Appendix A
FINANCE OF LOCAL GOVERNMENTS

A. Problems of Local Finance

Specifically, the present finance of local government is subject to five grave weaknesses or problems.

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B. Need for Stronger Local Government

The functions of local government are peculiarly close to the people. These functions include such vital services and facilities as education, hospitals, prevention of disease, sanitation, relief, child and maternal welfare, police and fire protection, roads and streets, recreation, housing, and care of defective persons. They are designed specifically to provide opportunity for individuals, better living conditions, greater security, and protection from personal misfortune. The future progress and welfare of Japan, or of any country, depends as much on the quantity and quality of local government services available as upon any other factor.

Local government must be strengthened, moreover, because of its potential contributions to the democratic way of life. With strong, independent, and effective local governing bodies, political power is diffused and placed close to the people rather than centralized in a distant and impersonal national government.

Local government provides a useful vehicle for educating citizens and for training leaders in the arts of democracy. The manner in which local governments are administered can be readily observed and understood by the citizen. He can measure intelligently the relation between the benefits he receives from local services and the costs involved. Habits and attitudes developed at the local level may be expected to influence the conduct of government at the national level.

Local autonomy is also important simply because some tasks can be performed more effectively by small units that are familiar with the peculiar needs and problems of individual localities.

There are, of course, arguments against local autonomy. Sometimes independent local governments are unimaginative, inefficient, or corrupt. Sometimes they make mistakes. Some areas are too poor or too backward to support adequate local services. Indeed most local areas are unable to become completely self-sufficient because the revenue from the kinds of taxes that can be administered locally is limited. For these reasons, the concept of local autonomy should not be carried to an unreasonable extreme.

In Japan, the principle of local autonomy has not been widely accepted as practical until recently. Therefore, even if it is conceded that compromise is necessary in any realistic view of local autonomy, the problem in Japan is still to reduce the dominance of the National Government and to increase the independence of local bides. The next step is clearly to provide adequate and independent sources of revenue for local government, so that substance may be added to the form of local autonomy.

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C. Can Japan Afford Better Local Government?

It is frequently argued that Japan is so impoverished as a result of war that it should not attempt to maintain strong and progressive local governments. However, a strong case can be made for the view that Japan can afford to improve its local government. To be sure, an increase in local expenditures would require corresponding tax revenue to be raised either by the national government or the local governments. The question is: Which is more desirable, less tax reduction or a corresponding increase in local government services? If taxes are reduced, people will have more purchasing power, most of which they will use to try to increase their consumption. But because goods for consumption are largely limited by the supply of food and raw materials, the increased private spending will be used to bid up prices or to increase the amount being spent on inconsequential luxuries. Japan would not be materially benefited by the tax reduction unless its power to produce for the export market would be thereby increased. Such an increase in production for export would occur only to the extent that tax reduction would result in increased capital formation or in diverting productive resources to the export market. One may safely estimate that the extent of such capital formation or diversion of resources to the export market would be small. On the other hand, if the same money were devoted to local government, the result would be a direct investment in Japan's greatest resource, namely, its people. The investment would take the form of improved education, better health, greater security and safety, and expanded opportunity.

There are two ways to increase the standard of living of a people. One is to provide them with more goods for individualized consumption, and the other is to give them more goods for collective consumption. One of the most promising ways of raising the standard of living and the level of welfare of the Japanese people is to increase their collective consumption. This type of consumption can be supplied primarily through indigenous production. It depends only slightly on imports from abroad. On the other hand, any attempt to increase individualized consumption immediately raises the vexing problem of foreign markets. Thus, on purely economic grounds, a strong case for a vigorous and expanding local government can be made.

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D. Division of Functions

At present, the allocation of functions to the three levels of government is complex, and inimical to local autonomy and local responsibility on several grounds:

1. The present division diffuses, rather than fixes, political responsibility for the provision of particular governmental services. It is difficult to tell which unit of government should be held accountable for its stewardship with respect to particular governmental services.

2. The complexity of the present division of functions detracts from the ability of the citizen to understand his government, and in particular to understand how the taxes he pays are returned to him in the form useful and valuable governmental services.

