Keen Eye for Economic Trends: The future of new "hidden treasures"

SATO Motohiro
Faculty Fellow, RIETI

In preparation for future debt repayments and other needs, local governments have been setting aside funds as fiscal adjustment and other reserves. The fact that the outstanding amount of reserves has reached as high as 20.8 trillion yen (as of FY2014) has raised controversy.

Most local governments depend on fiscal transfer from the national government, including local allocation tax grants. While the national government's primary budget balance has remained in deficit (18.7 trillion yen in FY2016), local governments have amassed surplus funds. This situation is reminiscent of the contrast between the severe situation of the national government's general account balance and the abundance of surpluses in special accounts—known as "hidden treasures"—that we witnessed in the past. Of course, local governments have their own reasons for their hoard of reserves. A substantial portion of the reserves will be used for the redemption of local government bonds and other purposes including the payment for the cost of replacing social infrastructure such as public facilities. Indeed, as local governments are saddled with a huge load of aged infrastructure, they will be preparing replacement plans.

However, this explanation does not apply to all local governments. The amount of reserves held by metropolitan-area local governments with sufficient fiscal strength not to receive local allocation tax grants has increased not because of systematic funding plans but as a result of growth in tax revenues from companies (corporate business and resident taxes) due to the economic recovery.

Corporate tax revenue is a factor contributing to the widening inequality in tax revenue (per resident) across regions. As corporate tax revenue is prone to business cycles, its fluctuations make local governments' overall tax revenue unstable. Indeed, at the time of the global economic crisis triggered by the collapse of Lehman Brothers, the Tokyo Metropolitan Government's annual tax revenue declined by around one trillion yen. For metropolitan area local governments, setting aside reserves in preparation for future recessions is a natural course of action. Meanwhile, the instability of the tax sources of local governments, which provide public services essential to local residents' everyday life, in itself may be viewed as a problem. In principle, it is desirable for local governments to have a stable tax source, such as local consumption tax, rather than depending on corporate tax.

The hoarding of reserves is not limited to wealthy local governments. Some people have pointed out that local governments with a large amount of reserves are characterized by fiscal weakness and a high proportion of people aged 65 or older. Although the national government has been stepping up support for local governments in depopulated regions through the local community revitalization initiative, such local governments may be already having difficulty promoting economic revitalization and providing public services due to the population shrinkage. It is possible that funds are piling up as those local governments remain unable to make effective use of them on their own. If so, it is essential to implement regional reorganization measures, such as promoting local government mergers and cooperation between local governments in implementing economic revitalization and providing public services across broader areas.

In addition, local governments' distrust of the national government appears to be another factor behind the increase in reserves. In recent years, the national government has increased the national tax portion of the corporate resident tax in order to correct the regional inequality in fiscal strength through redistribution. Moreover, under the so-called "trinity reform" that was promoted by the Junichiro Koizumi administration, the amounts of local allocation tax grants and subsidies were reduced. It cannot be denied that these circumstances are prompting local governments to amass reserves in preparation for a further increase in the national tax portion of corporate resident tax and a further reduction of local allocation tax grants. Local governments' action in this respect is the same as the action of households and companies that are setting aside savings and internal reserves amid uncertainty over the future.

As described above, local governments' reserves that have ballooned to 21 trillion yen are a symbol of the problems surrounding the local fiscal conditions, including unstable tax revenue, population shrinkage in provincial regions, and local governments' distrust of the national government. In addition to figuring out what to do with the amassed funds, addressing these problems is important.

>> Original text in Japanese

* Translated by RIETI.

September 9, 2017 Weekly Toyo Keizai

December 11, 2017

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