment is appliedin the cities, towns, and villages, and all the throughout the country. Almost 178 millionrevenue should go to them. The tax is given to lots of land and 61 millions of buildingsthe municipalities rather than the prefectures, are regularly reassessed every three years.because the municipalities are more in need Municipalities must impose at least a standardof revenue, and because this is one of the few rate of 1.4 per cent of capital value, but if theytaxes that even the smaller municipalities can wish can increase the rate up to 2.1 per cent.administer with a reasonable degree of success. About 10 per cent of municipalities imposeAs figure 3 shows, property tax is largest one in higher rates. The tax is imposed on the ownerown tax revenue of municipalities. of the real estate, not the occupier.12
  20. 20. CHAPTER 4 INTERGOVERNMENTAL TRANSFERSCHAPTER 4 INTERGOVERNMENTAL TRANSFERSTRANSFER TYPES with a deficit and the central government with a surplus. Although the ratio of central to Japan’s local governments receive from the local government expenditure in Japan is 40central government about 5.7 per cent of to 60, on a final disbursement basis, the ratioGDP in transfers. There are about a dozen of central to local tax collections is the reverse:transfers. Table presents composition of 60 to 40 for the central government. Table 3transfers by type. Before discussing in turn the presents a comparison of the intergovernmentalmost important of these transfers, we must transfers in different countries. It confirmsconsider a few general issues. that grants play a relatively minor role in the US, Germany, Canada, and Sweden, while its relative magnitude in UK, France, and Japan isVERTICAL FISCAL GAP high. In spite of access to an uncommonly wide Given the differentials between expenditure range of revenue instruments, the Japaneseresponsibilities and revenue raising capacities, system is characterized by a significant verticalthe lower level of governments would end up fiscal gap.Table 3 Revenue received by state and local government, FY2010 as % of total revenue texes user fees grants others United kingdom 12 13 73 2 France 35 27 41 7 Japan1 45 6 36 13 United states1 49 21 24 6 Germany 2 68 4 18 10 Canada 53 10 21 16 Sweden 62 10 25 3 Note: For federal countries, state governments only, excluding local governments. 1. data for Japan, United states correspons to 200 ; 2. including tax sharing. Source: OECD and Korea Institute for Public Finance (2011) Institutional and Financial Relations across Levels of Government.CONDITIONAL OR UNCODITIONAL national VAT and, to all intents and purposes, on the national income tax. As a result of A large scale of transfers serves to close this centralized collection but also, de facto, in the‘fiscal gap’. This occurs explicitly through the presence of decentralized collection, there is aLocal Allocation Tax as well as Specific Purpose significant degree of harmonization in bothGrants. It also occurs indirectly as a result bases and rate structures.of local government’s piggy-backing on the 13
  21. 21. FISCAL DECENTRALIZATION IN JAPANFigure 4 Contribution of the LAT to reducing regional disparities (per capita, FY2003) ¥ 400,000 350,000 local tax revenue per capita the LAT per capita 300,000 250,000 200,000 150,000 100,000 50,000 0 tokyo saitama osaka aichi sizuoka hirosima gunnma nara tochigi mie okinawa ehime fukusima hokkaido niigata isikawa oita akagosima miyazaki saga iwate tokusima kochi simaneSource: Ministry of Internal Affairs and Communications (2005a) Annual Report on Local Public Finance Statistics The Local Allocation Tax plays a key fiscal functions performed by local governmentsequalization role in the Japanese transfer on behalf of the national government.system in Japan. The name of this transfer is Some involve substantial subsidies to localsomewhat misleading. LAT is not local tax, but governments in recognition of large spilloveressentially a kind of lump-sum unconditional effects. Some involve incentives for localgrants. The name comes from common desire governments to undertake specific projects.of local governments to view it to be ‘shared In total, central-local grants comprise almostresources’. It is funded out of a revenue pool one-third of local government revenues.based on fixed portions of five national taxes,and allocated according to formula based ondifferences in basic needs and fiscal capacities. LOCAL ALLOCATION TAXThe total size of equalization is a fixed portionof national taxes from individual, corporate CASE FOR EQUALIZATIONincome, alcoholic, tobacco taxes. The LATis paid annually to local governments whose The necessity for fiscal equalization arisesbasic financial needs exceed basic financial from the fact that the financial resources, therevenues. Those rich localities whose revenue need for services, and the cost of particularexceeds need are neither eligible for the grants local activities