Braun A. and Kubota, K., 2000, “The Effect of Government Capital on Labor Productivity in Japan’s Prefectures,” Working Paper presented at the University of Tokyo.
Doi, T., 2002, “The System and Role of Local Bonds Permits in Japan,” in Government Deficit and Fiscal Reform in Japan, edited by Ihori and Sato.
Fiscal System Council, 2004, Heisei 17 Nendo Yosan Hensei No Kihonteki Kangaekata Ni Tsuite (Proposal for FY2005 Budget Formulation).
Society of Local Government Management (Chiho Jichi Keiei Gakkai), 2000, Koritsu to Minkan tono Cosuto to Sabisu Hikaku (Comparison of the Cost of Services Provided by the Public Sector and the Private Sector), Tokyo.
Yoshida, Y. K., 1998, Chihou Bunken no Tame no Chihou Zaisei Kaikaku (Reform of Local Government Finances Towards Decentralization), Yuhikaku, Tokyo
Yoshino, N. and Nakano, H., 1996, “Interregional Distribution and Productivity Effect of Public Investment,” Financial Review 41, p.16–26.
Prepared by Dora Iakova (ext. 35365) and Takuo Komori (ext. 37613).
Local governments have discretion to vary the tax rates on their main tax sources within certain limits. For example, prefectures are allowed to raise the tax rate for corporate income tax up to 1.1 times the standard rate and for property tax up to 1.5 times the standard tax rate. There is no upper limit for the personal income tax rate. Local governments are also allowed to impose some minor taxes, subject to approval by the central government.
This Ministry oversees the operations of local governments.
Based on the formula, LAT should be equal to the sum of 32 percent of the individual income and liquor taxes, 35.8 percent of the corporate income tax, 29.5 percent of the consumption tax, and 25 percent of the tobacco tax.
Since 2001, half of the fiscal deficit that remains after the standard LAT amount has been allocated is financed by additional LAT allocation. The other half is financed through local deficit bond issues. Prior to 2001, the gap was filled entirely by additional LAT allocations and special account borrowing. In FY2004, for example, the standard LAT amount based on the formula was ¥11.2 trillion, while the actual allocation was ¥16.9 trillion.
The standard expenditure need is estimated separately for each expenditure item, taking into account its average cost and the cost differentials among different regions (based on factors such as population density, area and geography, and industrial diversification). The local governments’ revenue raising capacity is estimated as the local tax revenue that would be obtained under the standard tax rates determined by the central government.
There is a complex formula that determines the shares that need to be repaid by the central and local governments respectively, but since the LAT covers interest and principal payment for most local debt, full repayment is practically guaranteed by the central government.
The FILP is a government program that provides financing for public policy purposes. Doi (2002) argues that the central government implicitly supports financially weaker local governments with limited market access by allocating a larger share of FILP financing to them (according to his analysis, FILP borrowing is at interest rates slightly lower than that of privately placed funds for the same maturities).
A number of studies have shown that returns on public investment have declined over time (see Doi (1998) and Yoshino and Nakano (1996)). Kondo (2002) finds that rates of return differ significantly for different types of public capital and are relatively low in road construction and agriculture. EPA(1997) estimates that the return to social capital in cities is roughly twice the rate of return in rural areas.
Even the limited freedom to set higher local tax rates has been rarely used. In part, this has reflected policy preferences as fiscal policy has been stimulative for most of the last decade. However, the incentives to reduce local deficits through raising additional revenue are relatively weak, since debt repayment is effectively guaranteed by the central government.
Some credit rating agencies have already started rating local government bonds.