How Does Intergovernmental Competition through the Hometown Tax Donation System Affect Local Government Efficiency?

Many studies show that fiscal redistribution among regions carried out by a national government undermines the cost efficiency of local governments. In Japan, a unique fiscal system, the Hometown Tax Donation (HTD) system, was launched in 2008. Citizens may donate some of their inhabitant taxes to a different local government than their own. We examine the effects of the HTD using panel data of Japanese municipalities and stochastic frontier analysis. We find that revenue received by other regions leads to a misestimation of the cost of public services, even if this redistribution is based on residents’ intentions.