We model economic institutions behind Japanese local government bond issues. We also model the more market-oriented system behind U. S. local government bond and draw welfare implications from the comparison of Japanese and U. S. systems. Japanese system requires the permission of issuing from the central government which determines the use of funds raised by local government bond issue and who should buy those bonds. (Ex post) subsides for interest and debt payment as well as the mechanism for the reconstruction of local government budget in the case of (near) default also characterize the Japanese system. Under such heavy protection by the central government, bond yields do not reflect credit risk of local government and therefore ex post burden is transferred to national, not local, tax payers. On the other hand, U. S. system make credit risk to be reflected in local government yields becuse of rating and other market oriented mechanism, so that risk are shared by market participants. Implications for improvement of the Japanese system are presented and discussed toward the end of the paper.
