Below are the provisional minutes of Forum #9, prepared by the Secretariat of the ESRI Economic Policy Forum (for details, see the entire discussion at our Japanese website).

Date	July 17, 2002, 14:30-17:30
Panelists	Yoko Kimura	Council Member, Local Finance Council
	Sachio Konishi	Professor, Graduate School of Economics, Kwansei Gakuin University, Institute for Industrial Research
	Shin Saito	Professor, Graduate School of Economics, Osaka University	(Keynote speech)
	Naohiko Jinno	Professor, Graduate School of Economics,Tokyo University	(Keynote speech)
Moderator	Toshihiro Ihori	Executive Research Fellow, Economic and Social Research Institute, Cabinet Office,Government of Japan
Language	Japanese only

   At the beginning of the discussion, Professors Saito and Jinno made the keynote speeches.A panel discussion was then held, including questions from the general public and opinion exchange.
 

1.  Outline of the keynote speech by Prof. Shin Saito (Graduate School of Economics, Osaka University)
 

(1)  The four main points are as follows:
 

• Local governments need local taxes that will become their independent revenue sources.
   
• It is necessary to cut expenditures of the local governments in line with the promotion of efficiency. It is also necessary to review the distribution of roles between local and central governments based on the subsidiary principle.
   
• How appropriately do local governments use revenues, including transfers of tax resources?
   
• The assessment system and information disclosure are essential in determining whether transferred tax resources work well or not.
   

(2)  The present situation in local public finance (Appendix, Table 1)
 

• The deficit of primary balance of the local governments is not that big compared to the central government.
   
• The expenditures of local governments have not declined, even after the collapse of the bubble economy. Expenditures declined for the first time in fiscal year 2000, but it was primary due to the drop in ordinary construction works expenditures that were closely connected with measures by the central government to stimulate the stagnant economy.
   
• Expenditures greatly exceed local taxes and depend highly on local government bonds. (approximately 11 percent in fiscal year 2000)
   
• The rigid structure does not allow adjustment of expenditures, even if tax revenues drop. Reviews of expenditures have never been promoted . With the introduction of project evaluation, some steps have been taken toward making reviews a reality, but the extent of their effect is still uncertain. One reason behind the rigidity of local public finance is probably the enforcement of substantial regulations by the central government.
   

(3)  Transfers from the central government
 

• A Local Financial Plan specifying the local fiscal resources is the basis for tax allocation, the issuing of local government bonds, and other local finance policies. The important issue that requires a review is how expenditures are estimated in the Local Financial Plan. As there are many regulations from the central government, it is necessary to review them in conjunction with deregulation.
   
• In this era of decentralization, the part uncovered in the Plan – the part"outside the framework" – is becoming increasingly important. This part includes taxing at an excessive rate, the fiscal resources of institutions without Local Allocation Taxes, and the right of autonomy on taxation.
   
• If we want to change the current framework – in which the central government regulates local governments in return for guaranteeing the total amount of revenues – it is important to reduce the framework itself and to enlarge the part outside the framework.
   
• The share of Local Allocation Tax in the total amount of revenues of the local governments increased from 16.2 percent in fiscal year 1993 to approximately 23 percent, including the Special Local Allocation Tax, in 2000. This rapid expansion represents a serious problem. Excessive conjunction with economic stimulation measures and the excessively strong function of fiscal adjustment are often pointed out as reasons for this expansion.
   

(4)  Direction of the reform
 

• Well-known Italian scholar Vito Tanzi stipulates that it is possible to reduce public spending to 10 to 20 percent of GDP.
   
• If we look at the local government from the standpoint of economics, we see aspects such as regional monopolies and regulated industries. Some kind of analysis of these aspects is probably possible based on the previous research results of monopolies.
   
• On November 2, 2001, the Council on Economic and Fiscal Policy raised the issue of revision of increasing compensation of the Local Allocation Tax for smaller local governments.
   
• According to an estimation of the fairly recent research using the frontier function, 20 to 30 percent cuts in expenditures are possible, including other effects.
   
• Compensation methods for fiscal resources should be changed. Until now, compensation of an average level was a principle, but it is now unnecessary to compensate local governments that do not make efforts.
   
• Reduction in the budget deficit from the view of both revenues and expenditures must be considered.
   
• Economic stimulation measures should basically be the responsibility of the central government. In the opposite sense, however, governmental activity cannot be independent from the level of economic activity.
   
