SUB MODULE 2 DECENTRALIZATION AND THE ROLE OF THE CENTRAL GOVERNMENT

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1 SUB MODULE 2 DECENTRALIZATION AND THE ROLE OF THE CENTRAL GOVERNMENT Case Study 2 Function and Role of the Council on Economic and Fiscal Policy Trinity reform as an example In this case study, we will present an overview of the Council on Economic and Fiscal Policy, which was installed with the aim of helping to formulate new policy, led by the prime minister. Overview of the Council on Economic and Fiscal Policy The Council on Economic and Financial Policy was established within the Cabinet Office following the reorganization of central ministries on January 6 th, Its purpose has been to represent the opinions of intelligent individuals in the private sector on national economic and financial policies, and to strengthen the prime minister s leadership. The main role of the Council is to conduct research, discuss certain topics, and submit reports and opinions. In the current Koizumi administration, the report from the Council on Economic and Financial Policy plays an important role especially in important policy decisions. The items for discussion are: Upon inquiry by the prime minister, the Council looks into key matters relating to economic and financial policies, such as basic policies on overall economic management, fiscal management, and formulation of the budget. Upon request by the prime minister or ministers of related areas, it looks into such important matters as the Comprehensive National Development Plan, in order to maintain policy consistency that reflects the nation s overall economic situation. Usually, these reports are presented at the Cabinet meeting. Once the opinion is accepted by the Cabinet, it becomes the basic policy of the Cabinet. Meetings are held 30 to 40 times a year and all content and data of the meetings are officially announced. 1

2 Keynote Address by Aso Taro, Minister of Economic and Financial Policy As minister in charge of economic and financial policy, I would like to present my basic views on our nation s economic problems and the management of our policies. First of all, I would like to announce the formation of the Council on Economic and Financial Policy on January 6 th. The Council is one of the key components created following the reorganization of central ministries. It is made up of bureaucrats involved in economic and financial policies and highly intelligent people who provide valuable insights into the economic situation and our entire economy. With the prime minister as chairman, the Council s main mission is to investigate and discuss important matters of economic and financial policies, such as the basic policies on general Japanese economic management, budget formation, and financial management. The Council will then submit a detailed proposal to the government. It is important that the Council performs its investigations in a comprehensive and practical manner, in order for the government to produce effective policies that will convey its message clearly to all citizens, and respond to citizens expectations through appropriate policy management. I will put my best effort into pursuing these objectives. The first focus for this Council is to bring a steady and autonomous recovery to the economy. To do so, it is necessary to obtain accurate insights into the current and future economic situations. Once those insights are obtained, the Council has to examine the management of the economy and finance, such as financial policy. When the budget is being prepared, it has to examine the basic concepts of economic management such as the allocation of expenditure and the relationship with businesses. These measures are necessary in order to support the implementation of effective economic and financial policies. The second focus is to determine the principles by which the economy and society as a whole should be constructed. This refers to economic and social structural reforms. The key here is to determine the policies that would increase development potential in the Japanese economy, and would help to bring forth a promising economic society. It is important to proceed with these comprehensive investigations with an understanding of the macro-economic balance. It will be necessary to draw up mid-to-long term views of the economic society, taking into consideration various system issues, such as role sharing between central and local governments, the social security system, the development of social infrastructure, the taxation system, etc. 2

3 New Policy Adjustment Process After the installation of the Council on Economic and Fiscal Policy, policy adjustments and budget preparation of central ministries were conducted as shown in diagram below. Overall Plan Budget Summary Basic Policy on Preparation of Budget Reform and Perspective Overall plan of the management of the economy and finance, and structural reform The overall plan outlines the importance of structural reform and the future direction of Japan. It forms the basic framework on which structural reforms of various sectors such as the economy, finance, administration, and the society itself are built. At the request of 3

4 the prime minister, reports will be prepared by the Council and approved at cabinet meetings. Budget Summary Prepared by the Council, the summary provides on overview of: 1. initial estimates of expenditures, 2. budget distributions to focused sectors, 3. system reforms and basic plans that affect the budget. Basic Policy for Budget Preparation This lays down the underlying definitions behind the preliminary budget that is based on the overall plan, before the government compiles the detailed budget. Reform and Perspective This provides the vision for the Japanese economy and society, and a mid-term (5 years) perspective on future economic and financial management. Also included are structural reforms that would help make that vision a reality. This perspective is revised yearly to reflect economic updates. Trinity Reform The Trinity Reform refers to the reform of the financial structures in the central and local governments. It was mentioned in the Basic Policies for Economic and Fiscal Policy Management and Structural Reform 2002 (adopted by Cabinet decision on June 25 th, 2002). The main idea was to conduct three reforms in the following areas concurrently reduction of national subsidies, reform of the local allocation tax, and a review of tax resource allocation including the transfer of tax resources to the local governments. Contents of the Trinity Reform Reduction of National Subsidies Abolish or cut back national subsidies by around JPY4 trillion Review local projects and the national subsidy system Reform of the Local Allocation Tax (LAT) Review of the system and reduction of the size of the system guaranteeing the allocation of fiscal resources Examination of local expenditures and cutting back of the LAT 4

