The Unfairness of Leaving Local Governments to Fight Each Other for Extra Tax Revenues

It is no longer news that Japan's provincial areas are facing a steep long-term decline, as the country's overall population decreases and ever-more opportunities for work and high living standards become concentrated in Tokyo. As provincial areas face a steady decline in population, the local tax base, proportional to the declining number of people and businesses that make the locality their permanent home, is also declining in tandem. With the same areas facing ballooning costs from pensions and healthcare as the population ages, the fiscal shortfall threatens to break the fragile balance of payments for the local governments.

The Japanese national governments, keenly aware of the local governments' fiscal difficulties, have been trying different ways to shore up their operations from a revenue point of view. COVID has brought forth a new opportunity to encourage more working professionals and young families to move away from Tokyo, as the prospect of remote work becoming permanent rises with the continued high COVID infection rates in the densely populated capital city. It is hoped that as more people settle in more rural areas, businesses will follow their employees and customers, creating a more geographically balanced economic development, and tax revenues, in Japan.

But both local and national governments realize that the long-term push to get more people and businesses to rural areas cannot resolve the much more immediate issue of fiscal precariousness facing some declining localities. To increase the tax base of rural areas in the short term, the Japanese government instead came up with what seems to be an ingenious way to allow people from anywhere in the country to pay a part of their income tax to any locality in the country. Termed Furusato Nozei (ふるさと納税) or "hometown tax payment," the system is nominally geared toward individuals who live far away from their rural hometowns but still would like to contribute financially to the hometown's development.

Yet, in reality, Furusato Nozei has gone far beyond appealing to the hometown pride of a few professionals who live in the big cities. Because the system is not restricted to where tax payments can be made, some local governments began to use the system to attract taxpayers from all over the country, including those who have absolutely nothing to do with those particular localities. To do so, local governments advertised gifts that taxpayers can receive in return for paying taxes to their towns and villages, often consisting of local specialties such as seafood or meat. With the e-commerce platform Rakuten jumping in to provide local governments with a convenient way for people to place their Furusato Nozei "order" online, the whole process has become not so different from online shopping.

As more local governments shifted their message for paying local taxes from the love of the locality to what gifts taxpayers can get from choosing their localities over others, a debilitating "one-upmanship" among different local governments have quietly emerged. To get more taxpayers, local governments have to spend every more money on marketing themselves over other towns and villages, and secure ever more lavish gifts for taxpayers, both of which ultimately reduce the proportion of the Furusato Nozei incomes that actually go into productive use for the local government to provide public services and shore up their fiscal gaps. At some point, it is no longer difficult to imagine that it would make little financial sense for many local governments to even participate in Furusato Nozei.

Moreover, Furusato Nozei enables localities that are not so fiscally deprived to benefit the most, going against the original intention of helping those who are most financially at risk. After all, those local governments that are capable of providing lavish local produce as gifts to taxpayers are also in the position of taxing those businesses producing and selling the same local produce to keep themselves financially afloat. It is those localities that are unable to find any good gifts to give that are truly bereft of any notable local sources of income that can be taxed sustainably. Furusato Nozei, thought this way, only enable the richer localities to get even richer, while producing little benefits for the poorest ones.

There is, in the end, a question of "fairness" when it comes to government budgets. Common logic would state that localities that have larger populations, especially the young and old most in need of public services, ought to have more money at their disposal than less populated areas. But Furusato Nozei system, in both its original intention of showing hometown pride and the current reality of getting nice gifts, entirely ignores the relationship between taxation and population. The correlation of a larger local population with a larger number of high earning natives residing elsewhere or the ability to produce highly demanded local products does not always exist. There would be no surprise to see many localities disgruntled by how they are not helped by Furusato Nozei at all.

Instead of merely trumpeting Furusato Nozei as a flagship revenue increase project for the country's fiscally strained local governments, the Japanese national government should take a more direct role in its implementation to ensure fairness and avoid it simply becoming a free-for-all among localities offering up ever more lavish gifts. Instead of having taxes directly paid to each local government, it makes sense for them to go through a centralized "pot" managed by an independent entity that determines how much out of the total amount collected should go to each locality, based on the local population and financial needs. This would ensure that the local governments that need the extra tax revenues the most are not deprived of them simply because they cannot compete with others through marketing and gifts.