vary widely among differentnor liable to contribute money for fiscal local areas. For example, the per capita taxableadjustment. It is worth noting the extent capacity of some prefectures was 3 timesin which the Japanese equalization system that of others, and same holds true for thereduces territorial fiscal inequalities is very difference between the richest and pooreststrong (see, figure 4). municipalities. Unfortunately, the areas requiring the most local service, namely, those Specific purpose grants are funded out of in which there were more needs for education,general revenues. It is essentially a kind of health services, roads, welfare activities, wereconditional matching grants. Some involve likely to be the precise areas having the leastfull payment by the national government for taxable capacity. These differences were not14
  22. 22. CHAPTER 4 INTERGOVERNMENTAL TRANSFERSonly unjust but undesirable in their effects on Where Iik is a measurement unit for service Kindividual and national welfare. of ith region, Uik unit cost for service K of ith region, and Mik a modification coefficient for service K of ith region. A measurement unit orFORMULA “workloads” reflects the number or size of the The Local Allocation Tax plays a key fiscal beneficiaries of a particular expenditure. Unitequalization role in the Japanese transfer cost is a kind of financial cost of providing a setsystem in Japan. Let us in turn discuss the of services. The unit cost, however, is uniformcomputation formula of LAT. throughout the country, and no consideration is given to either the unique services or the First, it is funded out of a revenue pool special circumstances of localities. So anbased on fixed portions of five national taxes. exceedingly complex adjustment is made of the unit cost applicable to such services. TT = 0.32 × (NTy + NTa) + 0.358 × NTc + 0.295×NTv + 0.25 × NTt Forth, fiscal capacity of Ci is the sum of 75 Where TT denotes total financial pool of per cent of local tax revenue and tax sharing.transfer, NTy the personal income tax, NTc the Let us assume that local tax revenue is JPY 5corporate income tax, NTa the alcoholic tax, million. The locality will deceide to hike taxesNTv 80 per cent of value added tax revenue, by JPY 1 million. Hold basic needs constant.and NTt the tobacco tax. LAT will decrease by JPY 0.75 automatically, while additional JPY 0.25 million is retained Second, the revenue pool are allocated in the pocket of localities, thereby givingaccording to formula based on differences in incentive for local governments to collectbasic needs and fiscal capacities, rather than their own taxes. In addition, national standardbeing determined at the discretion of higher tax rate and bases are used to equalized taxlevel governments. The LAT is paid annually capacities. Let us assume that tax base isto local governments whose basic financial JPY 100 million. The locality will decide toneeds exceed basic financial revenues. lift up the rate from standard of 5 per cent to 7 per cent. Tax revenue will increase by LATi = Ni - Ci JPY 2 million, but ‘fiscal capacity’ remains unchanged, thereby insulating local autorities Where LATi denotes local allocation from loss of LAT. Local governments withtax to ith region, Ni basic need of ith high tax efforts will not be penalized, whileregion, and Ci fiscal capacity of ith local governments with low tax effort notregion. Rich localities with revenue that encouraged.exceeds need are neither eligible for the Finally, the funding pools do not necessarilygrants nor required to contribute money match formula-driven entitlements forfor fiscal adjustment, as is the case in transfers. A way of resolving these conflictingsome countries. demands is to fix the funding pool to a certain percentage of national revenue and to review Third, national average costs and standards this rate through regular negotiations. Theof services are used to equalize for needs. Basic Local Allocation Tax Law (Article 6, paragraphneed of Ni are calculated as the number of 3-2) indentifies a critical situation in whichmeasurement units by multiplying the unit the gap comes to roughly 10 per cent or morecost, adjusted by modification coefficients of the LAT transfers, and this condition hasexpressed as follows: continued for two years and is predicted to Ni = ∑k (Iik × Uik × Mik) continue for another year or longer. The law 15