5 Substantially increasing the population of local governments without the LAT Paying attention to adjusting the financial disparities between local governments Review of tax resource allocations including transfer of tax resources to local governments Transfer tax resources to local governments in accordance with national subsidy reforms Bring up the level of basic taxes in order to transfer tax resources In cases where tax resources are not transferred, each project is reviewed and examined to transfer about 80% of necessary funds, depending on the nature of the subsidy. For compulsory projects, to improve efficiency before transferring the necessary costs to local governments. Increase the local authority over independent taxation Increase tax resource allocation to local governments by the Trinity Reform in order to reduce the difference between local expenditures and local tax revenues, By way of background to this reform, the gap between expenditure and revenue between central and local governments is evident from the fact that the tax income ratio between the central and local governments is 6:4, while the expenditure ratio between the two is 4:6. Every year, funds worth about JPY14 trillion are allocated to the local governments from the central government. This encourages a financial dependency by local governments on the central government, and disturbs decentralization. The goal of this reform is to overcome this problem. 5

6 Diagram: Tax resource allocation between central and local governments (FY2002) Allocation of tax Work load (JPY79.2 trillion) Based on expenditure (JPY150.9 trillion) 6 : 4 National Tax JPY45.8 trillion (58%) - Income Tax - Corporate Tax - Consumption tax - Alcohol Tax etc Local Tax JPY33.4 trillion (42%) - Municipality Tax - Prefecture Tax - Property tax etc -LAT -Local Transfer Tax -National Treasury disbursement s National JPY17.0 trillion (21.5%) Local Governments JPY62.2 trillion (78.5%) - Local Tax - Local Allocation Tax - Local Transfer Tax - National Treasury Disbursement etc ( National Expenditure JPY57.5 trillion (38%) (including income from government bonds etc) Local Expenditures JPY93.4 trillion (62%) (including income from local government bonds etc) 4 : 6 The transfer of tax resources to local governments had been impossible due to differences in the policies among central ministries. For instance, the Ministry of Finance oversees the national budget, the Ministry of Internal Affairs and Communications takes charge of local administration, and other ministries implement policies through subsidies and administrative guidance (the Ministry of Land Infrastructure and Transport, the Ministry of Agriculture, Forestry, and Fisheries, etc.). After the reform, the Council on Economic and Fiscal Policy guides all transfers on the following basis: 6

7 Basic Policy 2002 (June, 2002) adopted by Cabinet decision The government confirmed the Trinity Reform. Subsidies were stated to be cut back by JPY 500 billion Basic Policy 2003 (June, 2003) adopted by Cabinet decision Reform of national subsidies: subsides were to be abolished or to be cut back by about JPY4 trillion by FY2006. Review of the allocation of tax resources : By FY2006, tax resources will be transferred to the local governments for locally managed projects whose subsidies will be abolished. Upon review of the projects, 80% of the necessary funds will be transferred, depending on the nature of the subsidy. For the compulsory projects, the necessary costs are transferred to local governments, after improving efficiency. Reform of the Local Allocation Tax: By FY2006, there are plans to review the system, and cut back the size of the system guaranteeing the allocation of fiscal resources. Basic Policy 2004 (June, 2004) adopted by Cabinet decision Future process: To disclose the full picture of the Trinity Reform in the fall of 2004 and reach decisions by the year-end. In the disclosure, to include the procedure of national subsidy reform (cut back by JPY3 trillion) to be conducted in FY2005 and This will include details of the transfer of tax resources and the reform of the LAT. Transfer of tax resources: To target JPY3 trillion. By FY2006, to transfer tax resources from income taxes to residents taxes. To examine the possibility of introducing a flat rate of tax on residents incomes. That should minimize uneven distributions and the tendency to complain about the benefits received. Reform of the national subsidies: To request local governments to make a detailed plan for subsidy reform and to examine the reform based on those plans. To conduct reforms that will enable the transfer of tax resources and expand the independence and discretion of local governments. Local Allocation Tax: To review and cut back local governments expenditure in order not to discourage local government incentives towards reforms. On the other hand, to provide appropriate fiscal resources to improve local administration that will, in turn, secure the general revenue necessary for stable fiscal management. To review the calculation of the LAT in order to promote efficient local management of administration and finance. For local governments with weak fiscal power, to provide appropriate fiscal support through calculation of the LAT, etc,, as the transfer of tax resources may not be enough to cover the necessary fiscal needs. 7

8 Summary and Case Study Discussion The Council on Economic and Fiscal Policy was established under the prime minister s leadership to direct the policy formation process. Under the Koizumi administration, the report from the Council plays an important role especially in deciding important policies. All data and content from meetings are officially announced. As a result of discussions, reports, and opinions from the Council, the transfer of fiscal resources to local governments, which was previously not possible due to confrontation among ministries, is now underway. 8