Chapter 2
INTERGOVERNMENTAL FISCAL RELATIONS

The national, prefectural, and local governments are bound together by a complex network of fiscal relationships. Only a part of this network consists of taxes. Nevertheless, the whole must be examined and suggestions made for changing even the non-tax sections of it, before a proper system of taxation can be devised.

Our suggestions for change are based on two facts. The first fact is that local autonomy is one of the announced goals of the Occupation and of the Japanese government. The second fact is that local autonomy is far from being fully achieved at the present moment, and has little chance of being achieved unless the fiscal powers of the local governments are strengthened, including a more equal division of power among the richer and poorer areas. "Local" refers both to prefectures and to cities, towns, and villages. (When we wish to refer only to cities, towns and villages we shall use the word "municipalities").

Realistic recommendations cannot be given without some estimate of the amount of additional resources that the local authorities need, if local autonomy is to be developed. We estimate that for 1950-51 the local units would need about 100 billion yen more than they are budgeted for this year, if they were not relieved of any of the cost of the functions they are now performing. ^*1 In fact, however, they should be relieved of some costs they are now bearing, notably with respect to rehabilitation following natural disasters. The entire cost of such rehabilitation should be borne by the national government directly. When allowance is made for changes like this, the need of the local units for additional resources drops to about 80 billion yen.

Not all of this 80 billion yen would in fact represent additional expenditure. Part of it would reflect merely the budgeting of expenditures that are already occurring but that don not now appear in any budget because they are financed informally by so-called "voluntary contributions" and, perhaps, charges akin to service fees. These contributions are for building schoolhouses and for other local functions that the local units want to perform but for which they are unable or unwilling to raise regular local tax revenue. The expenditures financed by these contributions, which are in reality more like taxes, may amount to as much as 40 billion yen this year, though this is a highly uncertain estimate, and the actual total may be considerably smaller. The role of contributions will probably diminish greatly if the localities are given more adequate regular sources of revenue. We assume that, if the changes we recommend are carried out, some 30 billion yen of these non-budgeted outlays will move into the local budgets, to be financed by regular sources of revenue rather than contributions.

Not all of the 80 billion yen needs to be met by added tax revenue, however. We may assume that in 1950-51 the localities will be allowed to borrow somewhat more than the 18 billion yen net they are limited to in 1949-50 (23 billion yen borrowing, minus 5 billion yen debt retirement). Perhaps as much as 35 billion yen, net, could be borrowed in 1950-51. This extra borrowing of 17 billion yen would reduce the additional revenue needed to about 60 billion yen.

In 1949-50 the local units are apparently spending, from all sources, 376 billion yen, including the doubtful estimate of 40 billion yen financed by contributions. The comparable figure for 1950-51, under the plan outlined above, would be 425 billion yen (including 10 billion yen assumed to remain from contributions).

The localities get their present 376 billion yen from several sources. We suggest major changes with respect to each of these, in the course of moving the total up to 425 billion yen.

*1 Supporting data for this estimate are given in an appendix to this report.

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A. Local Taxes

About 150 billion of the 376 billion yen is being obtained from regular local taxes. A little less than half (71 billion yen) goes to the prefectures, and a little more than half (79 billion yen) to the municipalities. Indeed, all of the sizeable local taxes are split exactly 50-50, by the device of having the prefecture impose the tax at a certain rate, while the municipalities add a 100 percent "surtax" to the prefectural tax. (The inhabitant's tax is split not quite 50-50 this year).

These figures are taken from the budget for localities as it was approved last spring, and include an allowance for subsequent increases in rates.

We recommend that this local tax system be altered in four important respects:

1. The total amount raised by local taxation should be increased from 150 billion yen to about 190 billion yen. Without more tax revenue of their own, the localities would continue to depend too much on voluntary contributions or would become too dependent on the central government for money. We recommend that all of this 40 billion yen increase go to the municipalities. It is they that need strengthening, rather than the prefectures, if local autonomy is to develop.

2. The device of municipal surtaxes on prefectural taxes should be abandoned. Each of the two local levels should have its own kinds of tax. The citizens of any locality will then know which set of government officials to hold responsible for the rate set on each tax. We also believe that, under prevailing circumstances, each tax is likely to be more vigorously administered if revenue and administration are concentrated at one level.

3. There should be fewer taxes, at somewhat higher rates, in place of the present medley of taxes.

4. The three major local taxes, the land and house tax (now to be called the tax on real estate and depreciable assets, or "the real estate tax" for short), the inhabitant's tax, and the enterprise tax, should be extensively revised; the yield of the inhabitant's tax should be more than doubled, and the yield of the house and land tax more than tripled. The revenue consequences of these changes are presented in Table 2 in the next chapter. The details of the changes recommended are given in Chapters 11-13.