  23. 23. FISCAL DECENTRALIZATION IN JAPANstipulates that, in such critical situations, the a remote rural prefecture, collects only JPYtax-sharing ratio will be raised. Such critical 87,000. Looking at total resource fromsituation has continued since 1996, however, the LAT transfer and local tax, the latter’sthe tax-sharing ratio has not been raised. figure increases to JPY 341,000 compared to the former’s JPY 158,000. Overall, some poor or remote jurisdictions end upDISPARITY REDUCING EFFECTS having more financial resources than those As for how Local Allocation Tax is being available in the richest ones. Figure 5 gives anachieved, and how the impact of Equalization overview of fiscal capacity indicators of localcan or should be measured: The Local governments before and after equalization.Allocation Tax Law identifies main purposes Regional disparity shown by Gini coefficientof it: ensuring to perform national standard are virtually eliminated. In conclusion, theservice on a reasonable but minimal basis; and actual degree of equalization was perhapscompensating for disparities in fiscal resources more important before the 1970s, when theand needs. transfer system contributed significantly to equality (Mochida 2001:101-104). Since On the second objective, disparity reducing then regional fiscal disparities have beeneffect of LAT is extremely high. For example, reduced, there has so to speak been lessAichi prefecture of industrial complex of big ‘inequality’ to fix through local allocationcompany like Toyota Motor collects local tax tax, and subsequently the intensity of theof JPY 143,000 per capita, while Shimane, equalization effect has fallen.Figure 5 Degree of equalization (1950-2002)Gini coefficient 0.35 Regional disparity 0.3 0.25 0.2 0.15 0.1 Post-Equalization regional disparity 0.05 0 1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001Note: Regional disparity is defined by Gini Coefficient of per capita local tax in each prefecture and post equalizationdisparity is defined as Gini Coefficient of per capita LAT plus local tax in each prefecture.Source: Mochida, N (2004) Fiscal Decentralization and State-Local Finance , table 1-6.16
  24. 24. CHAPTER 4 INTERGOVERNMENTAL TRANSFERS Another objective of LAT is guaranteeing for the future. The following providesadequate revenue to allow local governments highlights of the key themes and issuesto provide national standard level of public identified (Mochida ed. 2006).services( The Local Allocation Tax Act,article3). Taking primary education and First, the coverage and costs of fiscallong term care for the aged as a example, equalization scheme have increased over thethe central government requires/mandates past decades. Several factors have contributedlocal governments by law to provide these to the upward pressures on the equalizationpublic services. Furthermore, the central system. The local allocation tax becomesgovernment imposes strict and detailed asymmetric in adjusting for the business cycleoperational standard of these responsibilities (Mochida 2004; OECD 2005). The funding(students-teacher ratio, pay standard of pool—namely, a set percentage of the nationalteacher, benefit level of long term care etc.). tax—expands when the economy is growing.Because of this, the central government has Cyclical windfall tax revenue made it possibleobligations to guarantee adequate revenues for to upgrade national standard for local publiclocal governments, thereby allowing them to services. However during downturns, it hasfulfill these responsibilities. The upper level been difficult to cut back these transfers.of government, however, does not pay full Second, with respect to adverse incentivecost of providing the services. Instead, it gives effects, Japan’s equalization system has bothconditional grants covering about one-half strength and weakness. The formula containsin general. Local governments having less tax some strong points that are intended tocapacity are eventually forced into using up contain inefficient behavior. For one thing, it isown tax plus LAT revenues to cover remaing calculated based on standardized tax revenue,cost. Actually, the Local Finance Law requires the entitlements are not affected, even if thethat basic needs of LAT must include local actual tax rate changes. Furthermore, 25cost associated with mandate responsibilities per cent of the estimated tax revenue is not(article 11-2). included into fiscal capacity, thereby giving Overall, LAT focus is not on making sure local governments the incentive to expandall local governments have the fiscal capacity their tax base to some deliver reasonably comparable service to However, LAT transfer hinders localtheir resident at reasonably comparable levels governments’ incentive to provide efficientof taxation. Instead, it is designed to ensure services in a number of areas. The mainthat common standards in outcomes of public problematic points are as follows:services are achieved. LAT is not textbook-likeunconditional grants. Put it differently, the • The local debt service are often includedLocal Allocation Tax is uniquely designed to in the basic need of the LAT. It is donereflect the Japanese reality where the central through the modification coefficientgovernment has strong influence over local for debt services. For example, in somedecision making, thorough detailed conditions regional development projects, 75 perattached specific purpose grants. cent of financial resources were procured by isuing local bonds, but 55 per cent of the debt service was by law addedISSUES to the LAT entitlement in the future. For the past decade, we listened to a wide Mochida(2004) estimate that 36 perrange of opinions and ideas about the Local cent of total local debt outstanding willAllocation Tax and how it should be changed be redeemed by the central government 17
