It is argued that financing local bonds by the public funds provided by the central government and the compensation through the Local Allocation Tax have largely reduced the interest payments on local bonds. This reduction in interest payment on local bonds has induced inefficient local expenditure which has led to rapid accumulation of local public debt. In this paper, the validity of this line of argument is examined by estimating the effect on reduction of interest payments in Nagoya City for the period since 1989. As the result of the estimation, financing local bonds by the public funds reduced the interest payments by Nagoya City in the first half of 1990s, but it increased the interest payments in the second half of 1990s and in 2000s. And it is also clarified that the effect on the reduction of interest payments through the compensation by the Local Allocation Tax is limited for Nagoya City due to its high level of fiscal ability.
