Intergovernmental Finance

In reality, an intergovernmental finance system is likely to be established between systems (i) and (ii) whereby government incorporates the benefits of both systems into a unified system. Namely, central government has the role of providing nationwide public goods and redistribution measures, while local governments have the role of providing local public goods and other local public services.

If the objectives of central and local governments are not consistent with the interests of residents, the above intergovernmental allocation of public finance may not be optimal. Generally, both types of government could fail. Moreover, some local residents apply significant political pressure in order to seek their own fiscal privileges. If local governments are politically weak and influenced by such political activities of interest groups, they may well fail.

In Japan, some local politicians in rural areas often seek their own privileges from their local governments rather than maximize overall residents’ welfare in the regions. Thus, local governments may not be effective at maximizing residents’ welfare in a political economy. If so, higher-ranking governments are required to monitor local governments. In addition, central government should have notable power in terms of intergovernmental finance.

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