Appended Note 3-8 Method for Simulation of Tax Base Transfers

1. Outline of simulation

• - The simulation covers general accounts of all prefectural and municipal governments (including 47 prefectures, 671 cities, 2,558 towns and villages, and Tokyo' s 23 special wards). Public corporation accounts are not covered.
• - FY 1999 is subject to the simulation.
• - Presumed is the case where the ratio of national and local taxes is about 5 to 5.
• - Partial transfers are made from the national income tax to the local individual inhabitants tax and from the national consumption tax to the local consumption tax.
• - The local allocation tax and national treasury disbursement are cut by the equivalent of the tax transfers to ensure the transfers' neutrality to overall tax revenues.
• - At the same time, ordinary construction works expenditure are cut by 10% so that the simulation can indicate the effect on revenues of such a cut.
• - We calculate tax transfers to each local government in accordance with its tax revenue conditions in order to consider revenue structure changes, improvements in financial capacity and an increase in the number of local governments receiving no local allocation tax.
• - We do not consider the impact of a permanent tax cut implemented in FY 1999.

2. Individual inhabitants tax

(A flat tax rate is adopted for the income tax)

The transfer is made to the income tax portion that accounts for most (98.1% in FY 1999 on a settlement basis) of the individual inhabitants tax. The per capita tax portion is left unchanged. At present, three progressive rates (5%, 10% and 13%) are adopted for the income tax portion. Two ways are conceivable for the transfer: (a) A certain rate (e.g., one percentage point) is added to each of the present progressive rates. (b) The progressive structure is modified into a flat-rate system. After their comparison, we have in this simulation adopted the flat-rate system that features less maldistribution of tax revenues than the progressive-rate system. The flat rate is 10% (3% for prefectural governments and 7% for municipal governments).

(Tax rise for each local government)

For each local government, we multiply the total standard income subject to the income tax portion of the individual inhabitants tax by the above flat rate to calculate the tax revenue value after the transfer. The excess of the value over the present system-based value is theoretically a revenue increase. The excess is multiplied by the tax collection rate to determine the final tax revenue increase.

- Standard taxable income

The income is based on the municipal taxation survey as conducted by prefectural governments at the request of the Ministry of Public Management, Home Affairs, Posts and Telecommunications. We have requested each prefectural government to provide municipal data, and have received the data.

- Tax collection rate

We have used the collection rates (real figures for local governments) for the income tax portion of the individual inhabitants tax as specified in the "Annual Report on Fiscal Statistics of Local Governments." Because of constraints on data, however, we have used prefectural collection rates for prefectures, ordinance-designated cities and municipalities other than core cities.

Estimated tax revenue rise = (Standard taxable income x Tax rate

- Traditional tax revenue value ) x Collection rate

3. Local consumption tax

The consumption tax rate is now at 5% -- 4% for the national consumption tax and 1% for the local consumption tax. The national government collects all the consumption tax and allocates the equivalent of 1% to local governments. We can change the rate to make a tax base transfer from the national government to local governments. We transfer 1.5 percentage points of the national tax portion so that the 5% consumption tax consists of 2.5% each for the national government and the local governments.

The systems remain unchanged for coordination between prefectures and prefectures' allocation to municipalities.

- Distribution of the consumption tax

The national government (taxation offices) will collect the national and local portions altogether. The national government will allocate the local portion to prefectures where businesses as payers of the consumption tax are located. Later, final adjustments (distribution) will be based on the "annual retail sales and other consumption-related indicators in the commercial statistics" for each prefecture.

A half of local consumption tax revenues after adjustments between prefectures will be allocated as the "local allocation consumption tax" to municipalities in accordance with population and the number of workers.

(Tax revenues for each local government)

Local consumption tax revenues are adjusted and allocated in the above way. Under the settlement statistics, however, all local consumption tax revenues are treated as prefectural revenues. Those for municipalities are treated as allocations from prefectures to municipalities. In this simulation, we have treated those revenues as tax revenues of local governments that are entitled to finally receive the tax revenues. This means that local consumption tax revenues for municipal governments are the local allocation consumption tax from prefectures to municipalities. The prefectural portion of the local consumption tax represents local consumption tax revenues after adjustments between prefectures, excluding the local allocation consumption tax given to municipalities. Because of our failure in collecting municipal data, however, we have used prefectural outlays (local allocation consumption tax) and the above consumption tax allocation standards (population and the number of workers) to calculate values of allocations to municipalities.