  25. 25. FISCAL DECENTRALIZATION IN JAPAN (Mochida (2004)). To do so provided an clear separation of central and local function. adverse incentive for local governments to Major programmes (education, health, public incur higher levels of debts. works) are formulated by central ministries• Local allocation tax gives premiums and financed by many specific grants. to small local governments (called Therefore, the issue for Japan is not so much modification coefficients for local to change/enlarge the expenditure assignments government size). Originally, this themselves, but to redefine responsibilities for adjustment is intended to take into designing, implementing, and financing these account diseconomies of scale where assignments. fixed cost must be spread among a With this respect, central control through smaller population. However, these specific purpose grants over local choice is of generous premiums are criticized by a critical importance. Specific purpose grants, The Council of Economic and Fiscal called ‘central government disbursement’ Policy for obstructing efforts to merge. (kokko-sisyutukin), accounts for 14.8 per cent Consequently, the modification of total local revenues. It seem to be given to coefficients for local government size were local authorities for purpose relating to public scaled back in fiscal year 2002. works such as road and urban planning, for• As discussed before, quarter tax revenue compulsory education, for social services such is not included into fiscal capacity. This as welfare benefit to low income family. Several reserve gives local governments incentive central government disbursements for specific to expand their tax base. However, facing purpose, in legal terms, can be grouped into with incredible debt accumulations, three broad categories depending on the degree The Council of Economic and Fiscal of central government’ obligation; “payment Policy (CEFP) severely criticized it for for agency tasks”, “obligatory share”, “grant- creating ‘poverty trap.’ Consequently, in-aid”. central government had reluctantly The desirability to use specific purpose grants lifted up the reservation rate for the of first two seems to be almost self-evident. prefectures from 20 per cent to 25 per For instance, where local authorities act in cent in 2002. However, other observers reality as mere agents of central government, argue that this criticism does not have the latter should normally reimburse the sufficient empirical evidence (Horiba, full costs. “Payment for agency task” such as Mochida, and Fukae 2003). They argue compiling national census, registration of that it is systematically impossible for foreigner, quarantine activities can be thought local governments to get more LAT of in this way. For another, with regards to transfer by lowering the effective tax rate functions which have a large spill-over effect or by making less effort to expand local or in which central government seeks to economy, because they are not allowed standardize the level of activities, the cost wide range of discretion over setting rate should be borne or shared by higher level of or changing tax base. government. “Obligatory shares” such as grant for expenditure on public works, education,SPECIFIC PURPOSE GRANTS health, welfare, narcotic controls can be justified by such reasons. The central government remains heavilyinvolved in almost every aspect of local public In contrast, the desirability to use “grant-spending. This is so because, unlike the in-aid” is now under critical review. This isAmerican or Canadian systems, there is no so because, grant-in-aids are, by their very18
  26. 26. CHAPTER 4 INTERGOVERNMENTAL TRANSFERSnature, privileged instruments for the central During this selection process, the centralgovernment to influence the expenditure government often requires modificationspatterns of local authorities and, therefore, to to projects so that it will conform to centralinduce them to act in a manner which accords governments standards. Needless to say, almostwith its own priorities. The way in which all local governments accept the conditionsthis aim can be achieved as follows; first, a required. Conditions accompanying thelocal government submits an application for allocation of grant-in-aid provide the centrala disbursement to central government. The government with powerful method of controlapplication describes the project and explains over the activities of the local governments. Inthe reasons for its importance. The central general, in order not to undermine the localgovernment then assesses all of the applications democratic process, government grants shouldsubmitted by local governments and selects be used as little as possible to restrict localthose projects to which payment will be given. discretion in providing services. 19