3. Because the National Government participates in so many activities of municipal government, local autonomy is impaired. Moreover, municipal governments sometimes have onerous new duties prescribed for them unilaterally by the National Government often without adequate financial provision. When traditional functions of National Government are transferred to municipalities, the new duties of the local bodies are regarded as work performed for the National Government. It is assumed that in such cases subsidies should be paid and national controls exercised. For example, primary education, police and fire protection, and elections have been transferred as independent functions of local government, yet the attitude prevails that these are national functions being carried on by local government and therefore requiring direct subsidy and national control.

4. Specific functions are in some cases assigned to units of government which are not well-suited to discharging them effectively and efficiently.

We recommend that the division of functions among the various levels of government should be studied in detail, and a reallocation of functions effected. This study should be carried on by a special national commission created specifically for the purpose, and empowered to make recommendations to the Diet. This Commission should be composed of five persons having recognized professional competence in public administration. One member each might be appointed by the President of the Association of Prefectural Governors, by the President of the Association of Mayors of Cities, and by the President of the Association of Mayors of towns and villages. Two members might be appointed by the Prime Minister. This Commission should have funds provided for the employment of technicians and consultants.

The work of the Commission should be based upon the following general principles:

1. So far as possible or practicable, the functions of the three levels of government should be clearly demarcated, and each specific function should be assigned exclusively to one level of government. The level of government would then be fully responsible for performing the function and for financing it from general funds.

2. Each function would be allocated to that level of government which is equipped by virtue of its size, its power, and financial resources to perform it efficiently.

3. In the interests of local autonomy each function would be given to the lowest appropriate level of government. Municipalities would have first priority in the sense that no function would be given to the prefecture or national government which could be performed adequately by municipalities. The prefecture would be given second priority, and the national government would assume only those functions which cannot be administered effectively under local direction.

We recognize that there are difficulties in applying these principles in practice. In many cases, a sharp division of functions would be unwise or even impossible.

Although we have not been able to undertake a comprehensive study a few tentative suggestions will illustrate the possible solutions.

1. Financial and operating responsibility for the entire 6-3-3 school system might eventually be assumed by the municipalities (and their associated boards of education), in a series of steps.

2. Full responsibility for police could be assigned to all levels of municipalities except as national rural police are provided for. The municipalities should be free to determine the number of policemen they will employ. This number should be determined with full consideration of local circumstances and local needs rather than by the allocation of an arbitrary quota.

3. The National Government could well assume full financial responsibility for reconstruction and rehabilitation following natural disasters. However, the actual work relating to locally-controlled facilities might be done by local governments. At present, the National Government assumes part of the burden, but prefectural and municipal governments also carry a heavy load. Because natural disasters are unpredictable and involve sudden and heavy costs, their occurrence tends to demoralize the finances of the affected local bodies. As a result they are forced to borrow, to raise emergency funds, to tax heavily, and to curtail normal expenditures. The problem is one that can met satisfactorily only by the National Government.

4. The tendency of the National Government to assign its work to local authorities, with or without subsidies, should be curtailed. (See Articles 10 to 22 of the Local Finance Law). Many such activities could be assigned with full responsibility to local bodies or carried on directly by the central government -- in some cases through regional offices. There would be great advantages in a clearer separation of state and local functions by narrowing the range of activities in which the local governments serve as agents of the National Government. For example, functions that might be largely taken over by the National Government are statistical services, or agricultural land adjustment, and functions that might be transferred fully to local areas are the conduct of elections, or local planning.

5. In cases where municipalities have difficulty in supporting schools, police, or other activities independently, they should be encouraged to join together cooperatively with contiguous areas. Similarly, adjoining prefectures should be encouraged to cooperate in order to enlarge the scale of particular services, e.g., flood control or university education. The consolidation of municipalities or of prefectures should also be encouraged when desirable for increasing efficiency of operations. In this way, the disadvantages of small scale operations could be overcome.

A special effort should be made to eliminate duplication and overlapping between the activities of prefectures and of large cities within their boundaries for roads, health services and high schools.

These recommendations cover only a few of the many cases where reorganization of local government would be advantageous. They are illustrative of widespread overlapping, duplication and inefficient allocation of functions. Our primary recommendation is that the entire organization of local government, and the division of functions among these levels of government, be subjected to a through study looking toward far-reaching reform and rationalization.

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E. The Local Tax System

In formulating a tax system for autonomous local governments, several basic principles should be considered.

The present system of local taxation in Japan should be reformed in accordance with these principles.

