Strategic Price Competition between Local Governments with the Brand Externalities of Reciprocal Gifts in the Hometown Tax Donation (Furusato Nozei) System in Japan

This study analyzes donation price competition between leader local governments with strong brand power and follower local governments with weak brand power, where multiple local governments offer similar local products as reciprocal gifts under the hometown tax donation (Furusato Nozei) system in Japan. We construct a strategic price competition model in which the strategic variables are donation prices and the timing of decision-making is sequential, with some governments acting first and others acting second in the presence of the brand externalities of reciprocal gifts. Based on a theoretical model grounded in household utility maximization and local governments' net donation revenue maximization, we formulate donation price reaction functions and demonstrate the policy implications for surplus through a comparative static analysis. To validate this theoretical model, we estimate donation demand functions using spatial econometric analysis. In an analysis targeting governments in Hokkaido offering reciprocal gifts with the well-known Hokkaido brand, the coefficients indicating complementarity between reciprocal gifts are significant due to brand externalities. Consistent with the theoretical model's assumptions, the empirical analysis also suggests the existence of leader governments, confirming the structure of strategic price competition, where the donation price of leader governments influences that of follower governments. The contributions of this study lie in its theoretical model of strategic price competition for the hometown tax donation system, comparative static analysis, and empirical verification of the existence of leader governments using spatial econometric analysis based on the haversine distance. We find that strengthening the brand power of reciprocal gifts is crucial for gaining a surplus.