B2 Intergovernmental Transfers in Japan

In particular, in Japan intergovernmental transfers are mainly conducted by using the local allocation tax, whereby the gap between the basic fiscal needs and basic fiscal revenues of each local government is offset by transfers from the central government (see Chapter 13). The criterion of basic fiscal needs in the local allocation tax formula has not been explicitly specified. Thus, the amount of local allocation tax is actually determined by political negotiation among various interest groups and politicians, wherein local politicians have strong bargaining power. Further, local governments do not determine the local tax rates of their respective regions in accordance with the regions’ needs; instead, they seek heavy subsidies from the central government.

As a result, Japan’s intergovernmental finance system is characterized by a substantial amount of transfers from the central government to local governments. The central government subsidizes local governments with an amount that is approximately 5 % of GDP every year. Since local governments depend heavily upon such subsidies from the central government, the former may try to obtain as much money as possible from the latter, irrespective of regional economic conditions.

Comparing the data on Japan’s public works with those of other countries, we can say that local residents in Japan have greater privileges than those in other countries, reflecting the influential role of their interest groups. As explained in Chapter 1, although expansionary fiscal measures have often been conducted in the 1990s, these measures have not produced any expansionary effects on the economy. In particular, agriculture, fishing, forestry, and flood control are allocated substantial financial resources because of the lobbying activities of local interest groups.

In Japan, representatives of the rural regions, influenced by local interest groups and voters, exert political pressure on the central government to allocate higher grants to the rural regions. As a result, the allocation of region-specific privileges in the form of subsidies and public works from the central government has been determined mainly by political factors. Indeed, the lobbying activities of local interest groups and local governments were exaggerated during the 1990s, as shown in Ihori et al. (2011) and in the empirical evidence of Doi and Ihori (2009). This is one of the main reasons for excessive counter-cyclical measures adopted by the government in the form of wasteful public works, and the lack of progress of fiscal reconstruction in the 1990s.

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