Business Cycle Risks and Intergovernmental Function Allocations

(Abstract)

There are two kinds of policy options to respond to business cycle risks; social security policies that will mitigate damages arising from those risks, and pump priming policies that will boost the GDP output in the recession times caused by those risks. The policies to sustain boom period are also regarded as part of the measures to address business cycle risks. It is useful to make use of automatic stabilizers by mobilizing respective policies, while appropriate discretionary policies are also needed.

Automatic stabilizers are precautionary measures against business cycle risks. It is also important that those policies should be supplemented by discretionary measures in order to respond to big boom-and-bust cycles. And there is a lot of room for local governments as well as the central government to contribute in these policy areas. If we take into account the fact that there are regional disparities in business cycle risks and that information has an asymmetric nature, local governments play a relatively bigger role in implementing discretionary social security policies. And fiscal sustainability is the prerequisite for sustainable economic stimulus measures. We should study the introduction of automatic stabilizers which will automatically rein in expenses as well as boost tax revenues when governments accumulate budget deficits.

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Intergovernmental Risk Allocations and the Budget for the Reconstruction from the Great East Japan Earthquake Disaster

(Abstract)

The Great East Japan Earthquake brought about massive damages in wide areas across eastern Japan the death and missing people totaling around 19 thousands. The size of the budget for the reconstruction from the disaster has turned to be substantial

The present paper undertakes two tasks. One is to estimate the sizes of the reconstruction budgets, especially those of respective devastated prefectures, based upon the data gained from the experiences of the reconstruction from the Great Hanshin-Awaji Earthquake in 1995. Our estimate has suggested that the size of the 5-year budget for the reconstruction from the Great East Japan Earthquake will reach \28.3 trillion, a little less than three times that for the Great Hanshin-Awaji Earthquake. The central government will pay \17.1 trillion-worth of the project costs, while local governments will shoulder \11.1 trillion. The central government will play a bigger role this time around, while local governments paid the larger sums after the Great Hanshin-Awaji Earthquake. By prefectures, Miyagi Prefecture will top the table by paying around \13 trillion, followed by Iwate and Fukushima prefectures which will shoulder \7 trillion, respectively, and Aomori Prefecture will pay \1.25 trillion.

Our next task is to consider the incentives for disaster-prevention/mitigation efforts that will lead to damage reductions at the time of disasters. Although some local governments have shown visionary approaches, the planning of effective disaster-reduction strategies has not spread among many of the local governments. One of the reasons for the delay is that there arises moral hazard incentive among those local governments refraining from investing in disaster-prevention projects, as nobody can predict when disasters will come, and dare to take on the “wait-until-they-really-occur” attitude, as they can expect to receive massive financial assistance from the central government in the reconstruction process after disasters, enabling them to build more robust disaster-prevention infrastructure than before.

Then we calculate the “option values” of those “waiting” attitude (expected profit margins per one unit of public projects). Then we proceed to analyze the impact of those “option values” upon administrative investments per capita. As a result we have detected significant negative effects in public civil engineering facilities and agriculture, forestry and fisheries facilities.

Generally, Japan’s relief policies for disaster victims have been based upon the assumption that the state will not fall into fiscal bankruptcy. But faced with massive natural disasters, it is impossible for the state to shoulder indefinite burdens for disaster relief programs. Therefore, it is important to clarify in advance the boundaries (qualifications) and scales (sums of relief money and so on) of relief programs for the central and local governments. Limited but highly feasible assistance programs will improve policy predictability and create environments that will facilitate necessary precautionary measures (self-help efforts) against disasters rather than huge assistance promises with low feasibility.

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Local Governments’ Creditworthiness and Intergovernmental Risk Sharing

(Abstract)

Here we review the previous discussions as to local government bonds and the central government’s role in enhancing their creditworthiness in light of risk sharing between the central government, local governments and municipalities, and consider what measures will be necessary in strengthening fiscal discipline in local governments.

Several institutional reforms have been put in place recently. Under these circumstances, however, the central government’s involvement in the issuances and redemptions of local government bonds has been kept effectively intact , and the central government’s credit enhancement role (tacit government guarantee) is still regarded as robust. Of course, even under the current system the possibility of local governments falling into default is not entirely ruled out, and that is reflected in mild disparities in credit ratings and the yield spreads between local government bonds.

The recently enacted Act on Assurance of Sound Financial Status of Local Governments stipulates that new institutional measures should be put in place to secure the financial soundness of local governments, but the current monitoring practices by local assemblies and auditors do not necessarily function adequately. Therefore, it is useful to make use of market functions as supplementary measures to instill fiscal discipline into local governments, and it is necessary to review the national government’s involvement in the local governments’ bond issuances and redemptions from that point of view.

There may be a trade-off between the enhancement of fiscal discipline by use of market functions and the securing of stable fund procurement. In securing stable fund procurement, .it will be appropriate to make use of joint issuances of local government bonds as well as to maintain the current schemes in some local government bonds.