About 25 billion yen is obtained from rents, fees, and miscellaneous sources. We have not studied these revenue items, and make no recommendations concerning them.

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B. Subsidies (Specific Grants in Aid)

There exists at present in Japan a complex system of numerous subsidies, or grants, by the national government to the local governments. For the FY 1949-50 they will total about 85 billion yen (80 billion yen net, since 5 billion yen is scheduled to be repaid to the central government this year). We believe that the general idea of grants-in-aid is sound, and that the total of such grants should increase somewhat. However, the present system needs to be extensively revised

First, almost all of the 100 percent subsidies, where the national government supplies all the money but the function is performed by local officials, should be abolished. In most of these cases the national government's own officials should carry out the work. In some cases the localities might continue to perform the function, but also defray the expenses. The present system confuses the citizen as to which level of government is really responsible for the activity; it subjects local officials to undue control from the national level; and decisions on how much money is to be devoted to each function give rise to friction between national and local officials. About 10 billion yen is being given this year in 100 percent subsidies.

Second, the amount given in partial subsidies should be lowered. There are some 210 partial subsidies by the national government to the prefectures and localities. They will amount to about 40 billion yen in 1949-50. These subsidies range from 25 percent to 80 percent of the local expenditures for a particular purpose. For example, the national government supplies funds to pay 50 percent of the salaries of teachers in the local elementary schools. Indeed, most of the grants are on this 50-50, or "matching" basis.

Some of these subsidies, called "shares" of the national government, reflect a theory that certain government services are partly of national interest and partly of local interest. They are given to help finance education, local police, and other well recognized functions of government. We believe that national support for such activities should instead be given through a general equalizing grant, described below.

Others of the partial subsidies are promotional in nature, designed to encourage the localities to pioneer in new filed of government service, or in better ways of rendering familiar services. This class of partial subsidies should be retained - provided a general equalizing subsidy is also a part of the system. We suggest that the promotional subsidies total about 15 billion yen or so.

Third, subsidies for local public works, estimated at nearly 35 billion yen this year, might be continued much as at present, except that rehabilitation following natural disasters should be made entirely a national-government responsibility. Such action would drop some 20 or 30 billion yen out of local expenditures; or if it remained, it would be financed by a 100 percent grant.

Fourth, the "distribution tax" should be replaced by a larger, general purpose equalization grant. "Distribution tax" refers to the share of the localities in the personal income tax and in the corporation tax. This share is distributed among localities with some but not sufficient, attention to relative need and ability. The size of the share, expressed as a percentage of the yield, has changed form year to year, chiefly according to what the authorities at the national level thought was needed by the local units. For 1948-49 the share was 33 percent. It is 17 percent for 1949-50. Such a fluctuation is unduly upsetting to local budget plans. But even if the percentage were kept constant, the device would not be a good one, for then the amount received by localities would still fluctuate too much, since the income tax yield is very sensitive to changes in business conditions.

The equalization grant should be computed for each locality separately. It should equal the difference between: (a) what would be yielded by local taxes at certain standard rates; and (b) the minimum cost of providing necessary local services in that locality. In 1950-51, however, and even for a year or so thereafter, this full degree of equalization could hardly be achieved. But even in 1950-51 the grant should be large enough to assure the localities that, in total, their fiscal resources will reach the 425 billion yen figure specified in an earlier paragraph. The equalization grant would thus have to be about 120 billion yen in 1950-51.

A comparison of subsidies, etc., for 1949-50 and as proposed for 1950-51 indicates that the national government's annual contribution to local finances would increase by 22 billion yen^*1, in addition to 20 billion yen or so that it would spend on rehabilitation following natural disasters.

	1949-50 Budgeted	1950-51 Recommended
Subsidies:
100 percent subsidies	10	0
Partial subsidies	40	15
Public-works subsidies	35	30
Distribution tax	58	--
Equalization grant	--	120
Total	143	165

*1 27 billion yen, if the 1949-50 figure is taken net, at 138 billion yen.

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C. Local Borrowing

The amount of local borrowing and the terms on which the loans are contracted directly influence the size of the requisite tax program. Therefore, a few observations on local borrowing are relevant here.

As part of the program to half inflation, new local borrowing was limited, by national law, to 23 billion yen in 1949-50, Since 5 billion of debt is to be retired, the net increase is 18 billion yen. If inflation continues under control, net borrowing of perhaps 35 billion yen could be allowed for 1950-51. Otherwise, too great a strain will be placed on the newly reformed local tax system.

