Effects of Fiscal Transfer through Taxpayers’ Donations on Local Governance

This study analyzes the effect of donations to local governments. In Japan, the so-called “Furusato Nouzei” system was introduced several years ago which encouraged taxpayers to donate to local governments other than their places of residence. The system enables donors to pay a certain proportion of their local tax payments to local governments of their choice. The donors not only receive tax reductions from their residential government but also receive gifts from the governments to which they had provided donations. This unique system was planned to help fiscal transfer between local governments, especially from urban areas to rural areas, alongside the formal tax allocations to local governments. Essentially, fiscal transfer to local governments is implemented vertically through an institutional scheme of local allocation tax which national government arranges. Therefore, personal donation did not seem to be significant at first, but donations have unpredictably become very popular among taxpayers in recent years. According to a certain survey, 10 percent of taxpayers in Japan used this scheme in 2016. As a result, some rural governments gained significant sources of revenue from such donations, while some urban governments lost fiscal resources due to their residents donating a proportion of their taxes to other local governments. Local governments therefore not only merely receive stable nation-allocating resource, but need to compete with other local governments to acquire fluid resources which each taxpayer discretionally distributes. We investigate the effect of these irregular fiscal transfers by taxpayers on the policy of local governments. Previous studies emphasize that local policies in general depend on political and socio-economic conditions, such as partisanship of governor and assembly, demographics, industrial structure and so on. We suggest similar political and socio-economic conditions cause a variation in the local governments’ responses to this system of tax donations. Furthermore, we show that the extent of fiscal balance brought about by the donation system has effects on policy making and budget allocation in each local government.