Growing problems in the local public finance system of Japan

The current system of local public finance evolved in the aftermath of World War II, and there is an increasingly prevalent view that the system is no longer functional. Under it, the central government has been responsible for monitoring local governments and assuring them of the finance for their shortage of revenue mainly through providing intergovernmental transfers. When the gap between local tax revenue and expenditure widened in the recessionary period of the 1990s, intergovernmental transfers expanded. These transfers have especially served local governments whose own resources were limited owing to geographically and economically unfavorable conditions. As it has become increasingly difficult to finance the growing gap solely by transfers, the central government has also allowed local governments to actively issue bonds and has supported such issues with guarantees, uniform issuing conditions, and secured finance from public funds. It is increasingly recognized that this system has induced local governments to spend excessively and unproductively, rather than encouraging them to voluntarily rationalize. This article identifies three types of dilemmas that stem from the present system and discusses recent reform efforts as well as the challenges presently faced by local governments.