Do caps on intergovernmental competition work? The case of Japan’s Furusato Nozei program

This paper examines the effects of a regulation aimed at mitigating competition among municipalities to attract donations by offering return gifts under Japan’s Furusato Nozei program. While the cap is widely viewed as a competition-mitigating policy, we show that it may generate a significant unintended consequence in the form of a competition-promoting effect once municipalities’ participation decisions are taken into account. We develop a theoretical model in which municipalities endogenously decide whether to compete for donations. The main theoretical finding is as follows: when a cap is imposed on the return gift rate for donations, both regulated and unregulated municipalities reduce their return gift rates, thereby lessening competition. However, the reduction in return gift rates induced by the cap may incentivize municipalities that had previously refrained from competing to newly enter the competition, potentially intensifying overall competition. A comparison of descriptive data before and after the introduction of the regulation reveals that municipal responses are consistent with the theoretical predictions.