Economic Behavior of Local Governments and Hometown Tax Donation (Furusato Nozei) in Japan: Effects of Regulations in a Monopolistic Competition Model

The hometown tax donation system (Furusato Nozei), which has become an important topic in Japan's local government finances, is not financially sustainable and has led to excessive competition for reciprocal gifts. Behind this are local governments eager to obtain donations. This study presents a model of the economic behavior of local governments eager to obtain donations and analyzes the effects of the Ministry of Internal Affairs and Communications (MIC) regulations (the Appropriate Recruitment Rule and the Reciprocal gift Ratio Rule). Given that reciprocal gifts have brand power, the lower the donation price, the higher the number of donations. Assuming that local governments act like firms, this study employs a monopolistic competition model based on the household donation demand curve. It examines how the number of donations varies with changes in parameters, considering that the equilibrium number of donations that maximizes net donation revenue is greater than the number of donations under MIC regulations. The study uses data to investigate the policy effects of the introduction of MIC regulations. Local governments, ranked 1-200 in net donation revenue per capita is consistent with the economic behavior model, increased the expense ratios before the regulations and decreased the number of donations after the regulations. The donation revenue share of the top 100 local governments decreased from approximately 50% before the MIC regulations to 30% after, indicating that these were effective in regulating the economic behavior of local governments eager to obtain donations. Not all around 1,700 local governments are enthusiastic about obtaining donations, but some local governments could be accelerating the competition for reciprocal gift.