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Policy Research Institute

Table of Contents : Current Issues

Vol. 113 : Legal Analyses of Public Finance with “Law and Economics”


Summary of Articles: Current Issues

Public Finance Revisited: A Scope for Substantive Law of Public Finance

By Minoru Nakazato (Professor, Graduate Schools for Law and Politics, The University of Tokyo)

(Abstract)

Our goal here is to analyze the stipulations on public finance in the Constitution. When we study public finance, or the economic activities of the state, from a legal perspective with the help of the neo-classical market-oriented principles, we must, as a basic premise, describe the state as a private economic entity. We need a theory of law, which adopts the methodology of “law and economics”, with which we can analyze the economic activities of the state, not from a procedural point of view but from a substantive one. For such a research, we basically need the dual perspectives of 1) more emphasis on the market and the private law, and 2) more emphasis on economic theories.

As a preparatory work for such researches, we propose to use private law as a bridge between economics and public finance law. That way we could explore the way to introduce the methodology of economics into the discussions on public finance law. Because the Constitution is conceptually based upon the premise of the existence of market mechanism with the system of private law, we couldn’t envisage a system of public finance that totally ignores the concepts of property and contract in private law. Because of this, it is imperative that we should presuppose, to a certain degree at least, the homogeneity between the state economic activities and the private economic activities in the market. Here we present such a theory that connects private law underlying the Constitution and public finance law.

We assert that, by focusing on the relationship between public finance law and private law, we may be able to radically change Japan’s public finance law doctrines, which have only engaged in interpreting the procedural stipulations of the Constitution. Thus we could directly cut into the areas of the relationship of rights and duties regarding the state’s property rights. By doing so, we may also be able to think about the interlocking relationship between public finance and monetary policies. And further, based upon such preparatory research works, we think we could secure the basis for bringing the achievements in public economics and public finance into the study of law.

Our basic concept is to provide basis for shifting the focus of public finance law researches from procedural to substantive aspects. And it is none other than shifting public finance law from “the Budget Law”, which are centered and focused upon the Japanese Diet’s budget deliberation procedures, to “the Law of Public Finance” in its true sense, which explore the substantive aspects of the state’s economic activities.

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The Roles of Public Finance and Markets under Uncertainty

By Hiroyuki Kohyama (Associate Professor, Graduate School of Law, Kobe University)

(Abstract)

The purpose of this paper is to reconsider the relationship between the public financial supports as the last resort and the legal systems such as limited liability. If we fail to take into account the possibility that the combination of the public financial supports and the legal systems could more efficiently cope with social crisis, we ignore way of reducing budget deficits without harming the public.

We follow the research result of [Kohyama 2011], which studies an efficient control over explicit contingent liabilities, and extend the scope of discussion to a control over implicit contingent liabilities. In this paper, we search for a more efficient relationship between the legal system of limited liability and the public assistance to insolvent companies. In addressing this issue, we focus on the relationship between the risk “distribution” by market and the risk “redistribution” by the government.

It is common for the government to introduce a limited liability system through corporate law and bankruptcy law, in order to enhance private investment and business activities. However, in doing so, the government might suppose implicit liabilities for involuntary creditors, such as victims of torts by corporations. It is important to take into account the interaction between the legal system which provide limited liability to the private party and public support which the government is likely to be requested to provide for the insolvent companies by the political pressures.

In order to consider how and why the government is expected to suppose such implicit liabilities, it is useful to understand the legal system of limited liability as the trades of “put option”, which strike price is the companies’ net assets. Thanks to the limited liability system, shareholders take a “long put” position. Voluntary creditors such as banks and bondholders take a “short put” position. Also involuntary creditors such as victims of environmental pollutions and torts are forced to take a “short put” position. Involuntary creditors often fail to receive compensations beforehand for taking a compulsive short put position. As a result, when damages much bigger than the net assets of companies break out, heightened public and political pressures are likely to require the government, which have created the legal system of limited liability, to rescue those creditors.

Under the current budgeting system, the government is not required to estimate such implicit liabilities. In order to improve a risk distribution by markets, the government should use a combination of compulsory insurances, regulations, and intergenerational risk sharing mechanisms through tax systems and government bonds.

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Governance Organizations’ Financing and Income Redistributions – The Implication of Decentralization, Globalization and Super-aging Society

By Satoshi Watanabe (Professor, School of International and Public Policy, Hitotsubashi University)

(Abstract)

In the process of globalization and decentralization, an inevitable mismatch is appearing between the units of delivery of public finance, especially the delivery of income redistribution functions, and the scope of economic activities that produce tax revenues for the government. As a result, it is becoming difficult to suppose that public finance will function in way that it produces expected results. Here we, taking into the above-mentioned situations into consideration, try to summarize basic issues about the entities of public finance, especially the income redistribution functions of public finance as well as the roles played by those entities.