The number of taxes levied by local authorities should be reduced. At present, about 30 different legalized taxes are levied and, in addition, most local areas impose numerous non-legalized taxes -- usually of a petty nature. (Non-legalized taxes are defined as those not specified in law as available to local authorities). For example, a report of the Hokkaido Towns and Villages Association indicated that 77 different non-legalized taxes were being levied by various municipalities in Hokkaido.

In the interests of local autonomy, we recommend that local units be permitted to levy these taxes, as non-legalized taxes, along with other non-legalized taxes which they may choose to levy. We would counsel the local authorities to restrict the number of non-legalized taxes. But we believe that each local body should be generally free to decide this matter for itself. The new Local Finance Commission proposed in this report should maintain general surveillance over the non-legalized taxes levied by local authorities. It should have the power to disallow existing non-legalized taxes, and to disallow the applications of local authorities to levy new ones. Such taxes would be disallowed only when they are clearly opposed to the national interest, for example, when they have the effect of burdensome inland "customs" duties, when they impose intolerable discrimination, or when they interfere unduly with the collection of national taxes. The Commission should be permitted to restrict the financial independence of local authorities only in exceptional cases where the national interest is clearly jeopardized.

The underlying reason for the present tendency of local authorities to make excessive, and perhaps unsound, use of fragmental non-legalized taxes is that they are desperately short of revenue. If they are given access to substantial and dependable tax resources, the problem of non-legalized taxes will be greatly reduced and could be safely entrusted to local determination except in unusual cases.

The precise rates of particular local taxes should not be prescribed by the National Government. Since local taxes would be largely independent of national taxes, under the program recommended here, except for the income element in the inhabitants tax, local authorities would not be competing with the national government for identical tax bases, and would be less likely to endanger national tax revenues. Each locality would be prevented from raising its taxes far out of line with those of other localities because of the pressure of its citizens and because of a desire to avoid driving enterprise and wealth away from the locality. Each locality would be deterred from shirking its financial responsibilities by the requirement that it must raise a reasonable minimum of total revenue, in relation to its tax base, in order to qualify for the basic equalization grant from the National Government. (This basic equalization grant, discussed below, would replace the present distribution tax.)

It has been argued that the local tax system should be composed of taxes having elasticity of yield. By elasticity is meant the capacity of the tax to produce increasing revenue under inflationary conditions. The widespread concern with elasticity is due to the fact that the country has just experienced a devastating inflation and the particular local taxes in effect have been found unresponsive to rising prices. The proposed local tax revisions would add somewhat to the elasticity of the local tax system, but would not make it exceptionally responsive to changing prices and employment. Indeed, elasticity is in some respects a disadvantage for local taxes. It implies contraction of revenue in times of falling prices and unemployment. Rather, the major factor of adjustment in local revenues should be the equalization grant. The onus of adjustment to changing economic conditions would then be placed upon the National Government, which is the only level of government that is fully equipped to perform that function.

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F. Financial Requirements of Local Government

In general, the financial difficulties of local government are due to the combined effect of increased responsibilities and restricted revenues. Their increased responsibilities have resulted from war damage and other war-related demands for local services, and from the transfer of schools, police, and fire defense to the local authorities. The restriction on their revenues has been due to the failure of some taxes (notably the land and house tax) to produce revenue in proportion to rising prices and costs, to the unexpected halving of the percentage of the national income and corporation tax distributed to them and to restrictions on their power to borrow.

There are many evidences of the financial squeeze on local government. Local officials and the informed individuals are in almost unanimous agreement that the present financial position of local government is unsound and in urgent need of repair. Many mayors and village chiefs, in some areas as many as 10 per cent, have resigned partly because of financial inability to carry out their programs. Most local authorities have resorted to fragmental non-legalized taxes which are universally deplored but nevertheless resorted to in emergency. Examples are; garden tax, sewing machine tax, electric fan tax, paper manufacturing machine tax, tank tax, sleigh tax, bee-keeping facility tax, ice storage tax, driftwood tax, charcoal kiln tax, mah jongg set tax, and lumber-loading machine tax. Some local areas are reported to be financing this year's expenditures out of revenues collected for next year's taxes. Many prefectures are trying to gain revenue from lotteries, and are requesting the right to legalize other forms of gambling for revenue purposes. Other local areas are reported to have relied on voluntary unpaid labor of citizens as a means of getting work done that could not otherwise be financed. Many local loans, though nominally for capital purposes, are used to meet operating deficits.

