How does intergovernmental competition through hometown tax donation system affect local government efficiency?

In Japan, a unique fiscal redistribution system, the Hometown Tax Donation (HTD) system, was launched in 2008. Citizens may donate some of their inhabitant taxes to a different local government than their own. We examine the effects of the HTD on local governments’ cost efficiency, using panel data of Japanese municipalities and stochastic frontier analysis. While financial resources provided by other regions may weaken residents' monitoring of local government financial management, donors have an incentive to maintain active monitoring. However, we find that revenue received by other regions hinders efficiency of local governments by misestimation of the cost of public services, even if this redistribution is based on residents’ intentions. JEL classification