IV BUDGET PROGRAM BY FUNCTION

(1) Fiscal Relationship between the Central and Local Governments (Chart IV-9-(1)/(2))
In Japan, local governments (prefectures and municipals) play an important role in the government sector. They provide various kinds of public service such as police and firefighting, inhabitant registration, primary education, water supply and so on.
As a result, expenditures of local governments (net basis) consist of about 60% of total expenditures of the government sector (net basis) (See Chart IV-9-(1)). However, on the revenue side, the ratio of local tax revenue to total tax revenue of the government sector is about 40%. This is one of the reasons why the central government should fill the difference between the expenditures and tax revenues at local level by the following measures (See Chart IV-9-(2)).

1) Local Allocation Tax (LAT)
    The Local Allocation Tax System was introduced in 1954 and its framework has not been amended until now.
    Its objectives are twofold. First is the adjustment function. The level of local tax revenues varies among local governments according to economic activeness of each area. However, as the level of basic government service should not be proportional to economic activeness, there should be a system to equalize the difference in tax revenues of local governments. This is the first function of the LAT. Second is the revenue guarantee function. The LAT fills the gap between the total expenditures and the total revenues without the LAT. As explained below, the amount of the LAT is determined in the annual Local Public Finance Program to cover the cost of standard level public service at local level.
    Because of these objectives, the LAT is a general revenue resource in a sense that the use of the resource is not controlled by the central government. Each local government is free to spend the fund allocated as the LAT. The system should not impair the autonomy of local authorities. In the case of national subsidies, however, the central government provides the fund for specific policy and local governments should use the fund for specific policy purposes.
    The stipulated amount of the LAT is a portion of five national taxes:
a. 32% of Individual Income Tax, Liquor Tax and Corporate Income Tax

Note:

The rate for Corporate Income Tax is temporarily set at 35.8% due to the permanent tax reduction implemented from 1999.

b. 29.5% of Consumption Tax
c. 25% of Tobacco Tax
However, as explained below, in consideration with the fiscal condition of local governments, the actual LAT may be more or less than the sum of a. to c.
    The LAT is divided into the Regular Local Allocation Tax (the Regular LAT) and Special Local Allocation Tax (the Special LAT). The Regular LAT is 94% of the total amount of the LAT and the rest is the Special LAT. The central government allocates the Regular LAT for local governments that cannot meet their standard expenditures with their standard revenues according to the difference between the standard expenditures and the standard revenues. The Special LAT is granted to local authorities according to their special financial needs such as expenditures for disaster relief that cannot be satisfied by the allocation of the Regular LAT.

2) Local Transfer Tax (LTT)
    The Local Transfer Tax is a portion of taxes collected by the central government that is transferred to local governments according to objective standards such as the length of roads in each local area, frequency of aircraft take-offs and landings at the airport in the local area and so on.
    The LTT is composed of the total revenue of Local Road Tax, 1/2 of the Petroleum Gas Tax revenue, 2/13 of the Aviation Fuel Tax revenue, 1/3 of the Motor Vehicle Tonnage Tax revenue, and the total revenue of the Special Tonnage Tax. The LTT is not put into the General Account but is deposited directly into the Special Account for the Allotment of the Local Allocation Tax and the Local Transfer Tax (hereinafter referred to as the Special Account) and distributed for local governments from the account.
    In most cases, the use of the LTT is specified. For example, the LTT from the Local Road Tax, the Petroleum Gas Tax and the Motor Vehicle Tonnage Tax are to be used for road-related expenses.

3) Central Government Disbursement
    The central government provides funds for local governments to achieve specific policy objectives in a number of ways. These funds or subsidies are usually categorized into three kinds. First is the central government obligatory share for certain local expenses such as primary education, public work projects and disaster-related projects. Second is the disbursement to cover the cost of local authorities acting as agent of the central government to carry out nation wide administration such as performing national elections or collecting national statistics. Third is the national subsidy that the central government provides for local authorities with a view to supporting, encouraging, and promoting certain policy objectives.
    Many items of disbursements relate to social welfare, education, public works and so on. These disbursements from the central government has played an important role in enabling local governments to maintain their administration at standard level and to obtain sufficient revenues for large-scale construction works including restoration from natural disasters. However, it should be noted that the excessive control by the national authority over local governments through national disbursement may hinder local autonomy.

4) Special Local Grants
    The central government provides the Special Local Grants to supplement a part of the decrease in local tax revenues due to permanent tax reductions implemented from 1999. From FY2003, the Special Local Grants also covers the decrease in local revenue due to reduction of certain national disbursements.
    The Special Local Grants are put from the General Account from the Special Account and distributed to local governments from the Special Account.