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The Welfare Analysis of the Functions of Local Allocation Tax Grants and the Regional Income Fluctuation Risks

(Abstract)

Our purpose here is to conduct a welfare analysis by building a theoretical model for numerical analyses on the role of Local Allocation Tax (LAT) grants system in response to regional income fluctuation risks. Our model describes regional income fluctuation risks by introducing uncertainties in the extent to which policy efforts of a local government will actually boost regional incomes. LAT grants system in Japan is the current system of intergovernmental fiscal transfer, which has both the revenue assurance function and the fiscal equalization function. We build a theoretical model with uncertainties of regional income and describe the current system. As a result, it has become clear that the current LAT grants system has a distribution rule that contains the disincentives for each local government to make policy efforts in response to regional income fluctuation risks. Besides, our numerical analysis strongly suggests that, although the current LAT grants are distributed according to the system that is supposed to redress interregional disparities in local tax revenues (fiscal equalization function), the disincentives within the distribution rule in this system will rather expand regional income gaps.

Akai, Iwamoto, Sato and Doi (2004) proposed an intergovernmental fiscal transfer system where the revenue assurance function and the fiscal equalization function are separated and assigned to different grants, and here we formulate this proposed system for numerical analysis. As a result, it is strongly suggested that the proposed intergovernmental system is more desirable than the current LAT grants system from the viewpoint of not only efficiency of resource allocation but also equity by comparison of expected social welfare.

It is also implied that the (expected value of) regional income gaps will be smaller under the proposed intergovernmental system than under the current LAT grants system mainly due to policy efforts. Under the proposed intergovernmental system, where the revenue assurance function and the fiscal equalization function are differentiated, local governments cannot expect the increase of fiscal transfer from the central government when they neglect to make policy efforts while increasing the supply of local public goods, because the volume of fiscal transfer is designed to stay unchanged against the volume of supply of local public goods (local expenditure). Besides, local governments cannot increase the supply of local public goods unless they make certain policy efforts because the extent of the equalization of local tax revenue is limited under the proposed fiscal equalization system. Therefore, this system will enhance each local government’s policy efforts more effectively than the current LAT grants system.

In the discussions about the current LAT grants system, some argue that the functions of revenue assurance and fiscal equalization are inseparable and should be implemented simultaneously under the single system. But our results show that the current LAT grants system, with those two functions combined, not only enlarges the distortion of resource allocation but also widens regional income gaps. Therefore, in the future reform process of local government finances, it is desirable that the intergovernmental fiscal transfer system should be adopted where the functions of revenue assurance and fiscal equalization should are separated and assigned to different transfers.

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The Economic Theory of Disaster Prevention Investments and Intergovernmental Function Allocations

(Abstract)

Here we draw upon the model developed by Yokomatsu and others (2001) and review the previous theories about the intergovernmental function allocations in relation to disaster risks. This model features a theory that, assuming there are two asymmetrical regions and a free movement of people between those regions is secured, if one of those regions suffers a natural disaster, the damage caused by it constitutes an increasing function, and that the disaster prevention investments can decrease the occurrence probability of natural disasters.

Here governments are required to play a role in correcting inefficient population distributions, in conducting fiscal transfer to a devastated area when the disaster occurs, and in investing in an appropriate level of disaster prevention programs. Of those three functions, the central government should not be involved in the fiscal transfer at the time of disasters if the insurance market functions properly. And supposing that the losses caused by the disaster will level off, one region’s disaster prevention investments will give indirect benefits to another area, and local governments, as a result, will underestimate the social benefits of disaster prevention investments. This argument is also valid in the world where there is no population movement except for the rectification of population distributions.

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The Factors for Smoothing Premiums in the System of National Health Insurance

(Abstract)

In this study, we examine factors that contribute to stabilizing the changes in premiums for the National Health Insurance (NHI) in Japan. After delineating institutional backgrounds for the NHI system, we quantify how layers of fiscal adjustment mechanisms buffer the changes in the NHI premiums from the fluctuations in regional medical needs (i.e., the municipal NHI benefits). In particular, we demonstrate the following results. First, the stabilizing effects of a given adjustment mechanism varies substantially from one year to another, which probably reflects institutional changes in the NHI that occurred almost every year during the period of our investigation. Second, the discretionary transfers from municipal general accounts to municipal NHI special accounts exhibit little impact on stabilizing the changes in the NHI premiums except the fiscal year of 2005, despite the wide spread criticism that they are a potential source of the “soft budget problem” in controlling municipal NHI expenditures. Third, the stabilizing effects of the layers of fiscal adjustments are almost perfect in the sense that they successfully prevent the changes in the NHI benefits from transmitting to those in the NHI premiums. This result corroborates the criticism of the NHI that it has no “cost-benefit link” that contributes to cost-containment in the system, whereas such a link is institutionally embedded in another municipality-managed system of social insurance in Japan, i.e., the system of Long-term Care Insurance.

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