A more important indication of financial stringency is the universal practice of obtaining quasi-voluntary contributions and membership fees to defray costs of local government. Contributions have been collected for many purposes, but most frequently for schools, police, fire defense, and roads. Estimates vary as to the amounts of contributions being collected. The amount that appears in the budgets of local governments averages only 1 to 2 percent of total revenues. But most of the contributions do not appear in formal budgets. In the aggregate they probably total 5 to 10 percent of all local revenues. The Local Autonomy Agency has estimated the total at \40 to \50 billions.

Contributions should not be sweepingly condemned. Within reasonable limits and if collected on a truly voluntary basis, they are a legitimate supplement to public revenues -- especially for education, health services and welfare activities. But, in Japan today they are being used for purposes beyond these; the method of collection is such that they are not wholly voluntary; and they are regarded by local officials and citizens alike as a necessary evil which they wish to eliminate at the earliest possible time. One must conclude therefore, that the wholesale use of contributions is a strong indication of the financial weakness of local authorities.

The present stringency of local finance is also indicated by a comparison of present expenditures of local government with pre-war expenditures. The total expenditures of local government during the period 1933-34 to 1935-36 averaged \2.4 billions; and during the period 1936-37 to 1940-41 they averaged \2.7 billions. In terms of the present value of the yen, these figures would be somewhere between \400 billions and \500 billions, the precise figure depending on the particular price index employed. The actual expenditure of local government for the year 1949-50 are estimated at \350 billions, which is considerably lower, in real terms, than the most conservative estimates of the adjusted pre-war level. Hence, local government has considerably less real purchasing power than it had before the war -- despite the fact that responsibilities of local government have expanded as a result of the war-related costs, the transfer of education, police and fire-defense to local bodies, and population increase. That local governments have been able to operate with relatively inadequate funds has been due in part to the fact that salaries of governmental employees have not increased in proportion to wages in other industries. This differential cannot be maintained indefinitely. While it is in effect it exerts a harmful influence upon the efficiency and quality of local government.

How much additional revenue should the local bodies have under present conditions in Japan? There is no objective answer to this question. However, a tentative estimate of the general magnitude may be submitted.

First, the present combined budget of all local governments has a purchasing power between 12 percent and 30 percent smaller than that of the corresponding budget of pre-war years. Second, local governments have assumed new responsibilities and have been subjected to new costs -- notably for education, police, fire-defense, war rehabilitation and greater self-government. Third, the population to be served is about 19 percent greater than in 1935, and the general facilities of local government are in a dilapidated condition. To bring local expenditures up to the pre-war level and in addition provide even modestly for the factors of increased cost and increased population would require an increase in revenue of at least \100 billions.

This figure corresponds approximately to the results of a study by the Local Autonomy Agency, showing that local governments currently are in need of \ 80 billions of additional revenue even if the present rate of contributions is continued. If the more onerous contributions were to be discontinued, further revenues of at least \ 20 billions would be needed, making the total requirements \ 100 billions.

A study of the Hokkaido mayor's association also placed the figure at about \ 100 billions. Numerous discussions with local officials and inspection of local facilities has reinforced the view that a figure of around \100 billions would be required to place local government and local autonomy in a reasonably secure position.

If present restrictions on local borrowing were to be relaxed somewhat, some of the needed \ 100 billions could be obtained without resort to increased local taxes or grants from the National Government. Moreover, if the National Government were to assume financial responsibility for disaster rehabilitation, as recommended above, the needs of local government would be diminished by perhaps \20 to \30 billions.

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G. Subsidies

Subsidies are an important element of local finance in Japan. For the fiscal year 1949-50, they are estimated at \80 billion yen. About 350 separate subsidies, under the control of 14 different Ministries, are in effect. Subsidies are of three different types (1) 100 percent subsidies, (2) partial subsidies and (3) public works subsidies.

The 100 percent subsidies are paid to compensate local authorities for services which are considered to be performed by them for the National Government. Approximately 130 such subsidies, totalling \ 10 billion yen, are currently in effect. The largest items are for expenses relating to termination of the war, statistical work, agricultural adjustment, and agricultural land commissions. We recommend that the activities for which 100 percent grants are currently being paid be re-examined by the proposed commission on Local Government Organization to determine whether some of these activities might not well be transferred to the central government or the cost transferred to local government. Further we suggest that the practice of requesting local governments to perform services for the National Government be discontinued in the future except in cases of clear necessity. Present practice is undesirable because (1) it tends to confuse the responsibilities of national and local government, (2) it places local authorities unnecessarily under the detailed control of the National government, and (3) it leads to petty friction between local and national officials in the determination of the amount of the subsidies. For such 100 percent subsidies as remain in force, the National Government should pay sufficiently to cover a fair share of local overhead as well as direct costs.