In 1951-52 or shortly thereafter, the limit on total local debt should be changed in form. The best kind of limit is probably one that runs in terms of debt interest rather than debt principal. A locality would be allowed to borrow so long as the annual interest charge (plus amortization of discount) did not exceed some stated percentage -- perhaps 10 or 15 percent -- of its average operating budget for the past three years.

An effort should be made to sell local bonds to the public directly, rather than to the national government's Deposit Bureau. And it should be possible to borrow at lower rates of interest than now obtain.

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D. Local Finance Commission

A permanent commission or agency of some sort is needed to answer questions that will continually arise in national-prefectural-local fiscal relations, questions which cannot be answered in advance, in the law. Such a commission is needed to consider applications by localities to levy taxes which may be appropriate on occasion, but which cannot be safely granted to localities by general law. It should distribute among the localities the limited amount of total local borrowing authorized, as long as that kind of limitation is retained. It should allocate among prefectures the profits element in the enterprise tax, with respect to corporations doing business in more than one prefecture, Maximum rates of local taxes specified in national law could be temporarily suspended by the commission. The commission should be charged with setting the "adjustment" factor recommended in Chapter 12 for valuing farm lands under the revised land and house (real estate) tax. The commission should also make the studies necessary to determine standards of need and standards of ability for the local units under the formula for the general equalization grant. It should assemble continuous series of data on local finances. Still other functions would doubtless be required, in the course of adjusting to the new intergovernmental relations. All in all, this new body would be one of the most important organs of government. It must be so constituted as to represent local interests adequately, something that the existing committees of somewhat similar status seem not to have done.

There are at present two bodies that have authority to national-local fiscal relations; the Local Tax Deliberation Committee and the Local Autonomy Agency. Neither one as it now stands is quite suitable to act as the Local Finance Commission. These boards should therefore be abolished, and a Local Finance Commission should be constituted, approximately as follows: a five-man committee, one member each to be appointed by the President of the Association of Prefectural Governors, the President of the Association of Mayors of Cities, and the President of the Association of Mayors to Towns and Villages, and two members appointed by the Prime Minister. All five would be subject to confirmation by the Diet.

A temporary commission on Local Government Organization should be formed at once to recommend which functions of government can best be performed by municipalities, which by prefectures, and which by the national government -- and which by joint action at two or more levels of government. In the course of this study, this Commission should formulate the details of the changes recommended in the present report concerning the system of 100 percent subsidies.

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E. The Fiscal Program and Local Autonomy

Under the recommendations listed is this chapter, the proportion of total local government outlay that is obtained from independent local taxes is not substantially different from that which is found under the existing system. The proportion that is covered by grants from the national government is likewise not very different. (See Table 1 in Chapter 3.) It might therefore seem that the proposed program did little to strengthen local autonomy. But this conclusion would be based on a misconception of what local autonomy means, in financial terms. We conceive that it means:

1. The possession by the localities, of taxes that are potentially strong enough to support additional demands, if those demands reflect a genuine desire by the local inhabitants for more government services, for which they are willing and able to pay. The present system of independent local taxes is not sound enough to meet such demands if they should occur. Moreover, it is hedged by too many requirements for getting permission from national government authorities.

2. The assurance that the localities will not be at the mercy of a yearly decision by the national government of what the localities need for the coming year. Under the present system, the amount coming to the localities from the distribution tax is, in effect, fixed in just this way, Consequently, the localities can make few if any long-term plans, or indeed even short-term plans. Under the system we recommend, the national government's grants to the localities will be fairly well fixed in amount from year to year. At least, there will be definite rules of the game that the national government must follow.

3. The focussing of responsibility for the imposition of each particular tax and the performance of each particular function. This principle cannot be applied strictly. There must be some sharing of responsibility. But responsibility can be focussed much more than it now is. This action increased local autonomy because it increases the citizen's awareness of what his local government does for him and what he has to pay it for these services. This is an essential step in promoting an intelligent interest in local government.

4. Special support from the national government for the exceptionally poor areas, so that they are in fact, as well as in principle, free to vary the amount of services they supply their citizens with, through changes in their own tax rates. A poor locality that is already exacting the maximum in local taxes just in order to maintain the bare essentials of local government, or not even that much, does not have effective local autonomy. It has no leeway for action. Under the kind of equalization grant that we recommend, such a locality is given enough support so that is gains at least some degree of true freedom of action.

It is, therefore, not primarily in the ratios but in the structure that we place our expectations of a strengthened local autonomy under the program recommended here. If the localities are truly free at the margin of their activities, so to speak -- free to more forward or backward, with the responsibility clearly on them when they do so - then local autonomy can be a reality.

An appendix to this report presents details respecting most of the topics covered in this chapter.

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