• The government’s regulations should be reviewed. It is also necessary to think about the accountability of local governments. In that sense, works that are not deregulated could be returned to the central government.
   
• Establishment of a system that allows local governments to fulfill marginal fiscal responsibility is crucial. For this reason, tax reform and tax resource transfer, especially concerning the "unintended" reallocation of tax resources by the collapse of the bubble economy, are indispensable. Moreover, the right of autonomy on taxation is important, but the present situation does not leave much hope for increases in revenues. What is more important is the adjustment of tax rates on the existing tax items. Concerning bond issues by local governments, each individual effort should be assessed on the market.
   
• Administrative evaluation and information disclosure are essential for reforms. These functions today are insufficient. It is necessary to establish a more thorough assessment system and to link it to the budget system.
   

2.  Outline of the keynote speech by Prof. Naohiko Jinno (Graduate School of Economics, Tokyo University)
 

• Fiscal adjustment can be divided into vertical fiscal adjustment and horizontal fiscal adjustment. This is a German concept.
   
• A fiscal adjustment system was implemented during Erzberger’s reform in the Weimar Republic in 1920. Popitz is said to be the father of this system. Germany, unlike the United States, adopted a cooperative federal system; it collects taxes and allocates them between the national and local governments at a fixed rate.
   
• Vertical adjustment means adjustment between national and local governments; horizontal adjustment means adjustment among regions. Allocation of administrative duties between national and local governments requires the decentralization of taxation rights as well (vertical fiscal adjustment).
   
• As a result of allocated administrative duties, local governments will need to adjust fiscal demand; it will therefore become necessary to adjust taxation power among the local governments (horizontal fiscal adjustment). (See resume 2)
   
• According to this concept, horizontal fiscal adjustment is impossible without vertical adjustment. In other words, the idea that the reform of the Local Allocation Tax System is first of all necessary is wrong.
   
• To decentralize horizontal fiscal adjustment,it is necessary not only to distribute administrative duties to the local governments but also to address the determination and the expenditure implementation.
   
• An additional problem is the deviation between the administrative duties and the right of local governments on taxation.To promote the decentralization of the government,it is necessary to dissolve this mismatch.
   
• EU integration entailed changes in the role of the nation–state. The European Charter of Local Self–Government of 1985 prescribes the scope and finance resources of the local authorities based on the subsidiary principle. At present many countries have approved ratification. The same Charter was proposed in the United Nations, but it eventually failed due to objections from the United States and China.
   

3.  Panel discussion

(1)  Comments

(Yoko Kimura, Council Member, Local Finance Council )
 

• Japan’s aging population, combined with the diminishing number of children, causes administrative demand in the immediate surroundings of citizens; thus, citizens must make their own decisions concerning their immediate surroundings.
   
• Will all local authorities be able to perform the same duties whether the population is diminishing or increasing? Is the present system sustainable?
   
• I think marginal fiscal responsibility is feasible even under the present system. Until now, the deficits of local finance resources were covered by Local Allocation Taxes, local government bonds, cuts in expenditures, disruption of initial capital, and other factors. Though increasing taxes is possible under the present system, it has not yet been implemented. Increasing corporate taxes is possible, but increasing individual taxes is not. The same situation applies to the central government. There is a property that makes marginal fiscal responsibility ambiguous. This must be changed.
   
• The present local budget deficit was triggered by the economic measures implemented by the central government. The present system of enforcement of the local authorities by the central government is unlikely to create effective demand; besides, it does not contribute to the promotion of competition among regions. The central government should better implement more intensive economic measures in collaboration with regions.
   
• Concerning fiscal adjustment, it is impossible to abolish expenditure compensation, and smaller local self–governments can reduce the scope of duties.
   

(Prof.Sachio Konishi, Graduate School of Economics, Kwansei Gakuin University, Industrial Research Institute)
 

• It is true that local governments make wasteful things if they do not have their own fiscal resources. We have to distinguish between the average (the total sum) and additional sum corresponding to the new provision of marginal services.
   
• An exceedingly large Local Financial Plan means the central government delegates too many duties to the local governments. Local governments’administrated duties are three times more, but the problem is tax revenues. Essentially, the local governments are delegated too much work. The central government should increase directly controlled projects.
   
• Local self–governments that rely on the allocation of tax revenues mistakenly issue local government bonds.
   