About 210 partial subsidies are in effect totalling about \37 billions. These subsidies range from 25 to 80 percent of local expenditure for particular purposes. For the bulk of them, the payment is 50 percent of expenditures which means that local governments must match the subsidy payments of the National Government. For a few subsidies, the total amount is fixed instead of being computed as a percentage of expenditure.

The partial subsidies have been developed under two theories. The first is that certain services of local government are partly of local concern and partly of national interest, and that the National Government should share in the cost according to the degree of national interest. Accordingly, some of the subsidies are referred to as the "shares" of the National Government. Among those so labelled are the subsidies for education, local police, extermination of rats and insects, and prevention of communicable diseases. The second theory is that partial subsidies may provide an inducement for local authorities to undertake particular functions which they might not otherwise be willing to perform. Presumably, the term "subsidy" is used to designate this type of payment.

The first of these two theories is objectionable as a basis for distributing national aid to local authorities for largely the same reasons that the 100 percent subsidies are objectionable. This theory is also objectionable for other reasons. (1) It provides no method of equalizing the burden of localities having different financial ability. The subsidies to the richest area are at exactly the same percentage of cost as the subsidy to the poorest area. As a result, the poorer areas are required to assume undue burdens, or are induced to neglect unsubsidized activities in order to qualify for subsidies. (2) There is no objective way to determine what percentage of a given activity is of national interest and what percentage is of local concern. Therefore, the selection of the particular activity to be subsidized and the determination of the percentage of national support are likely to be arbitrary. This arbitrariness is illustrated by the fact that a large majority of the present partial subsidies are at 50 percent of expenditure. The figure 50 happens to be a convenient round number which is selected because there is no basis for deciding upon a more "accurate" figure.

In view of these considerations, we recommend that the partial subsidies based on the theory of dual responsibility be sharply curtailed and that full responsibility for these activities be assigned to the level of government best equipped to undertake them. Financial adjustments would then be made through the equalization grant.

The second of the two theories underlying the partial subsidies has more merit. This theory is that partial subsidies may be used to encourage local authorities to undertake particular functions which they would otherwise not assume or to include them to improve the quality of local services in particular respects. Such subsidies might be called "promotional subsidies".

Through the use of promotional subsidies, accompanied by consultation and technical assistance, the National Government can exercise leadership and provide inducement for improving local government and enhancing public welfare. In doing so, the National Government need not assume full responsibility for the activities involved nor encroach unduly upon local autonomy. The subsidy would be regarded as a tool of leadership and not as an instrument of domination. For subsidies to perform this function, they should not be paid for the regular and fully-assimilated functions of local government. For example, they should not be paid for ordinary teachers' salaries or for the administration of routine health services or for the control of weights and measures. These functions should be financed through local taxes supplemented by equalization grants. Promotional subsidies should be used, rather, to stimulate local authorities to develop new or improved services, for example, public housing, the special education of handicapped children, imaginative programs to eradicate tuberculosis, high school scholarships for gifted children, etc. In granting such subsidies, the government would expect that eventually the subsidized activity would be assimilated into the regular functions of local governments throughout the country. At that time, the specific subsidy would be withdrawn and the finance arranged in the ordinary manner through local taxes and equalization grants. Then, new objects for subsidization would be adopted. In this way, the quality of local government would be steadily improved and the welfare of the Japanese people consistently increased.

If a sound system of equalization were in effect, promotional subsidies of the type suggested would be available to poor as well as to rich areas. The revenue to defray ordinary costs of government would be equalized throughout the country. Each local authority would then be able to finance its share of the subsidized activity by an increase in taxes involving about the same addition to aggregate financial burden. And all localities would be in a position to decide, on about the same terms, whether or not to accept the subsidy and the corresponding increase in local tax burdens. On the other hand, if subsidies were granted without prior equalization of financial resources, as it currently the case, the subsidy would tend to place increasing burdens on the already overburdened poor areas.

In order to avoid the possibility that subsidies may have the effect of stimulating activity along subsidized lines at the expense of the ordinary activities of government, proffered subsidies should be limited to an amount that is possible for local areas to accept without financial stringency in meeting the local share.

