Economic Welfare and Local Government Fiscal Balance under Japan's Hometown Tax Donation System (Furusato Nozei): A Salop-Type Circular Model

This study develops a Salop-type circular model to analyze the impact of Japan's Hometown Tax Donation system (Furusato Nozei) on the fiscal balance of local governments and household economic welfare. In the model, households endogenously choose the local government to which they donate based on the donation price, the brand strength of the reciprocal gifts, and idiosyncratic attachment. The system affects household welfare through two channels: private utility derived from reciprocal gifts and utility from public goods financed by local government fiscal balances. We develop a unified theoretical framework incorporating these channels and examine its implications using both numerical simulations and empirical analysis. The results show that deficit local governments are predominantly located in urban areas, whereas surplus local governments are more common in rural areas. Urban local governments experience fiscal deterioration due to donation outflow, leading to a decline in per capita welfare through reduced public goods provision. In contrast, rural local governments can sustain per capita welfare by improving their fiscal position through attracting donations, even in the presence of population decline. Furthermore, the Local Allocation Tax system partially offsets revenue losses, thereby mitigating the decline in economic welfare.