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This book investigates the reasons for persistent public deficits and delayed fiscal reform in Japan, placing a special emphasis on political economy aspects. Japan is confronted with the need to pursue fiscal discipline for fiscal consolidation and implement structural reforms for reorganizing fiscal expenditures. Focusing on particular policy fields including social security, female labor supply, public works, and intergovernmental transfer schemes, the book clarifies economic and political elements that have hindered effective steps toward these two goals. Facing population aging and a business downturn, the Japanese government was urged to increase social security expenditures and the budget for Keynesian stimulus policies. As elucidated in the book, the institutional design has worked to over-represent the demands of elderly generations and local interest groups and to expand these expenditures. Rigorous theoretical and numerical analyses reported throughout the book consequently provide readers with insights into incentive designs and institutional reforms necessary for fiscal consolidation, also presenting points of view for public policy and public debate.



Comprehensive Views of Japan’s Fiscal Policy


Chapter 1. Fiscal Consolidation in the Political Economy of Japan

The present chapter highlights several important factors of fiscal consolidation in Japan by investigating incentives for governments and private agents to either implement or postpone consolidation and structural fiscal reforms in a political economy. This chapter shows that the counter-cyclical fiscal measures, which result in the accumulation of public debt, are not always desirable from a long-run perspective. The long-run commitment to fiscal consolidation may enhance fiscal structural reforms even if these reforms might produce short-run costs and, hence, cause severe resistance from interest groups.
Toshihiro Ihori

Chapter 2. The Political Economy of Social Security Funding: Why Social VAT Reform?

Recently, taxation reforms entailing a “social” valued-added tax (VAT), i.e., a social security reform shifting funding from traditional wage-based taxation to consumption taxation, have been obtaining political support in some developed countries, e.g., Japan, France, Denmark, and Germany. This paper analyzes the political economy of social security funding in an overlapping-generations economy. In particular, we consider how population aging influences the choice of wage or consumption tax financing by focusing on their differential impact on inter- and intragenerational redistribution. Our results show that population aging may drastically alter the political equilibrium: if the population growth rate is higher than the interest rate, wage taxation is the only equilibrium choice, but if it is lower, multiple equilibria are likely to emerge, in which the introduction of consumption taxation emerges as an alternative equilibrium choice.
Hideki Konishi

Fiscal Problems in Japan


Chapter 3. Female Labor Supply, Social Security, and Fiscal Consolidation

This paper numerically examines the impact of expanding female labor supply on economic growth and the government revenue in an aging Japan within a dynamic general equilibrium framework with multi-period overlapping generations. The difference in full-time and non full-time workers of both male and female labor force is explicitly considered. Simulation results indicate that even if all potential female labor force who cannot work currently due to child care becomes full-time workers and thus labor force in efficiency is most expanded, the impact of such an increase on the Japanese economy and fiscal consolidation through an increase in tax revenue as well as contributions to the public pension scheme is very much limited. Even in the most expanding case, production only increases by 1.50 % and the improvement in the government budget would be 1.34–1.46 % in year 2050. The most crucial reason of such limited impacts is found in the large gap in the wage profile between male and female workers, and if the gap vanishes, the impact drastically becomes quite large.
Ryuta Ray Kato, Masumi Kawade

Chapter 4. Fiscal Consolidation and Local Public Finances in Japan: Incentive Problems Associated with Intergovernmental Transfers and Their Political Roles

Japanese local public finances are supported by large intergovernmental transfers from the central government. Intergovernmental transfers have two roles. The first is to guarantee fiscal standards at local levels. The second is to reduce the degree of fiscal inequality among local governments. However, both roles induce incentive problems. This chapter focuses on the incentive problems associated with intergovernmental transfers in Japan and explores how the behavior of politicians in terms of designing the transfer system affects this problem.
Nobuo Akai

Chapter 5. Public Policy and Economic Growth in the Integrating Japanese Economy

In an economy where goods and factors markets are progressively integrating and modern industries with scale economies and externalities are prevailing, economic activities tend to concentrate in a limited number of regions. This paper considers the outcomes of fiscal competition, competition in tax and subsidies and competition in public infrastructure provision among regions in this process. There is no pure strategy Nash equilibrium. A region’s choice of capital subsidy or public infrastructure provision is not deterministic. We therefore consider a mixed strategy Nash equilibrium. Fiscal competition tends to be fiercer in this equilibrium. Concentration of economic activities causes serious and persistent income gaps among regions. As a consequence, regions are impelled make more aggressive efforts to attract modern industries within their borders. Yet the industries the regions seek to introduce will settle in only a limited number of regions. Many regions fail in introducing an industry after making tremendous investments in public infrastructure. As a consequence, huge amounts of public infrastructure remain are left unused in many regions, incurring huge welfare losses.
Hiroki Kondo

Institutional Reforms Necessary for Fiscal Consolidation


Chapter 6. Tax Policy Under the “Generational Election System”

This chapter investigates the effects of introducing the “generational election system” proposed by Ihori and Doi (Nihon-seiji no keizai-bunseki (Economic analysis of Japanese politics), Bokutaku-Sha, Tokyo, 1998). The generational election system (or the election district by generation) consists of election districts divided by not only region but also generation. In industrial countries, intergenerational conflicts of interest are large at present. In particular, the older generation has more political power because of aging and fewer children. In an electoral system that consists of election districts divided only by region, conflicts of interest among regions can be dealt with in the Congress, but intergenerational conflicts are buried in each district because the opinions of older people dominate those of younger people. Therefore, this chapter analyzes the effects of introducing the generational election system using an overlapping generations model. The results of the voting equilibrium show that the preferred policy of the younger generation can be better represented in the generational election system compared with the current majoritarian system. Furthermore, the selected policy does not depend on the turnout rate of the younger generation. These results suggest that introducing the generational election system benefits both the younger and future generations.
Takero Doi

Chapter 7. Budgets Under Delegation

Consider a principal who sets a budget that the agent allocates among different services. Because the preferences of the agent may differ from those of the principal, the budget the principal sets can be lower or higher than in the first-best solution. When the principal is uncertain about the agent’s preferences, the agent may choose an allocation that signals his type, thereby affecting the size of the budget the principal will set in the following period. The equilibrium may have separation or pooling. In a pooling equilibrium, the agent may mis-represent his preferences, aiming to get a large budget in the future period.
Kimiko Terai, Amihai Glazer


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