We have considered each of the current prefectural and municipal portions to be the equivalent of a 0.5% tax rate (half the 1% rate for the local consumption tax). Based on this consideration, we have multiplied consumption tax revenues by the transferred tax rate to calculate revenues transferred to local governments.

4. Local allocation tax and national treasury disbursement cuts corresponding to tax base transfers

Since the tax base transfers must be neutral to overall tax revenues, national taxes are cut by the equivalent of the tax base transfers and the national financial transfers (the local allocation tax and the national treasury disbursement) by the same equivalent.

The local allocation tax can be reduced automatically as the standard financial demand increases on the tax base transfers. The value added to the standard financial demand is the tax base transfers excluding reserves (20% for prefectures and 25% for municipalities). The local allocation tax is reduced by this value.

As for the national treasury disbursement, we cannot estimate how revenues for each local government would decline on a cut in a certain component of the disbursement. For convenience, we here reduce the national treasury disbursement by the tax base transfers excluding the equivalent of the local allocation tax decline. The national treasury disbursement reduction, as calculated in this way, has been distributed to local governments in proportion to their respective shares of the national treasury disbursement in FY 1999.

Total tax base transfers = Total local allocation tax declines  + Total national treasury disbursement declines

5. Reflecting ordinary construction project outlay cut in revenues

At the same time as the tax base transfers are implemented to enhance the local financial base, we must reform outlays to improve the financial health. Ordinary construction works expenditure sharply increased especially in the 1990s. According to the "Local Financial Situation," ordinary construction works expenditure for all local governments totaled some ¥26 trillion in FY 1999 on a settlement basis, accounting for 25.7% of total outlays. As an outlay reform, we here have reduced ordinary construction works expenditure and included the reduction' s effect on revenues into the simulation.

Specifically, we have here reduced ordinary construction works expenditure of local governments by 10% and measured the reduction' s effect on revenues--the local allocation tax, the national treasury disbursement and local bonds.

As for the local allocation tax, we have made a 10% cut in investment expenditures out of the standard financial demand. Since a standard financial demand breakdown for each local government is unavailable, we here have used such expenditures' shares of the demand (22.2% for prefectures and 26.9% for municipalities) to calculate the cut for each local government.

As for the national treasury disbursement, we here have made a 10% cut in ordinary construction project disbursement out of total revenues for each local government. Since ordinary construction project disbursement data are unavailable for each of towns and villages, however, we have determined ordinary construction project disbursement' s share of the total national treasury disbursement for each prefecture and multiplied the national treasury disbursement for each town or village by the share to calculate the ordinary construction project disbursement for each town or village.

As for local bonds, we here have multiplied ordinary construction project costs for each local government by local bonds' share of financial resources for these projects to calculate the value of local bonds required for these projects for each local government. We then have made a 10% cut in the calculated local bond value.

6. Statistics used for simulation

- Annual Report on Fiscal Statistics of Local Governments, Prefectural Financial Settlement Survey, Municipal Financial Settlement Survey, Population Census, Business Establishment and Enterprise Statistics Survey, Ministry of Public Management, Home Affairs, Posts and Telecommunications

- Annual Report on National Tax Administration, National Tax Administration Agency

- Financial Statistics, Ministry of Finance

- Municipal Taxation Survey, each prefectural government

7. Bibliography

- Tokyo Tax Commission (2000), Tokyo Tax Commission Report--Tax and Financial Systems to Support Local Autonomy in 21st Century

- Naohiko Jinno, Masaru Kaneko (1998), Tax Bases for Local Governments, Toyo Keizai Inc.

- Sumitomo Life Research Institute (2001), Considering Tax Base Transfers to Local Governments--Roads to Budget Reconstruction and Local Revitalization

- Hiroaki Hayashi (2001), Future Local Tax System, Chuokeizai-Sha

8. Major results of tax base transfer simulation (summary table)