  28. 28. CHAPTER 5 LOCAL BORROWING AND BUDGET CONSTRAINTSCHAPTER 5 LOCAL BORROWING AND BUDGET CONSTRAINTS Japan plunged into a long-term recession The law stipulates that gap betweensubsequent to the collapse of the bubble entitlments and funding pool should beeconomy. Japan’s fiscal arrangements have been addressed by increase in tax-sharing ratiostrained since then. The fiscal arrangements (The Local Allocation Tax Law 6-3-2). It is,rely heavily on explicit revenue sharing however, difficult to raise tax sharing ratioarrangements between the national and local of five national taxes during severe recession.governments. As a result of the downturn, Actually, LAT revenue shortage has beenrevenues to be shared have been significantly covered by: 1) ‘ad hoc’ transfer from generalreduced. The growing gap between revenues account of central governments, 2) financingand expenditures at the local level has led to by LAT special account borrowing, 3) ‘extra’an increase in equalization entitlements under local bonds issuance. Let us turn our attentionthe existing formula, while the revenue pool to local bonds and debts.available for equalization purposes has been indecline.table 4 Local debt outstandings, trillion Yen local borrowing from local enterprise total local as percentage government special account bonds borrowing of GDP bonds for LAT 1991 54 0 14 68 14.7 1996 103 14 21 138 27.0 1997 111 15 23 149 28.8 1998 120 17 24 161 31.6 1999 125 22 25 172 34 2000 128 26 27 181 35.2 2001 130 28 28 186 37.4 2002 134 30 28 192 39.4 2005 140 33 27 200 40.0 2006 139 33 27 199 39.2 2007 138 33 26 197 38.5 2008 137 33 26 196 40.0 2009 139 33 25 197 41.8 Source: Ministry of Home Affairs and Communications (2011) White paper on local public finance. 21
  29. 29. FISCAL DECENTRALIZATION IN JAPANDEBT SURGE FISCAL RULE As table 4 demonstrates, local debts has In addition, National laws dictate a numbersoared rapidly since the early 1990s, reaching of fiscal rules to be respected if a localto 40 per cent of GDP in FY2000, from 15 government intends issuing local bonds. Inper cent in FY1990. The trend has remained order to maintain sound level fo bond issues,on a plateau in the 2000s. This is so because the effective debt service ratio is watched.Thelocal governments were encouraged to issue ratio of local debt service (excluding thosebonds by the central government to cooperate though Local Allocation Tax) to the standardwith fiscal stimulus package. As a result, scale of local finance (the general purposelocal debts hit a postwar record and this level resource) is calculated as rare anywhere in the world at the time. Ratio ={(A+B) - (C+D)}/(E - D)While local government borrowing has largelyused to finance infrastructure projects, local A : Redemption of principal and interests ofgovernments’ ability to repay their debts is the concerned yearcontroversial matter. B : Provision to special account, which were used to service public enterprize bondLOCAL BONDS C : Special Revenue used for A In Japan, the Law limits subnationalborrowing to investment purpose. Local D : Debt service, which were included in theFinance Law (article5) stipulates that bonds Standard Fiscal Need in the caluculationcan only be used to finance: 1) expenditure of the LATfor public enterprises (e.g.trasportation, E : Standard scale of local finance (thegas, and water service, 2) investment in and general revenue estimated necessarylending to organizations involved in areas to maintain ordinary administrationof publis interest(e.g.roads, airport, sports), standards)3) loan refinancing, 4) disaster restorationworks ; and 5) expenditure on construction When ratio reaches18 per cent, localof public facilities and purchase of land for governments are required to receive approvalbuilding public facilities. These bonds are from the centralgovernment to issue bonds.called ‘Construction Local Bond’(kensetsu When ratio reaches 25 per cent, most bondchihosai). issues will not be approved. However, the Diet can enact special lawto allow the issuance of ‘Special Local Bond’ INCENTIVE TO EXCESSIVE(tokurei chihosai) in a number of specific BORROWINGsituations. These special local bonds areessentially deficit-covering bonds, intending Why do local debts hit a postwar recordmake up for revenue shortfall of the LAT. and is the level rare anywhere in the worldThese include; tax cut supplymentary at the time ? There are several reasons.bonds(6.1 trillion yen), temporary fiscal First, local governments have played bigmeasure bonds(21.5 trillion yen), revenue role in public investment projects indecrease supplementary bonds(5.1 trillion 1990s. They were expected to cooperateyen) and retirement benefit bonds(1.4 trillion with stimulas package launched by theyen). central governments since economic bubble popped. However, the central government22
