The Verdict is In: Japan’s Hometown Tax Donation Option is a Policy Failure.

Background

Furusato Nozei, Japan’s Hometown Tax Donation option for taxpayers, has evolved through multiple stages over its 16-year history. Established in 2008, Furusato Nozei began as a mechanism and a means through which ex-residents of rural municipalities of Japan could return tax revenues to their ‘hometown’ community. All they had to do was organise the necessary paperwork so as to re-direct a portion of their current residential tax burden to their hometown tax municipality for that fiscal year. The Hometown Tax Donation option was then expanded to allow any resident of any tax district in Japan to direct a portion of their current residential tax burden to any other tax district in Japan, an expansion initiated in part so that taxpayers throughout Japan could conceivably direct funds to disaster-stricken areas, thereby aiding these municipalities in their recovery. This clearly minimised the ‘hometown’ element of the option, but expanded it to a broader participation base. Of course, with the attraction of expanding tax redirections at stake and the potential of attracting tax revenues from throughout Japan rather than just within its own tax district, municipalities in rural areas began to offer incentives for the often-urban contributors to direct their Furusato Nozei allotments to their tax base, usually in the form of return gifts for making contributions. There were some initial issues to be settled, such as the value percentage of the contribution that the return gift could be, with the current limit set at 30 percent. Additionally, some municipalities began to allow the contributors, those tax-payment re-directors who are not actually residents of the municipality to which they are contributing, to determine the local policy area to which their contributions would be applied. Furthermore, with this expansion, Furusato Nozei came to be operationally-managed by a number of private and for-profit online information and application websites, the result being the number of participants and the value of tax re-directions skyrocketing.
 
There are many viewpoints that can be brought to analyse, assess, and evaluate Furusato Nozei. The original incentive of the option can be lauded on an individual taxpayer sense of commitment to one’s hometown through a ‘contribution-to-community’ basis. The expansion certainly brought with it a sense of ‘national Japanese citizenship’ in the form of offering an avenue of support for places in need of financial assistance. Such an innovative tax option can be viewed as government attempting to make ‘informed and progressive policy’ advances. Giving taxpayers an option in how their tax payments are used can be interpreted as progress toward ‘citizen autonomy’ and an incentive to become well-informed on issues. At the local level, the potential to attract additional tax revenues ‘incentivises local government’ to promote local industries so as to provide for area-based return gifts and to work to present a positive and attractive national image of the area.

The Present Discussion
 

The point of this brief discussion paper is to analyse, assess, and evaluate Furusato Nozei as policy and policy outcome. The amount of information in the form of both municipal homepage data and academic research work on the state of the Hometown Tax Donation option has risen with its increased use and the value of the contributions at stake. Hometown Tax re-directions totaled approximately 8 billion yen in the year of its inception in 2008 and rose to 160 billion yen by 2015, a 20-fold increase over this initial eight-year period; as of 2021, the value of re-directions had risen to 768.2 billion yen. Thus, in essence, Furusato Nozei can be considered a large-scale field experiment on the transition from an emergent and innovative policy experiment to an established and highly popular economic policy with important local fiscal implications. Summarising early research, it has been found that, while contributions do support the recipient communities, the effect is geographically sporadic rather than universal across the country; it has also been asserted that the act of re-directing local taxes to a far-off municipality on the basis of a return gift can negatively influence the local sense of community; the contribution element of the Hometown Tax Donation option has been viewed as distorting charitable giving through other channels and in other areas; and, the re-direction of taxes often leaves deficits in the municipalities which lose tax revenues, and creates uncertainty in the local tax base from year to year (Hagami, 2017a; 2017b, Sato, 2016a; 2016b). This discussion paper will focus primarily on five academic papers that are representative of assessment of Furusato Nozei as process and outcomes for local governments, all representing research published post-2020.

Inter-Municipal Competition

An important area of research relevant to policy implications of the tax option focuses on the competition between local governments that Furusato Nozei inevitably generates. Fukasawa, Fukasawa, and Ogawa (2020) found that the competition for donations has forced some local governments to experiment with ‘return rates,’ the value of the return gift as a percentage of the donation. Prior to adding restrictions on the value of the return relative to the donation, there were cases of municipalities using imported products that equaled up to over 50 percent of the value of the contribution. Using standard economic modeling, the Fukasawa research identifies that excessive competition, operationalised in the effort and costs associated with identifying ideal return rates and the local products that can be brought to match them, can reduce net revenue gained through Hometown Tax by up to 7.5 percent compared with municipalities that do not engage in such fine-tuning of gifts profiles. While the analysis is highly statistical, the implication is that in the face of competition for contributions, municipalities that re-direct staff to fine-tune their Furusato Nozei gift profile wind up losing revenue. On a larger scale, Uemura’s (2023) analysis of municipal response to the Hometown Tax Donation system concludes that such a taxation option is unsustainable at a national scale and over the long term. As local governments are eager to obtain tax re-directions and maximise their net donation revenue, they will match gift to donation by increasing the value of return gifts for lower contribution thresholds. Noting that their conclusions are consistent with established economic behaviour modeling, they concluded that an increase in the number of local governments that are participating in the Hometown Tax Donation system with a similarly competitive approach will lead to a corresponding decrease in the total number of donations. Over time, with increasing pressure to secure donations from a limited pool of taxpayers, the entire Hometown Tax Donation approach becomes unsustainable.

