This chapter analyzes the change in local governance with regard to the financial crisis in Japan. The Japanese system of public administration is based on a multilayered structure, which may increase efficiency but it is nevertheless severely constrained by the financial difficulties of local governments. Such a condition is likely to cause the underutilization of the innovation potential of local governments. What should be done to improve the situation is to recover the tax system, promote innovation in local public governance, and fix the existing intergovernmental fiscal relations by emphasizing the role of local government initiatives. The latter are essential to the attainment of the goal of creating high performance of local government in Japan.