Several policy lessons can be drawn from the evolution of intergovernmental fiscal relations in China.
1.An evolutionary approach to reform best suits conditions in China. From the tax-sharing system reform of 1994 to the income tax–sharing reform of 2002,
Figure 8.6 Year-on-Year Increases in General Transfer Payments, 1994–2005
4.2 5.4 6.1 6.2 8.4 9.6 10.8
20.8 21.6 35.5
47.3
0 10 20 30
Percent
40 50
1995 1996 1997 1998 1999 2000 2001 Year
2002 2003 2004 2005 Source:Ministry of Finance 2006.
Figure 8.7 Transfer Payments from the Central Government to Local Governments, 1994–2005
27 34
25 27 19 22 29 35 39 43 43 52
73 66
75 73 81 78 71 65 61 57 57 48
0 10 20 30 40 50 60 70 80 90 100
Percent
General fiscal transfers Specific-purpose transfers
1994 1995 1996 1997 1998 1999 Year
2001
2000 2002 2003 2004 2005
Source:Ministry of Finance 2006.
China adopted an evolutionary approach to reform. This approach focused on redistributing incremental revenues above a “hold harmless” transfer equivalent to all transfers before the reform. Adopting such an approach was important to avoid major disruptions and ensure buy-in from local governments. After reform, a large revenue-returned element was included, to provide a large, albeit diminishing, share of additional revenues to the provinces that generate the revenues; this feature has been important in protecting growth in these regions. Together these reforms created a unique tax-return system in China, reflecting principles that have now been incorporated in the new political economy literature on fiscal federalism (Ahmad and Brosio 2006). In 2005 the total amount of tax revenue distributed from the central government to the local governments reached Y375.8 billion, accounting for 32.7 percent of the central government’s expenditures as transfers to local governments (figure 8.9).
Most tax-revenue returns are concentrated in eastern China, resulting in the widening of regional fiscal disparities (World Bank 1989, 1993, 1995, 1999). This may reflect one of the characteristics of China’s evolutionary approach to reform.
It also reflects the balance between the needs of growth in the country as a whole and in the better-off regions. Moreover, as the annual increment of returned revenues of value added tax and excise duty is fairly small and the amount of returned income tax revenue is fixed, tax-revenue returns as a percentage of the central government’s expenditures as subsidies to local governments are gradually
Figure 8.8 Equalization Effect of Transfer Payments, 2005
3.77 3.68
3.08
2.74
0.42 1.06
0.45
0.73 0
1 2 3 4
Budgetary revenues Plus returned-tax Plus general transfers revenues
Plus specific-purpose transfers Ratio of average per capita budgetary revenue of five wealthiest provinces to average national per capita budgetary revenues
Ratio of average per capita budgetary revenue of five poorest provinces to average national per capita budgetary revenues
Source:Author calculations, based on data from the Ministry of Finance 2006.
Note:The y axis is defined as the average of the five wealthiest and five poorest provinces to the national average for different revenues and transfers. The five wealthiest provinces are Shanghai, Beijing, Tianjin, Zhejiang, and Guangdong. The five poorest provinces are Sichuan, Anhui, Gansu, Guizhou, and Tibet.
decreasing (figure 8.10). This approach may have resulted in slower redistribution, but it weakened resistance to the reform, leading to stable and steady economic and social progress and is suited to conditions in China.
2. A moderate level of centralization is necessary for equalization in a large economy.
Over the past two decades, fiscal decentralization reform has swept across the world, aiming to bring public service decision making closer to the general public.
The situation in China is peculiar for several reasons.
First, in the early years of reform and opening up, reforms delegated power and gave economic benefits to local governments. Although the macro-control capacity
Figure 8.10 Change in Increment of Returned VAT and Excise Duty Revenues as a Percentage of Total Increment of Revenues of These Two Taxes, 1994–2010
27.0 26.2 23.2
21.0
18.917.6 16.6
15.313.7 12.7 13.5
10.0 8.8 7.7
6.7 5.9 5.1 0
5 10 15
Percent
20 25 30
1994 19951996 1997 1998 199920002001 Year
2002 2003 2004 20052006 2007 2008 2009 2010
Source:Ministry of Finance 2006; Ministry of Finance database.