Local Government Efficiency

Ogawa and Kondoh (2022) focused on efficiency as an outcome, considering the impact of Hometown Tax Donation on local government operational efficiency. Their analysis proposes that the Furusato Nozei option causes a misperception of the value of tax revenues, thereby leading to inefficiency in the provision of local public services. Specifically, they found that municipalities whose revenues are highly dependent on Hometown Tax Donations, more than average, tend to be more inefficient in their operation and service provision. They note that previous studies have shown the same pattern of inefficiency for local governments with a high rate of dependence of Local Allocation Tax and Corporate Inhabitant Tax Revenue, both of which provide tax revenue generated at the national level by the central government to local municipalities. They assert that such inefficiency is a significant factor when dependence on inter-governmental grants and local corporate taxation causes distortions in local public finance.

Winners and Losers

Putting a capstone on the question of Furusato Nozei as a government tax policy in light of the negative outcomes it generates are the concluding assertions outlined by Ishii (2022) and Kaneme (2023), particularly when viewed as overall outcomes for rural Japan as a whole. Ishii argues that ‘maximisation’ as the organising principle of structuring local Hometown Tax Donation efforts ultimately yields clear ‘winners’ and clear ‘losers’ among competing municipalities, rather than an overall positive result where the objective could be generating gains across rural Japan in total. Along the same line of thinking, Kaneme concludes that not only does the Furusato Nozei tax option exacerbate locale to locale discrepancies in the revenues and expenditures among municipalities across rural Japan, it also fails to provide a discernable improvement in local governmental performance and service. Simply put, Furusato Nozei both fails to improve rural finances equally across Japan, instead creating winners and losers, while also compromising local municipal performance for both the winners and the losers.

To conclude

Without doubt, Furusato Nozei originated in an innovative approach to allowing residents who have moved away from their hometown a way to ‘pay their community back.’ The Hometown Tax option may also be viewed as a positive trend in tax policy both from the perspective of individual taxpayer autonomy and because it creates a means for Japanese citizens throughout the country to contribute to the revitalisation of select locales in rural Japan. To some degree, the necessity of providing desirable and unique return gifts as a part of Furusato Nozei may contribute to energising the traditional and local specialty products industries of some rural areas. All of these are positive outcomes of the Furusato Nozei tax policy. However, as a national policy and in terms of the policy outcomes outlined above—inter-municipal competition and local government efficiency—the Hometown Tax Donation option is not only increasing municipal fiscal and service gaps within regions and across rural Japan and yielding many more losers with respect to the winners it generates, it is also compromising local government services in many municipalities and, by some measures, presenting Japan with an unsustainable approach to taxation and tax revenue distribution in the long run. Clearly, while Furusato Nozei shines in its inspiration and through selective cases, as national tax option, it is a clear policy failure.

References

Fukusawa, Eiji, Takeshi Fukasawa, Hikaru Ogawa. 2020. Intergovernmental Competition for Donations: The case of the Furusato Nozei Program in Japan. Journal of Asian Economics, 67. DOI 10.1016/j.asieco.2020.101178.
 
Hagami, Tarō. 2017a. Zenkou 1741 jichitai sontoku kanjo list (A list of a profit-and-loss account for 1741 local governments all over Japan). Chuo Koron 3: 40-59.
 
Hagami, Tarō. 2017b. Henrei-hin kyoso ga shi-ku-choson no ryoshiki wo ubatte iku (Competition of the reciprocal gift comes to deteriorate a good sense of municipalities, towns, and villages). Chuo Koron 3: 68-75.
 
Ishii, Itaru. 2022. Furusato nozei ni kansuru kifu kingaku kyokudaika to risuku (The Maximisation and Risk related to Furusato Nozei). Kiken to Kanri, 50: 129-147.
 
Kaname, Tetsuro. 2023. Chiikikan no zaisei kakusa to [furusato nozei] no shishi ni kansuru kento (Investigation into the Regional Public Finance Differences in Revenue and Expenditure related to Furusato Nozei). Hirosaki University Jinbunshakaikagaku Ronso, 14: 139-148.
 
Ogawa, Akinobu & Haruo Kondoh. 2022. Does Hometown Tax Donation System as Interjurisdictional Competition Affect Local Government Efficiency? Evidence from Japanese Municipality-Level Data. MPRA Paper No. 115740. online at https://mpra.ub.uni-muenchen.de/115740/
 
Sato, Motohiro. 2016a. Imano Frurusato Nozei wa Okashii: Mikaeri wo motomeru kifu-wa nihon no kifu-bunka wo yugame kanenai (The current hometown tax donation system is unacceptable: Donation seeking a favor in return possibly distorts the donation culture of Japan). WEBRONZA, Asahi Newspaper.
 
Sato, Motohiro. 2016b. Frurusato Nozei wa konomama de yoika (Is the current hometown tax donation system right). Toyokeizai Shimpo, February 13.9.
 
Uemura, Toshiyuki. 2023. Economic Behavior of Local Governments and Hometown Tax Donation (Furusato Nozei) in Japan: Effects of Regulations in a Monopolistic Competition Model. Kwansei Gakuin University, School of Economics, Discussion Paper No. 264.

Article copyright Anthony Rausch.

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