The third class of subsidies, payments for public works, are estimated at about \33 billions for 1949-50, of which \18.5 billions is for rehabilitation following natural disasters, and \14.5 billions for other public works.

Subsidies for natural disaster rehabilitation are currently paid at the rate of two-thirds of the cost of the work resulting from major disasters. The works eligible for subsidies includes principally reconstruction of dikes, roads, harbors, irrigation facilities, and the like. It does not ordinarily include the repair of buildings. Our recommendation regarding disaster subsidies is that the amount should be increased to 100 percent of the costs involved, and all kinds of rehabilitation work should be included. The National Government should budget annually an amount equal to the estimated average cost of natural disasters during the preceding five years, and utilize this fund to defray all public costs incident to floods, typhoons, earthquakes, and similar calamities. In case the budgeted amount were not completely expended in any one year, the balance remaining ah the end of the year would be used for debt retirement. This recommendation, if carried out, would provide a national insurance system against disasters. In the actual operation of the plan a definition of what is meant by a "disaster" should be liberal, but should not include minor damage amounting only to a small percentage (say 5 to 10 percent in any one year) of the budget of affected localities.

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H. Equalization Grants

We have recommended that tax revenues available to local authorities be substantially increased, that subsidies be decreased, and that some of the present local expenditures be assumed by the National Government. The balance of the revenue required by local authorities should be met by an equalization grant. This grant should be distributed in such a manner as more nearly to equalize both the tax burdens and the quality of local services among local areas having differing taxable capacity and differing needs.

The concept of an equalization grant is not new to Japan. The local distribution tax is designed to provide equalization. The local distribution tax law provides that a certain percentage of revenue derived from the national income tax and the corporation tax shall be distributed to local authorities. Under the law of 1948, 33.14 percent of the yield of these two taxes was to be distributed. In the recent curtailment of the national budget, however, this percentage was halved. The estimated amount to be distributed in 1949-50 is \57 billions.

In practice the percentage to be distributed varies from year to year in an unpredictable manner. Today local officials are universally bitter regarding the decision to halve the distribution tax after they had planned their budgets on the expectation of receiving the full amount. They lack confidence in the distribution tax, the amount of which they feel will be determined each year according to the degree of stringency in national finance and the dictates of the National Government. But even if the percentage remained fixed from year to year, the fluctuation in receipts would be too great, for the income taxes are very sensitive to changes in economic conditions.

One-half of the distributed amount goes to prefectures and one-half to municipalities. The distribution of the funds among individual local authorities is determined by means of a formula which includes factors relating to local taxable capacity and to local financial need. The formula is intended to give larger amounts to poorer local areas or to areas having greater needs, and smaller amounts to wealthier local areas or areas in which needs are less urgent. Thus, the intended effect of the distribution tax is to reduce inequalities in the tax burdens and in the availability of services as among poor and rich local areas.

But the formula contains several arbitrary features that do not necessarily reflect actual financial capacity or the needs of different local areas. For example, one-half the distribution tax is paid to the prefectures and one-half to the municipalities. This particular division is a mere convenience and is not based on a study of the relative needs of the two classes of local areas. Most competent observers believe that under this division the financial position of the prefectures is made substantially stronger than that of the municipalities. Similarly, several arbitrary adjustments in the formula are made for cities of varying sizes of population.

To overcome these objections, the distribution tax should be converted into an equalization grant paid out of the general funds of the National Government. The aggregate amount of this grant should be determined through studies of the capacity and need of local authorities under reasonable standards. The distribution to local areas should be made in terms of a formula which gives full recognition to differences in capacity and need.

The method of distributing the grants would be similar in principle to that now used in the distribution tax formula. Today, however, the problem is approached from the point of view of the National Government in terms of its financial needs, resources, and administrative convenience. We recommend the total amount to be distributed and the method of distribution be determined more nearly in accordance with the needs and financial resources of the local governments.

The necessity for equalization arises from the fact that the financial resources, the need for services, and the cost of particular local activities vary widely among different local areas. In Japan, for example, the per capita taxable capacity of some prefectures is 3 to 4 times that of others, and the difference may be as much as 10 to 1 between the richest and poorest municipalities. Unfortunately, the areas requiring the most local service, namely, those in which there are the most children, the highest incidence of disease, the largest crime rate, and the greatest need for unemployment relief, are likely to be the precise areas having the least taxable capacity. The result is that poor localities are subjected to crushing tax burdens to maintain low standards of service, whereas rich areas may bear lighter tax loads to support much higher standards of local service. These differences are not only unjust but undesirable in their effects on individual and national welfare. The injustice arises from the differences in tax burdens imposed upon persons similar in all respects except that they live in different jurisdictions. The effect on national welfare arises from the inability of poorer localities to maintain education, health services, roads, welfare activities, etc., at an adequate level.