Figure 8.9 Tax Returns as a Percentage of Total Returns and Subsidies from the Central Government to Local Governments, 1994–2005
75.3 73.7 72.9 71.8 63.4
53.1 46.5
37.7 40.9 42.5 34.6 32.7
25 35 45 55
Percent
65 75 85
1994 1995 1996 1997
Year
1998 1999 2000 2001 2002 2003 2004 2005 Source:Ministry of Finance 2006; Ministry of Finance database.
of the central government was somewhat strengthened after the implementation of the tax-sharing reform, central government revenue as a percentage of total govern- ment revenues stood at 52 percent in 2005 (figure 8.11). (If tax-revenue returns are taken away and such government resources as extrabudgetary revenues are taken into consideration, the percentage is even lower.) This percentage is lower than in well- developed market economies and even other developing economies.
Second, the central government accounts for 24 percent of total government expenditures in China. This figure is lower than in other countries (figure 8.12).
The percentage of public servants working for the central government is also much lower in China (6 percent) than in the world as a whole (33 percent) (figure 8.13).
As a result of such an expenditure structure, many tasks that should be handled by the central government are passed on to local governments. The central gov- ernment provides specific-purpose transfers to local governments, and its inter- vention in local government affairs covers almost every field of the economy and society. After a series of reforms, various kinds of institutional conflicts still remain, and institutional barriers have yet to be completely removed.
Third, because of its many levels of government, vast geographical area, and relatively large economic and social disparities across regions, China has long followed the principle of “multiple levels of administration under a unified leadership.” As a result, institutional arrangements for intergovernmental fiscal relations at the subprovincial levels are made based on local conditions, leaving considerable room for discretion in the decision making of local, particularly provincial, governments.
Figure 8.11 Ratio of Central Government to Local Government Revenues, in Selected Countries
52 48
59 41
95 5
84 16
97 3
50 50
59 41
47 53
0 20 40 60
Percent
80 100
China
Canada United
States
Germany France United Sweden
Kingdom Japan
Country
State (provincial) and local governments Central (federal) government Source:China statistics are from China’s Ministry of Finance (2005); statistics for other countries are
from OECD revenue statistics (1965–2000).
Figure 8.12 Ratio of Central Government to Local Government Expenditures, in Selected Countries
24 76
38 62
68 32
69 31
56 44
36 64
44 56
39 61
0 20 40 60 80 100
Percent
China Germany Japan United
Kingdom France Sweden
United States Canada
Country
State (provincial) and local governments Central (federal) government Source:China statistics are from China’s Ministry of Finance (2005); statistics for other countries are
from OECD revenue statistics (1965–2000).
China is a populous country with uneven distribution of natural and human resources. As a result, economic development is very unbalanced across regions.
In the early years of reform and opening up, when economic development was at a fairly low level, regional fiscal disparities were not very obvious, and the means of redistribution at the disposal of the central government were also limited. In recent years, however, with the gradual improvement of the market economic system, productive factors have begun to flow across regions, concentrating in areas with better infrastructure and stronger manpower. As a result, regional fiscal disparities have widened. Under such circumstances, it would be difficult for the central government to effectively play its redistributive role or to promote equal- ization of regional public services without a fair degree of centralization.
3. A well-developed fiscal system at the subprovincial level is indispensable. The reform of intergovernmental fiscal relations involves intergovernmental systems and institutional arrangements at all levels of government; it should not be kept at the central and provincial levels alone. In the past, China paid more attention to fiscal relations between the central government and provincial governments, leaving the subprovincial assignment of revenues and expenditures and the sub- provincial transfer payment system to be defined and implemented by provincial governments based on local conditions. However, despite larger transfer payments from the central government, the capacity of local governments to provide public services has not improved accordingly, and fiscal disparities across subprovincial governments remain large. The share of expenditures of governments at the provincial and city levels increased constantly, while that of governments at the
county and township levels kept decreasing; at the grassroots level, considerable fiscal difficulties were encountered. Accordingly, in 2005 a policy was announced aimed at alleviating the fiscal difficulties faced by governments at the county and township levels within three years. The policy put in place an incentive/disin- centive mechanism featuring “three rewards and one subsidy.”2It encouraged provincial governments to take responsibility for coordinating balanced devel- opment in the regions under their jurisdiction, to increase transfer payments to governments at the grassroots level, to ensure that governments at the county and township levels have the fiscal means commensurate with their expenditure responsibilities, and to take measures to ease the fiscal difficulties of governments at the county and township levels. In order to simplify the hierarchy of fiscal man- agement and improve management efficiency within the current institutional framework of administrative governance, the center also encouraged qualified areas to actively experiment with the reform featuring direct supervision of county governments by provincial governments and to vigorously push ahead with supervision of township finance by county governments. Generally speaking, these efforts have resulted in remarkable achievements.
