An Empirical Analysis of the Hometown Tax Donation System and the Efficiency of Local Governments

Abstract

  This paper presents a quantitative analysis of the impact of the hometown tax donation system on local public finances, focusing on the cost efficiency of the provision of public services by local governments. Residents may underestimate the cost of providing public services because the hometown tax donation is a source of revenue to be borne by other regions. If residents become less cost conscious, inefficient provision of public services may be tolerated. In this paper, a stochastic frontier analysis using panel data shows that cost efficiency is undermined in municipalities that rely more heavily on the hometown tax donation, even after controlling for size of inhabitant tax deductions and the cost of return gifts. While there are many previous studies measuring the cost efficiency of local governments, there are few studies focusing on the impact of the hometown tax donation, and this paper contributes to a multidimensional evaluation of this tax donation system.