As to the income redistribution functions per se, other entities than the state, or the central government, are not capable of playing the roles of implementing them. Although due to the progress of globalization and the advent of super-aging society, the restrictions on the implementation of income redistribution functions by the state, or the central government, becomes stronger, the state, or the central government, is still expected to deliver a certain degree of income redistribution functions to secure the national minimum of welfare for the people within proper and well-targeted areas. On the other hand, local governments are expected to strengthen their functions of resource allocations in the process of promoting devolutions of power and it is likely that the devolution process may streamline the process of resource allocations of providing local public goods. But the delivery of this depends, as a premise, upon the streamlining of local government operations through competitions between local governments and the monitoring by the central government. At the same time we must accept local disparities to a certain degree in terms of resource allocations in the process of enlarging local governments’ roles, while if we erroneously combine the devolution and the “remedy for disparities” directly, it may lead to swelling expenditures and inefficient operations. Therefore the economic argument for the promotion of local devolution should be limited to the area of resource allocations, and the argument should not be linked to income redistributions or the “remedy for disparities.”

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Social Security Financing – Legal and Policy Perspectives

By Masahiko Ohta (Professor, Graduate Schools for Law and Politics, Tokyo University)

(Abstract)

Here we select out of various decision-makings regarding social security financing such topics as 1) the problems regarding the decision-making of the total sum of expenditures which should be financed for social security, 2) the problems regarding the decision-making over in what nominal terms and on what criteria the expenditures should be allocated to, or be burdened upon, some entities, and 3) the problems regarding the consequences stemming from financing social security expenditures from certain economic entities.

About the problem 1), we study the extent to which, and the logic in which, the total sum to be financed should be based upon the structures of social security, as well as the reason why such decisions appear NOT actually to be made, and finally, the reason why it is, none the less, important to conduct the above-mentioned analysis. About the problem 2), we first differentiate between general taxes, special-purpose taxes and social security premiums, and go on to study the significance of the decision-making as to whether the expenditures should be financed by taxes or by premiums, and finally, we study the entire features of the system described by the way in which social insurance premiums are collected. About the problem 3), we give a basic consideration to the problem over to what extent the link can be modified ex-post facto between social insurance contributions and its benefits, to which we should give a certain level of respect, or the protection of trust, as a result of financing the expenditures as social insurance premiums.

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Synthesizing Legal and Economic Considerations in Public Finance Management

By Kazuyuki Sugimoto (Former Vice-Minister of Finance, Government of Japan)

(Abstract)

Public finance is the state’s economic activities occupying a large part in the national economy. The government’s activities are backed up by financial resources without fail, and financed through taxation, the government bond issuance and so on. The government’s activities are not determined in the market, but through the decision-makings of the entire nation in the form of the laws or the budgets. As a result, in the management of public finance, both economic and legal considerations go along simultaneously in practice.

Public finance has the three functions of 1) resource-allocation in providing public goods, 2) redistribution of incomes and 3) stabilizing and optimizing the economy.

As pure public goods are not supplied in the market, it is the government’s role to provide goods and services. Laws prepare the mechanism of supplies, and the volume of goods and services is determined in the budget process (in such cases as defense services and public investments). As to quasi-public goods, or merit goods, as they can sometimes be also supplied in the market, there comes a right-duty relationship between the government and the people, where public laws and private laws coexist. Since one party of this relationship is a public entity, the legal system should be involved there (in such a case as compulsory education).

As to the function of income redistributions by public finance, social security and tax systems are the main part of it. As they respectively intervene in the right-duty relationship of individuals, and the government is involved, those systems are closely intertwined with the legal systems.

What extent of income redistributions should be regarded as optimal depends upon the value judgment of the society regarding the concept of fairness. But if we pursue the equality of results in income distributions too much, the efficiency and robustness of the entire economy will suffer a negative blow, lowering the welfare level of the economy, and as a result, the benefits enjoyed by individuals will deteriorate, too.

In the area of social security, after relevant legal systems are defined, the total sum of the outlays would be allocated according to the laws In the budget, the expenditures for the social security benefits stipulated by the laws are included in the annual government expenditures(these items are called compulsory expenditures), while the prospective sums of received social insurance premiums are shown in the side of revenues. Keeping the social security system sustainable and stable is one of the important challenges in the current public finance management.

Since taxation encroaches upon the nation’s property rights by forcefully imposing and collecting taxes on the people, it should be based upon the legal ground to do so. They are in the relationship where the government has the right to demand money from the people and the people have the duty to deliver money to the government in the form of tax (that is credit-debt relationship). Taxation has a large impact upon the economy, and it should be prepared in a consistent manner as a legal system.

Public finance has an economy-stabilizing function both through a built-in stabilizer and through discretionary fiscal policies. It is true that since the Plaza Accord concluded in the latter half of the 1980s, the public finance has been playing a certain role in underpinning the economy. But it is also true that a full-fledged economic boost has not been realized, and that the pump-priming function of the public finance has not materialized the recovery of the private economy, nor has it generated a sustainable growth path. Rather, accumulated budget deficits are regarded to threaten to destabilize the economy.