(2) Local Public Finance Program (LPFP)
    Every fiscal year, the Cabinet is obliged to formulate an official estimation of the total revenues and expenditures of all local governments. This estimation is the Local Public Finance Program, which shows the balance of local government sector by calculating the standard level of revenues and expenditures. The Cabinet presents the Program to the national Diet and makes public usually at the beginning of every February.
    The Program has two objectives. First, it clearly presents the relationship between the central government and local government finance. All flows of money from the central government, including the LAT, are registered in the Program. Second, it works as an important policy indicator for local government fiscal management every year. Local governments look at the growth rate of each expenditure item of the Program and set their number at that level. As long as they get along with the Program, they can obtain enough revenues.
    The total revenues and total expenditures of the LPFP for FY2003 are ¥86,210.7 billion, slightly larger than those of the General Account of the central government. (See Table IV-9-(1)) The composition of the LPFP for FY2003 is shown in Table IV-9-(2) and Chart IV-9-(3).

(1) Revenues

(2) Expenditures

	Note: The figures in parentheses are percentages.

1) Revenues in the LPFP
    There are six main revenue items that local governments use to finance the provision of various public services. They are local taxes, local transfer taxes, local allocation tax, special local grants, local bond, and national subsidies. Others are the rent and fees, and miscellaneous revenues. Among them, major sources are local taxes, the LAT and local government bond issues.
    In FY2003 LPFP, local tax revenues (¥32,172.5 billion) are the largest source, representing 37.3% of the total revenues, but 6.1% decrease over the previous year. The LAT is ¥18,069.3 billion, 7.5% decrease. The amount of local government bond issues comes to ¥15,071.8 billion, 19.2% increase. The central government disbursements are ¥12,260.0 billion, 3.6% decrease.

2) Expenditures in the LPFP
    Three are four major expenditure items. The first is the wages and salaries. It includes the compensation for governors and mayors, members of local councils, and people who work for local governments, including officials who are in charge of general affairs, teachers at public schools, policemen, firemen, and so on. The level of the wages and salaries are determined in consideration with the levels of the salaries of central government officials and employees of private sector. The second is the general administration cost. It includes the cost of providing public service other than public investment. Its examples are the provision of welfare relief, cleaning up wastes, and so on. The third is the debt service. It is the cost of paying back the debt, principal and interest payment. The last major item is the investment cost. It includes the construction cost of roads, bridges, school buildings, and so on.
    In the process of formulating the FY2003 LPFP, considering the severe fiscal situation of the central government as well as the local governments, the expenditures at both central and local level are reviewed dramatically. As a result, the total expenditure of the LPFP was decreased by 1.5% from the previous fiscal year. This decrease is second to that of the previous fiscal year.
    In FY2003, the expenditures for wages and salaries are ¥23,438.3 billion, 1.1% decrease. The investment expenditures are ¥23,286.8 billion, 5.3% decrease. The general administration expenditures are ¥21,026.3 billion, 1.1% increase. The local debt service is ¥13,767.3 billion, 2.5% increase. The debt service ratio is 16.0%, but as in Table IV-9-(1) the same figure for the central government 20.5%. Considering the debt outstanding, ¥450 trillion for the central government and ¥138 trillion for local governments, the central government's fiscal condition is far worse than that of local governments.

(3) Measures to maintain the fiscal balance of local governments in FY 2003
    In the budget compilation process, the Ministry of Finance and the Ministry of Local Affairs make a basic projection for the fiscal balance of local governments through formulating the LPFP. If there is a gap between the revenues and expenditures in the projection, the central government takes necessary measures to balance the gap in order to maintain sound fiscal management of local governments, considering the severe fiscal condition at both the central and local level. The most important tool in this process is the LAT.

    Under the projection for FY2003 local fiscal balance, the effects of the Permanent Tax Cut implemented from 1999, effects of FY2003 Tax Reform, effects of reduction in certain central government disbursements, and shortage in the ordinary balance excluding these effects are forecasted as follows:

	- Effects of Permanent Tax Cut		¥687.3 billion
	- Effects of FY2003 Tax Reform		¥3,243.7 billion
	- Effects of Reduction in CGD		¥234.4 billion
	- Shortage in the Ordinary Balance		¥13,445.7 billion

Note:

Although there is a gap between the revenues and expenditures of local governments in the fiscal projection, there is no such fiscal gap in every year's LPFP. It is because the Program is presented as the final form that includes the measures to fill the gap.

