Appendix: An Analytical Model of Central and Local Governments in Japan A1 The Local Allocation Tax in Japan
The local allocation tax (LAT) grants are a proportion of national taxes that the central government transfers to local governments. The purpose, in principle, is to balance local revenue sources between the central government and local governments without prejudicing the independence of local governments. The tax ensures smooth local administration.
The LAT grants have three functions.
- (i) To redistribute revenue between the central government and local governments. In particular, where central government and a local government share a function, the grant provides the local government with some of the funds needed to perform its part of the function.
- (ii) To ensure adequate local government revenue sources. If a local government lacks sufficient revenue sources to provide required administrative services, the central government fills the gap.
- (iii) To equalize revenue among local governments. The central government adjusts financial resources so that differences in financial condition among local governments do not affect the level and quality of the administration of services.
Figure 13.A1 describes the Japan’s complicated intergovernmental finance.
In principle, the central government determines the total amount of the LAT grants available to allocate to local governments. The total amount of the LAT grants in the general account is normally calculated in accordance with the “macroallocation rule of the LAT grants,” which is prescribed by the Local Allocation Tax
Fig. 13.A1 Intergovernmental finance in Japan
Act. The percentages in the formula are called the “local allocation tax rates.” For fiscal 2016, the formula is as follows.
Total amount of the LAT grants
= 33.1 % of personal income tax and corporate income tax + 100 % of local corporate income tax + 50 % of liquor tax
+ 22.3 % of consumption tax (as a national tax).
The amount determined in accordance with the macro-allocation rule is distributed as follows: 94 % for ordinary LAT grants and 6 % for special LAT grants. The latter are granted according to special circumstances such as a natural disaster.
A serious issue is that there is no guarantee that the total amount of LAT grants calculated by the Ministry of Finance (MOF) (the supply side) is consistent with the balanced revenue-source shortfall estimated by the Ministry of Internal Affairs and Communications (MIAC) (the demand side). The balanced revenue-source shortfall is computed by totaling the shortfall in the revenue sources of all local governments. In any year, the supply and demand numbers do not equal each other.
Any shortfall in the revenue sources of local governments is covered by an increase in the LAT grants (incrementally adding transfers from the general account, borrowing in the LAT special account, and so on) and an additional increase in issuing local government bonds. These measures mean that there are choices about whether the shortfall is covered by incurring debt on the part of the central government (in the LAT special account) or through the debt of local governments. The latter are called “revenue source measures bonds.”