Under the system of parliamentary democracy, the problem of asymmetry arises, and leads budget deficits to expand easily. It has become a big challenge common to all the developed nations to figure out how to architect legal systems that secure a fiscal discipline. This is also a problem of self-discipline for the lawmakers, and it should be addressed in an interdisciplinary way by legal, economic and political viewpoints.

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The Law and Economics of the “Assets” Held by the State

By Takeshi Fujitani (Associate Professor of Law, Institute of Social Science, Tokyo University)

(Abstract)

This paper examines the implication of the “asset”-holding by the state and other public entities, from the legal and economic perspectives. Here the term “assets” is defined purposefully in a broad manner so as to include “any legal status or economic position that may bring about cash flows to the holder-entity in the future.” Such a definition shall be distinguished from the word’s common usage in the fields of finance economics and accounting, by virtue of the following two aspects; 1) that this concept of “assets” focuses on the institutional significance of the expected future cash flow within the public finance system; and 2) that the concept of “assets” is associated with somewhat “autonomous” nature of certain set of money/property that belong to the state or public entities but nevertheless stay outside of the general fiscal account.

Such elaboration of “assets” concept is intended to capture the transformation of the contemporary public finance system, which the classic principles of public finance law cannot fully address. The classic principles have presupposed the democratic control over the public finance affairs through the annual budget resolution on the fiscal institution as integrity. However, in many dimensions, these presuppositions do not hold anymore; the public finance system now accommodates a number of fiscal mechanisms with multi-year effects and implications (as opposed to annual accounting principles), and special accounts (as opposed to the integrity of fiscal system). The “assets” concept serves as a heuristic framework to uncover these elements scattered in the public finance system, some of which are overt while others are covert, and facilitates reinvention of the outdated public finance law principles.

One of typical examples of the “assets” as defined in this paper is the a variety of “funds” reserved for certain purposes (e.g., social security trust funds), but many other fiscal institutions/operations within the public finance system indeed fall within the “assets” concept framework, such as; asset-financing by utilizing public assets, sovereign wealth funds and other investment/lending operations, revenues raised through the exercise of states’ regulatory prerogatives (e.g., spectrum auctions), financing by the collateralization of future tax revenue. The virtue of “assets” concept is to facilitate the across-the-board analysis of these seemingly unrelated elements, to extract the common features and mechanisms. This paper examines why such transformation —– captured by the “assets” concept”—– is required, identifies their economic rationales and risks, and calls for the new legal framework and principles of public finance law that can address these new challenges.

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Debt Finance and Governance of National States: Implications from Corporate Finance?

By Gen Goto (Associate Professor, Graduate Schools for Law and Politics, University of Tokyo)

(Abstract)

The present-day national states depend largely on the issuance of bonds, or debt finance, which are separate from tax revenues, for the procurement of funds necessary for their activities. What impact will this situation bring about on the governance of national states?

Stock companies similarly develop large-scale activities by means of debt finance. Stakeholders of those companies, such as shareholders, creditors and managers can be compared to the national states’ citizens, government bond holders and the government, respectively. On the other hand, there are differences between the stock companies and the national states in the goals of their activities (maximization of firm value vs. supply of public goods, economic stabilization and income redistribution), in the benefits enjoyed by the shareholders or the citizens, and in the negative influences suffered by the shareholders or the citizens in the case of bankruptcy. Also, when the national states are debtors, there is a limitation on the availability of judicial procedures such as lawsuits, compulsory executions and bankruptcies.

Here we, while paying attention to those differences, try to explore to what extent it is possible to apply the theories regarding the influence of debt finance on the governance of stock companies, such as the agency costs of debts, the monitoring by creditors and its delegation, and the disciplinary effects of debts, to the contexts of debt finance by the national states.

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Public Financing and Markets – An Approach from the Theory of Industrial Organization –

By Shinjiro Miyazawa (Associate Professor, Graduate School of Economics, Kobe University)

(Abstract)

Here we present the results of the preceding studies regarding the mixed oligopoly market, where public and private companies are engaged in quantitative competitions, and also the results of expanded analyses based upon those studies, and then study the implications of those results to Japan’s financial service market, where public financing entities and private ones are competing with each other. In the mixed oligopoly market, even if public entities are ideal existences which aim to maximize the social surplus, it is desirable that they should choose beforehand to produce less output than the equilibrium output of the Cournot competition, and then should keep commitment to it. Therefore, the upper limits on the volume of deposit and lending of public financing entities wil produce socially desirable results if they are appropriately set. For the same reason, public entities should at least be partially privatized, and the lower the productivity of public entities is and the more private companies there are, the more desirable it is for those public entities to be completely privatized. When public entities’ productivity is extremely low, and there are a sufficient number of private companies, public entities should be not privatized but liquidated. When it comes to judging whether public financing entities should be privatized or liquidated, we should throw a judgment based upon the social values in the equilibrium after detailed investigations of the market structures.

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Any article in the Review reflects the writer's own opinion, and has nothing to do with any statement issued by the Ministry of Finance or the Policy Research Institute.