Measures to fill the gap shown above are as follows:

1) Measures for the shortage of ordinary balance (See Chart IV-9-(4))
In formulating FY2001 LPFP, the Ministry of Finance and the Ministry of Local Affairs decided that they should abolish the borrowing of the Special Account to maintain the ordinary fiscal balance of local governments. This decision was made in order to increase the transparency of fiscal condition at both central and local level and to further to clarify the responsibility of both the central government and local governments as regards the fiscal gap in the ordinary balance. As the result, the borrowing for which the central government is responsible is transformed as the special addition of the LAT from the central government's General Account. The borrowing for which local governments are responsible is compensated by the introduction of special local government bonds (Temporary Fiscal Measure Bond).
However, in order to avoid the drastic decrease in the amount of LAT, the new borrowing of the Special Account to fill the ordinary balance is reduced gradually (1/2 in FY2001 and 1/4 for FY2002 of the ordinary balance shortage). Finally, in FY2003, the new borrowing for the ordinary balance is abolished to achieve the goal of the above decision.

- Shortage in the Ordinary Balance		¥13,445.7 billion
- Increase in Local Government Bond Issue		¥7,709.6 billion
	- Special Local Construction Bond	¥1,840.0 billion
	- Temporary Fiscal Measure Bond	¥5,869.6 billion
- Increase in the LAT		¥5,735.1 billion
	- Legal Addition	¥194.5 billion
	- Special Addition	¥5,541.6 billion

2)	Measures for the effect of the Permanent Tax Cut
	a.	Effe	cts of local tax reductions	¥1,813.7 billion
		-	Measures to compensate for the change in national and local tobacco tax rates, to increase local tobacco tax revenues	¥125.0 billion
		-	Temporary increase in the LAT transferred from corporate tax revenues (+3.8%)	¥346.3 billion
		-	Special local grants	¥889.0 billion
		-	Tax reduction compensation bonds	¥453.4 billion
	b.	Effe	cts of national tax reductions	¥1,430.0 billion
		-	Borrowing in the Special Account, etc. (Borne on the national responsibility)	¥714.4 billion
		-	Borrowing in the Special Account (Borne on the local responsibility)	¥715.5 billion
3)	Measures for the effect of FY2003 Tax Reform
	a.	Effe	cts of local tax reductions	¥241.0 billion
		-	Tax reduction compensation bonds	¥241.0 billion
	b.	Effe	cts of national tax reductions	¥446.3 billion
		-	Borrowing in the Special Account	¥446.3 billion
4)	Measures for the effect of FY2003 Reduction in NGD
	-	Special local grants		¥117.2 billion
	-	Borrowing in the Special Account (Borne on the national responsibility)		¥87.9 billion
	-	Borrowing the Special Account (Borne on the local responsibility)		¥23.9 billion

As the result of above measures, the LAT from the central government's General Account is ¥16,392.6 billion. New borrowing of the Special Account is ¥1,951.5 billion. That will lead to the total amount of LAT in the LPFP of ¥18,069.3 billion.

    The redemption of interest payments on the national debt and its administrative expenses are transferred from the General Account to the Special Account for the Government Debt Consolidation Fund.
    For the redemption of national debt, an amount equal to 1.6% of total government bonds outstanding at the beginning of the previous fiscal year and an amount not less than one-half of any surplus in the settlement of the General Account for each of the preceding two fiscal years are, in principle, transferred to the Special Account. However, fixed-rate transfer was suspended from FY1982 to FY1989 and from FY1993 to FY1995 under a special law enacted each fiscal year as part of measures taken to cut expenditures for the General Account in the difficult fiscal situation of recent years.
    The total amount to be transferred from the General Account is estimated at ¥16,798.1 billion for FY2003. It consists of ¥7,551.5 billion for redemption of the national debt, and ¥9,060.2 billion for interest payments. The remainder is for administrative expenses. (Table IV-10-(1))

    In FY2000, the ratio of civil servants (employees of national and local governments and public enterprises) to the total population was 3.8% (3.6% excluding Self-Defense Forces personnel) in Japan, and this is considerably lower than those in other industrialized countries. According to the Japanese Ministry of Public Management, Home Affairs, Posts and Telecommunications the ratio is 7.9% (7.2%) in the United States, and 9.7% (8.8%) in France.
    While the number of civil servants is relatively small, we have been carrying out a series of programs since FY1968 that determine the annual number of civil servants to be removed from the central government's payroll.
    Consequently, the number of civil servants working for the national government, which was 899,333 in FY1967, will be reduced to a projected 509,996 in FY2003, a reduction of 389,337 in 36 years. We had increased the number of staff in national universities, hospitals, etc. in response to an increasing need for high-level education and medical treatment, but recently we have reduced staff in more areas. A net reduction of 2,136 employees is planned for FY2003.

Chart IV-9-(1)	Schematic Diagram of National and Local Revenues and Expenditures (FY2001 Settlement)
Chart IV-9-(2)	The System of Local Allocation Tax and Money Flow

Table IV-9-(1)	Comparison of National and Local Governments Fiscal Positions in FY2003
Table IV-9-(2)	Local Public Finance Program