Under full equalization, grants would be determined by relating the financial resources of each local authority to its need for revenue. The amount to be paid to each locality would be its calculated total need for revenue assuming that it is to perform standard services on a reasonable but minimal basis, minus its calculated financial resources expressed as the yield of available taxes at reasonable standard rates. The total amount to be distributed by the National Government would be the sum of the amounts to be paid to the separate local authorities.

The equalization grant of each local area would be computed by means of a formula. The formula would contain two parts, the first relating to the measurement of the local need services, and the second relating to the measurement of local financial ability. As with the present distribution tax, the measurement of need would vary among different classes of local authorities according to their responsibilities, and the measurement of ability would vary according to the kinds of tax resources at their disposal. Separate calculations would be made for prefectures of various classes and for municipalities of different classes.

The financial need for each item of local service would be computed as the number of units of the service to be rendered multiplied by the standard cost per unit of providing the service at an acceptable but minimal quantity and quality. The total financial need would be the sum of the amount needed for all services combined. This computation would not imply that the local authority should limit its expenditures to the amount determined as its total requirement. This amount would merely be used in the calculation of the equalization grant. The local government would be free to exceed this standard and would be encouraged to do so through the influence of the central government and through the use of promotional subsidies. The local authority would be required, however, to spend at least the calculated total amount in order to qualify for the grant.

The financial capacity of each local tax would be computed as the amount of revenue that the tax would yield if levied at a standard rate with standard levels of assessment and collection. The total financial capacity would be the sum of the yields of all taxes, assuming that each was levied at the standard rate. The standard rate in each case would be a reasonable but minimal rate. The standard would be set low enough so that the local authority would be able to exceed the rate if it wished to raise more than the minimal level. There would be no implication that the local authority must actually levy each of the taxes at just the standard rates. They would be free to apply rates either below or above the standard. The only requirement, to qualify for the grant, would be that they raise total revenue at least equal to that which could have been produced by the standard rates.

Ideally, in calculating need, the formula would include every item of local government services, and, in computing ability, would include every item of revenue. In practice, however, only the main items of local services would be considered separately in measuring need, and all other minor services would be lumped together as a unit. Similarly, only the principal revenue sources would be considered separately in measuring ability, and all other minor sources would be treated as a unit.

It is sometimes argued that equalization would undermine local autonomy. It is true, of course, that any payment by the National Government to local government makes local authorities dependent and subjects them to restrictions and controls. The equalization grant, however, if the kind of grant which minimizes detailed national control of local bodies.

In particular, the equalization grant involves less detailed control than specific subsidies for particular purposes. To qualify for the grant the local authority must spend with reasonable efficiency an amount (including the grant) at least equal to the standard need, thus providing a minimum level of local service. Also, it must raise at least the amount of revenue that could be obtained by levying the standard taxes at standard rates, thus assuming its fair share of local costs.

Beyond these two limitations, the local authority may be completely free to decide on the kinds and amounts of local services to provide and on the kinds and rates of taxes to levy. On the other hand, if such freedom were likely to be abused, various additional conditions could be imposed, for example the requirement of specific standards for education. The equalization grant offers great flexibility in that the number of restraints or requirements imposed by the National Government may be reduced to a bare minimum or may be applied to any desirable degree. We would strongly recommend that in Japan today, where one of the major problems is to develop a vigorous independent local government, national controls in connection with an equalization grant be reduced to a minimum. It would be better to err on the side of excessive freedom than on the side of excessive restrictions.

The degree to which the equalization grant might impair local autonomy would vary with the amount of the grant and the resulting extent of local dependence. It would be desirable, therefore, to restrict the grant to the smallest amount that would be consistent with equalization. If this were done, some of the richer local areas would not ordinarily receive grants. This in turn requires that local authorities be given productive independent local taxes.