Figure 8.13 Percentage of Public Servants Employed by the Central Government and Local Governments, in Selected Countries, 2002
Central government Local governments a. China (36.00 million)
6%
94%
b. France (3.59 million)
61%
39%
c. United Kingdom (2.88 million) 32%
68%
d. Japan (3.90 million) 29%
71%
Source:Ministry of Finance 2006; Ministry of Finance database.
4. The equalization of public services is critical. Despite extraordinary achievements since 1978, China’s level of development is still very low in per capita terms.
Development therefore remains a major theme and top priority. At the same time, income disparities across regions and social strata are great. For these reasons, China must strictly adhere to the principle of giving priority to efficiency while putting emphasis on social equity and making unremitting efforts to advance the process of public service equalization.
At the current stage, implementing a minimum guarantee system for the basic level of public service across regions is not only a matter of urgency but also a practical and feasible policy choice. It was based on such a concept that in 2006, a mechanism was adopted to guarantee public funding for rural compulsory education.
Notes
This chapter is based on the author’s presentation at the “Roundtable on Public Finance for a Harmonious Society,” held in Beijing, June 27–28, 2006. The author thanks Ehtisham Ahmad for his valuable comments. Thanks also go to Qian Wang and Heng-fu Zou for providing references to this chapter.
1. The tax-for-fee reform was first introduced in 1994 on a pilot basis before being extended throughout China. Its aim was to eliminate the growing administrative and arbitrary fees imposed on farmers and to reduce and standardize farmers’ tax burden.
The central government abolished, exempted, or reduced 15 charges, including quarantine certificates, land-use certificates, licensing fees for using water, education fees, and charges for fishing-boat inspections. The central government later abolished all agriculture taxes.
2. “Three rewards and one subsidy” is the central government’s policy for alleviating pub- lic financial difficulties in poor counties and towns, promoting the healthy develop- ment of the rural economy, and building a harmonious society. The Ministry of Finance grants financial rewards to county governments that have increased their tax revenues and provincial governments that have increased fiscal transfers to poor coun- ties; county governments that have streamlined government departments and person- nel; and major grain-producing counties. It provides subsidies to areas in which county and township governments have performed well in reducing poverty.
References
Agarwala, Pamgopal. 1992. China: Reforming Intergovernmental Fiscal Relations. World Bank Discussion Paper 178, Washington, DC.
Ahmad, Ehtisham. 1997. “China.” In Fiscal Federalism in Theory and Practice,ed. Teresa Ter- Minassian. Washington, DC: International Monetary Fund.
Ahmad, Ehtisham, and Giorgio Brosio, eds. 2006. Handbook of Fiscal Federalism.
Cheltenham, United Kingdom: Edward Elgar.
Ahmad, Ehtisham, Li Keping, and Tom Richardson. 2002. “Recentralization in China?” In Managing Fiscal Decentralization,ed. Ehtisham Ahmad and Vito Tanzi. London: Routledge.
Huang, Yasheng. 1996. “Central-Local Relations in China During the Reform Era: The Economic and Institutional Dimensions.” World Development24 (4): 655–72.
Manion, Melanie. 1985. “The Cadre Management System, Post Mao: The Appointment, Promotion, Transfer and Removal of Party and State Leaders.” China Quarterly102 (June): 203–33.
Ministry of Finance. Various years. China Finance Yearbook. Beijing.
OECD (Organisation for Economic Co-operation and Development). Revenue Statistics 1965–2000.Paris.
Sachs, Jeffery, Wing Thye Woo, and Xiaokai Yang. 2000. “Economic Reforms and Constitutional Transition.” Annals of Economics and Finance 1 (2): 435–91.
Wang, Shaoguang. 1997. “China’s Fiscal Reform in 1994: An Initial Assessment.” Asian Survey37: 801–17.
World Bank. 1989. “China: Revenue Mobilization and Tax Policy Issues and Options.”
Report 7605-CHA, Washington, DC.
———. 1993. “China: Budgetary Policy and Intergovernmental Fiscal Relations.” Report 11094-CHA, Washington, DC.
———. 1995. “China: Public Investment and Finance.” Report 14540–CHA, Washington, DC.
———. 1999. China: Preferential Tax Policy. Washington, DC.
Wong, Christine P. W. 1991. “Central-Local Relations in an Era of Fiscal Decline: The Paradox of Fiscal Decentralization in Post-Mao China.” China Quarterly128: 691–715.
Xu, Shanda, and Ma Lin. 1995. “Tax Reform and Market Economy in China.” In Reforming China’s Public Finances, ed. Ehtisham Ahmad, Gao Qiang, and Vito Tanzi.
Washington, DC: International Monetary Fund.