  30. 30. CHAPTER 5 LOCAL BORROWING AND BUDGET CONSTRAINTScould not afford to give conditional grants Tax, which could not sufficiently fill thefor infrastructure projects(city hall, parks, revenue shortfall in Local Finance Plan. Ingymnasiums,sanatoriums etc), because of its addition, local debts induced by the centralfinancial distress. Instead, local governments government’s policy goal, is estimated towere encouraged to issue bonds by the central reach about 54 trillion yen (i.e. 39 per centgovernment to cooperate with fiscal stimulus of outstanding local bonds).On the contrary,package. local debts issued according to local own initiatives, is estimated to reach no more In return, the central government gave a than 18 trillion yen (i.e. only 13 per cent ofcommitment to service local bond through outstanding local bonds).future Local Allocation Tax. Dispite a rapidincrease in local debt, fiscal rules on debtservicing costs has not yet become biding, PRIVATE SECTOR CREDITORSsince it deducts bond payment costs, whichare financed through the LAT, from the In Japan, the central government hastotal amount of local governments servicing implicitly guaranteed creditworthiness of localcosts. As a result, most local governments government bonds through 1) dominant rolewere almost under the illusion that their of public institution in underwriting, 2) bonddebts would be redeemed by the upper-level approval system, and 3) fiscal reconstructionof government. Mochida (2004) estimates system. Under these administrative controls,that local governmets could recognize only both lenders and creditors have believed local47 per cent of debt outstanding as their own governments would not fall into bankruptcy.liabilities. However, recent reform initiatives could enhance greater self-responsibility of local Second, the growing gap between revenues governments.and expenditures at the local level has led toan increase in equalization entitlements underthe existing LAT formula, while the revenuepool available for equalization purposes hasbeen in decline. Since FY2001, the centralgovernment has gone halves the cost (gapbetween entitlments and funding pool) withthe local governments, the latter covers itscost by issuing temporary bonds for fiscal gap(rinzi zaisei taisakusai). Cap on the issuance ofthis bond is allocated to each local governmenton the basis objective criteria. It is essentiallydeficit covering bonds. While temporary bond for fiscal gap hasbeen introduced as a temporary legislationwith 3 year term limit, it has carried throughto the present. These debts are estimated toreach 25 trillion yen in FY2008 (i.e. about 18per cent of outstanding of local bonds). Theyhave not be issued according to local owninitiative. Rather, they should be consideredas complementary to the Local Allocation 23
  31. 31. FISCAL DECENTRALIZATION IN JAPANFigure 6 Main creditors of Local Bonds, in percent 100% 90% 80% 70% 60% 50% 40% 40% 20% 10% 0% 1973 1978 1982 1988 1993 1998 2003 2004 2005 2006 2007 2008 2009 2010 other private publicly advertised public cooperation central government sector fund private fund fund fund (FILP)Source: Ministry of Home Affairs and Communication(2011) White paper on local public finance. Who lends to local governments? The FY2007. Dominant role of public institutionanswer to this question is given in Figure 7. in underwriting has gone out of the window.First, it appears that fund rasing from publicand quiasi-public institution has been on a Second, private sector has underwritten andeclining trend, falling to 27 per cent of GDP increasing share of local government FY2009, from 63 per cent in FY1989. Private-sector funds cover about 60 per centThe government has long history to collect of total local bond issue-private bank buysa substantial amount of public fund through 26 per cent and remaining 34 per cent arecredit programmes such as postal saving and offered directly on the market. Private sectorpension fund, and manage these fund to carry picture is dominated by publicly advertizedout national goals. So called ‘Fiscal Investment bonds. 44 local governments issue publiclyand Loan Programme’ (FILP) gave long term advertized bonds. International ratingand low interest loan to local bond market. agency, Moody’s expects the rating of its 12FILP, however, was almost dismantled in rated prefectures and designated cities willFY2001. In stead, the central government remain at Aa2 with a negative outlook, thestarted to issue national bond to raise fund and same rating level as Japanese governmentsublease it to local governments. In addition, bonds, reflecting their belief that centraldirect loan of postal savings and pension fund government would step in to help any localto local government sectors were terminated in government experiencing a fiscal risk.24