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I. Implementation of Equalization

Local government in Japan faces a crisis. More money is needed, quickly. In view of this urgency, it is not practicable to wait for the development of a full-scale system of equalization grants. Therefore, we recommend that the equalization plan be adopted as a long-range objective but that immediate steps be taken to put local government in a sound financial position. These steps should be consistent with an contributory to the development of a full equalization scheme over the next two or three years.

We advise against continued use of the present distribution tax formula. The transition to a new type of scheme should be made when the total amount of local finances are being substantially increased. At this time the absolute amount of the revenue of most local authorities will be increased; hence the new plan will be received favorably. If, on the other hand, the transition is made later, when there is no increase in the aggregate amount of local revenue, those local authorities whose funds are cut will resist the change, and the reform may become politically difficult.

The new provisional formula for 1950-51 should approach the ideal of equalization as closely as existing data permit. The classification of local units now used in the distribution tax formula would be appropriate (perhaps with some further sub-classification on the basis of population), namely, prefectures with large urban populations, other prefectures, cities of more than 500,000 population, other cities, towns and villages with police, and towns and villages without police.

For each local authority of each class, the estimated revenue from major available taxes at reasonable standard rates would be computed. This amount would be adjusted by a standard percentage to allow for minor taxes and other sources of revenue. The result of this calculation would measure the financial capacity of each local area.

For each class of local authority, the standard cost of each major local service would be estimated. For example, the standard cost of education in a given class of local authority would be based on the amount required for teachers and other salaries, supplies, equipment, maintenance, new construction, etc., per pupil in the kinds of schools under the jurisdiction of that class of local area. Similarly, the standard cost of police would be the per capita amount required to maintain a standard police force. The standard cost of roads in cities, towns and villages would be based on cost per capita, but in prefectures on the cost per mile of different kinds of roads. The standard cost of health services might be based on population and on the local incidence of disease. The standard cost of welfare service would be based on population and on the amount of unemployment. Clearly, the setting of the standard amounts would be guided by present actual expenditures of local authorities of each class.

Having arrived at standard costs for each type of service in each class of local authority, these standard costs would then be applied to each particular locality. For example, if the standard cost of elementary education in small cities were determined to be x yen per pupil, the need of a given city having 2,000 elementary pupils would be 2,000 x yen, and similarly for other services. Adding the need for the various major services, and adjusting for minor services not included in the calculations, would give the total financial need of the locality.

When total financial capacity is subtracted from total financial need, the difference would be the basis for computing the equalization grant of that locality. (Zero or a minus figure would simply mean no aid) The total amount to be distributed by the National Government would be divided among all local authorities in proportion to the amount of the differences between financial need and financial capacity.

For the year 1950-51, the calculation of financial capacity, and particularly of financial need, would be imperfect. Adjustments would be required to provide for special circumstances. Accordingly, a present provision of the local distribution tax permitting 10 percent of the total to be distributed for special circumstances and emergencies might be continued at least temporarily.

The Local Finance Commission would meanwhile begin a continuous study of local services in order to develop authoritative measures of standard local costs. This would involve the analysis of local services and of costs for the performance of these services. As a result of these studies, the basis for computing local financial need would be steadily improved and the computation of the grants would be placed on an increasingly objective basis. These studies would be important, also, in other ways. They would aid in aim improving local government. The costs of different local authorities could be compared, and sources of waste and inefficiency detected. The people of local areas could determine whether they were getting full value for the money spent on local government. And by having detailed information on local affairs, the National Government would have a basis for directing its subsidies into the more fruitful fields, and for determining the total amount that should be appropriated for equalization grants.

Similar studies of the revenue collected by local authorities from various taxes would aid in determining local financial ability, and would help to detect cases of inefficient local tax administration.

When these studies had progressed sufficiently to provide reliable data on standard costs and standard revenue yields, and when the National Government's finances had reached a firmer base than at present, the amount to be appropriated each year for the equalization grant would be equal to the difference between the aggregate standard needs of all local authorities and the aggregate standard financial capacity.

In times of inflation or depression, the amount of the grant would automatically change to meet the financial problems of local government. The burden of adjustment to changing economic conditions would fall upon the central governments, where it belongs, rather than upon the local governments, which do not have the facilities or powers to adapt readily.

The amount of the equalization grant of each locality should be computed at the beginning of the year in which it is to be paid. It should be paid on a quarterly basis during that year. At the end of the year, in connection with the financial payment, adjustments would be made to take into account the differences between actual tax potentials and the potentials that had been estimated at the beginning of the year.

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