• It is a mistake to think that all the local governments should provide the same service regardless of the scale of the municipality and existence of individual financial resources.
   
• Decentralization means separation of the local and national governments, but the national ministries and agencies will lose face if decentralization proceeds.
   
• Regarding taxation rights, a flattening of the local inhabitant’s tax gives a substantial sense to the institutional framework, allowing the choice between big and small government at the local level. The uniform basis for the levying of the taxes makes little sense, since almost all local self–governments are protected from tax fluctuations by the System of Local Allocation Taxes. If the Local Allocation Taxes are to be revised, the uniform basis for the levying of the taxes is good, as it provides more options.
   

(2)  Discussion among Panelists

(Saito)
 

• It is ideal to reconsider the Local Financial Plan . Nevertheless, it is right that the reconsideration would be uneasy, as the opposition from the ministries and agencies is strong. One proposal is to increase the part beyond the framework of the Proposals and to enhance the part under the jurisdiction of the local self–governments. I think it may become an opportunity to revise the Local Allocation Taxes.
   
• It is a fact that the possibility to increase the rates of the fundamental taxes was not used. The present system of increasing the tax items is good as an option, but it does not mean financial reconstruction. The main bet should be made on fundamental taxes, but it does not involve an increase in the local inhabitant’s tax. However, if some local governments succeed, other local governments may follow.
   
• The establishment of a framework allowing local self–government to fulfill its marginal fiscal responsibility is crucial. If the cost and administration efforts are understood, it will be possible to levy taxes on individuals.
   
• The nation’s choice concerning fiscal adjustment is essential.
   

(Jinno)
 

• In Europe, where the fiscal adjustment system is generally accepted, poor regions strengthen the fiscal adjustment system by becoming autonomous, while the rich regions weaken it. It is the main principle of the fiscal readjustment system.
   
• As an interpretation of the subsidiary principle, local self–governments have the right to take on the work and the right not to. Work will be delegated to the superior government or the neighboring municipality.
   
• In France there is a system that allows the levying taxes at the same rate for external inhabitants and inhabitants if the inhabitant’s taxes exceed the standard tax rate. Does not this system serve as a useful reference? After the correction of over–delegation of work to the local governments, it is good to apply the French system.
   
• Merging municipalities have the merit of scale, but on the other hand it has the drawback of increased difficulty in reflecting the interests of the inhabitants.
   

4.  Audience discussion
 

(Audience)

• I think it is necessary first of all to think about our ideals concerning local finance without being swayed by the present situation. Otherwise, it will become a zero sum game of sharing the shares of strong regions.
• I consider it is necessary to think about the reasons for providing the administrative service by local self–governments from the standpoint of existing information in the government.
• Some scientists have pointed out that it is indispensable to consider the properties, externalities, spillovers, and other aspects of public service.

(Saito)

• The information perspective is extremely important. The problem of how many units are appropriate for decision–making is different from the economics of scale concerning the supply of public goods. It is essential to think not only about the merger of the municipalities, but also about the appropriate size of the prefectures.

(Kimura)

• Regarding the decentralization of government to local jurisdictions, it can be said that decentralization is the most effective in the sphere of social security for different reasons.
   

(Audience)

• I think the neighborhood association will become optimal if we pursue the principle of decentralization based on the fact that the local governments are the closest to the citizens. The size of the associations is necessary to decide the details, depending on the administrative service.

(Kimura)

• You are right that the size depends on the administrative service. For example, 50,000 to 100,000 people are considered optimal for nursing care.
• Some argue that 300,000 people are ideal if one considers the optimal scope of the administrative service from the viewpoint of successful communication.

(Konishi)

• The central government should cut the Local Financial Plan . The projects that the central government is willing to undertake can be implemented under its direct management. A local authority with 10,000 employees will need more staff, but to provide full–fledged service it is necessary to increase staff or to double the work of the existing staff. This problem precedes the issue of money. There is the option of merging, but as it is possible to employ 100,000 people there is no need for the merger in this sense.

(Jinno)

• Complementing the subsidiary principle is not a universal principle. In Canada there is an idea that a strong center needs strong regions.
• In Europe the decision on allocation between the national and local governments is taken on every administrative service separately. This system is different from Japan’s. Nevertheless, it is also feasible in Japan.
• One background factor of the decentralization idea is the weakening of the functions of the nation–state, which left no other choice but to decide what functions could be delegated to the regions.