Decentralization and Intergovernmental Finance in Japan

Ichiro Aoki
JEL codes: 
PRI Discussion Paper Series

Japans mid-nineteenth century opening-up to Western influence, the so-called Meiji Restoration, drove political leaders to form a politically modern centralized country. Although Japan experienced a number of major decentralization processes under the post World War II Allied occupation, the Japanese government reviewed these reforms after the occupation. In fact during the post WWII era, the centralized system played a major role in establishing a national minimum standard of living.
While political trends in the 1990s favored government decentralization, promotion of decentralization became a challenge for successive Cabinets. In 1999, the Diet enacted the Package Promoting Decentralization Act; this law repealed the delegation system under which local governments are subordinate to the central government. In 2003, the Koizumi Administration created the Trinity Reform plan. Trinity means the decentralization reform process that involves three factors: 1) A local allocation tax grant; 2) A national subsidy for local governments, and 3) A local tax. The package included reducing national subsidies to local governments and transferring tax revenue sources from the central government to local governments.
Both Japans central government and local governments are financially closely connected and both face severe fiscal conditions. Japan has an aging population and the coming increase of social security related expenditures is a huge fiscal challenge. It is financially questionable whether the central government can continue to provide the local allocation tax grants which guarantee financial resources to cover revenue shortfalls of local governments. The central and local governments have to review their budgets with a concerted effort to improve government efficiency.
The theorem on fiscal federalism argues that local governments can provide public services more efficiently and be more responsible to their residents through competition among local governments. However, decentralization in Japan contains two fundamental challenges: heavy duplication of roles and ambiguous fiscal responsibility across levels of government. What is necessary for decentralization in Japan is to narrow the role of the central governments. Furthermore, the central government revenue guarantee function should be limited; it is imperative to establish hard budget constraints at the local government level. The author would like to emphasize decentralization should be compatible with reconstruction of the public finance system.
In the first chapter, the author explores the historical background of the relationship between Japans central government and local governments. Then, in the second chapter, the author introduces the recent Japanese government promotion of decentralization. Thereafter, the author provides an overview of financial relationships across levels of government in the third chapter. In the fourth chapter, the author surveys economic theories on fiscal federalism, whereby the author would like to clarify the advantages of decentralization. Then, in the fifth chapter, the author summarizes the two fundamental challenges between the central and local government in Japan: duplication of roles and ambiguous expenditure responsibility. Finally, the author makes suggestions for promoting Japanese government decentralization mainly focusing on the use of fiscal instruments.