China’s fiscal situation has improved markedly over the past decade, and signs are that revenues will continue to increase, provided that tax administration keeps pace with the changing economy. General government revenues rose from less than 10 percent of GDP in the mid-1990s to almost 18 percent of GDP in 2005.
Some 2.0–2.5 percent of GDP social security contributions, which are included in government revenues in other countries, could be added to this figure, as could extrabudgetary revenues of some 3 percent officially and considerably more unoffi- cially. Together with a sustainable deficit of some 2–3 percent of GDP, this would provide China with a fiscal envelope of some 25 percent of GDP, comparable to the lower-income countries in the Organisation for Economic Co-operation and Development (OECD) and higher than most East Asian countries, including the East Asian newly industrialized countries. Indeed, excluding redistributive functions
3
through social security and noncontributory transfers, which take up more than half of government spending in advanced OECD countries, the size of China’s government is already comparable to the advanced OECD countries in terms of share in GDP.1
China is much more decentralized than are OECD and middle-income coun- tries, particularly on the spending side (table 3.1). In part, the sheer size of the country explains this degree of decentralization, but the structure of government and some unusual expenditure assignments also give rise to this pattern of spend- ing. Functions such as social security, justice, and even the production of national statistics are largely decentralized in China, whereas they are central functions in most other countries. Among subnational governments, subprovincial govern- ments account for more than half of total government expenditures (table 3.2).
Fiscal disparities among subnational governments are larger in China than in most OECD countries. These disparities have emerged alongside a growing dis- parity in economic strength across provinces. Between 1990 and 2003, the ratio between the per capita GDP of the richest and the poorest province rose from 7.3 to 13.0; by 2003 China’s richest province had more than eight times the per capita spending of the poorest province. In contrast, in the United States, the poorest state has about 65 percent of the revenues of the average state; in Germany any state falling below 95 percent of the average level is subsidized through the Finanzausgleich(and any state receiving more than 110 percent is taxed); and in Brazil the richest state has 2.3 times the per capita revenues of the poorest state (World Bank 2002).
Some countries for which data exist have higher fiscal disparities than China.
In the late 1990s, the richest of the Russian Federation’s 89 regions had per capita revenues that were some 40 times higher than the poorest (Martinez-Vazquez and Boex 1998). After transfers, the richest province in the Philippines had 28 times more per capita than the poorest province. This figure was 10 in Indonesia and 22 in Vietnam.2
Table 3.1 Subnational Government Share of Total Government Revenue and Expenditure, in China and Groups of Other Countries
(percent)
Developing OECD Transition
Item countries countries economies China
Subnational share of 9 19 17 40
government tax revenue
Subnational share of 14 32 26 73
government expenditure Source:World Bank forthcoming.
Note:Data for China are for 2003. Data for other countries are for various years.
Inequalities in spending are much larger at the subprovincial level. The richest county (the level of government in China that is most important for service delivery) has about 48 times the level of per capita spending than the poorest county (World Bank 2006). In contrast, in Indonesia the richest district govern- ment has 30 times the per capita expenditure of the poorest one (Hofman and Cordeiro Guerra 2005). These disparities in aggregate spending levels also show up in functional categories, such as health and education, where variation across counties and provinces is large (figure 3.1). These large vertical and horizontal fiscal imbalances put great demands on the transfer system, which should not only provide adequate resources to the various levels of government but should also reduce the large disparities.
The current transfer system is dominated by tax rebates, which can best be understood as a form of revenue sharing, and numerous earmarked grants, which together make up more than 60 percent of total grants. The general equalization grant (the “transitional systems transfer”) has been growing in recent years, but it still makes up only 10 percent of all transfers to the regions.
Vertical imbalances in China are large, but by itself this does not imply that on aggregate, insufficient resources are transferred to subnational levels. Indeed, without a better specification of the role and functions of various levels of government, it is hard to determine whether subnational governments receive sufficient resources for their functions.
Other signs suggest that the budgetary resources available to local governments are insufficient to cover their perceived functions. For one, subnational government indebtedness is growing. Even though local governments are formally allowed to bor- row only with State Council approval, this rule can be—and is—easily circumvented,
Table 3.2 Revenues and Expenditures, by Level of Government in China, 1993–2003
(percentage of total government spending)
Item 1993 1999 2003 1993 1999 2003
Revenues
Central government 22 51 55
}
35 61 66Provinces 13 10 12
Prefectures and municipalities 34 17 16
}
66 39 34Counties and townships 32 21 17
Expenditures
Central government 28 31 30
}
45 51 49Provinces 17 19 19
Prefectures and municipalities 23 21 21
}
54 49 51Counties and townships 31 28 30
Source:World Bank forthcoming.
and many local governments are thought to be in arrears on their debt. On aggregate, local government debt is estimated to be as high as 14 percent of GDP.3 This debt is one sign that the allocated budgetary resources are not sufficient to allow local governments to discharge their responsibilities.
Another indication of inadequate budget resources at the subnational level is the size of extrabudgetary resources, which have become critical to the finances of public service units. Although consolidation has taken place since the mid- 1990s, when extrabudgetary funds peaked, budgetary units throughout the gov- ernment system still generate considerable nontax revenues, which are by and large used for service provision.4
a. Education
0 100 200
Province
Province 300
400 500 600
Constant 2000 yuanConstant 2000 yuan
HebeiShanxi Inne
r Mon golia Liaonin
gJilin Heilon
gjiang Jiangsu
Zheji ang
Anh ui Fujian
Jiangxi Shandon
g Hen
an Hubei
Hunan Guangdon
g Guangxi
Hainan Sich
uan Guizho
u Yunnan
Tibet Shaanxi
Gansu Qin
ghai Nin
gxia Xinji
ang Total
b. Health
0 20 40 60 80 100 120 140 160 180 200
Hunan Anh
ui Guangxi
Hen an Liaonin
g Hubei
Sich uan
Jiangxi Shandon
g HebeiShaanxi
Fujian Guizho
uJilin Gansu Guangdon
g
Heilon gjiang
Shanxi Inne
r Jiangsu
Nin gxia
Qin ghai
Yunnan Zheji
ang Xinji
ang Tibet 5th percentile (bottom) mean 95th percentile (top)
5th percentile (bottom) mean 95th percentile (top)
Figure 3.1 Within-Province Disparities in per Capita Expenditure across Counties, 2003
Source:World Bank forthcoming.
The disparities in per capita expenditure cited above suggest that the transfer system has a limited impact on horizontal imbalances. Indeed, the transfer system as a whole is not equalizing, in the sense that per capita transfers to the provinces continue to show a positive correlation with per capita income (World Bank 2006). Even if tax return transfers are taken out, the remaining discretionary trans- fers show a positive correlation with per capita income (Persson and Erikson 2006), which suggests that considerations other than equalization dominate the transfer system.