He holds degrees from Cambridge University, the University of the Punjab and the University of Sussex, where he obtained a Ph.D. SHUILIN WANG is a senior economist at the World Bank's Vice President for Development Economics.
The Role of the State and Public Finances
China's public spending of 3.1 percent of GDP on education and 1.8 percent on health (in 2005) is lower than 5.9 percent and 6.7 percent for high-income countries and 4.6 percent and 3.8 percent for low-income countries. upper middle (Dahlman, Zeng and Wang 2007). The total fiscal envelope may have reached 25 percent of GDP in 2006, if extrabudgetary revenues of 3 percent, social security contributions of 2-2.5 percent, and a deficit of 2-3 percent of GDP are included.
Fiscal Reform and Revenue Assignments
In 2004, expenditure on pensions, social welfare, subsidies for consumer goods and off-budget expenditure on social insurance amounted to 13 per cent of gross domestic product (GDP). Public government revenues rose from less than 10 percent of GDP in the mid-1990s to 18 percent in 2005.
Intergovernmental Relations and Fiscal Transfers
A major success was the tax distribution reform, introduced in 1994, to increase the share of government expenditure in GDP and the share of central budget revenues in total budget revenues. Shifting more revenue downwards – that is, reforming the system of transfers from higher to lower levels of government to increase the resources available to lower strata, especially the poor and rural areas.
Provision and Delivery of Public Services
Unbalanced regional development and differences in the fiscal power and revenue capacity of subnational governments are part of the reason. Addressing the needs of the elderly requires a well-designed social security system and proper handling of transition and legacy costs of the system.
Public finance is at the heart of the role of the state in a market economy. It argues that public finance reform has lagged behind that of the economy as a whole.
Structural Change and Public Finance
It forms both an environment for growth and the inclusion or exclusion of parts of the population. This chapter shows the interaction between the structure of the economy and public finances, paying particular attention to the profile of total extra-budgetary revenues and the relationship between levels of governance.
The Fall and Rise of Government Revenue and Expenditure in Relation to National Income
However, the very large decline in the budget revenue ratio came along with a deterioration in the state sector's financial condition. The remarkable increase in the budget revenue ratio since 1995 is the result of the tax reform introduced at the end of 1994 and the "tax-for-fee" reform, which began in 2001.
Off-Budget Activities
Off-budget sources of revenue have always existed, but they grew in importance during the reform period. Since 1997, off-budget revenues and expenditures have been small relative to their on-budget counterparts in the government account, but significant relative to those of subnational governments.
Intergovernmental Fiscal Relations
Unusually, China assigns the responsibilities for providing the bulk of social security, primary education, health care, and public security to lower levels of government, while at the same time providing quite limited transfers to finance these services. As a result, lower levels of government tend to end up with spending responsibilities that exceed the revenues available to them.
Government Expenditure in Transition
This begins in the non-governmental sector with the gradual abandonment of centralized wage determination, a process that began in China in the mid-1980s.5 The widening gap between government and non-government wages forced the government to follow suit. The share of expenditure on pensions, social protection and benefits was extremely small, partly because social insurance, which covers about 20 percent of the workforce and cost the country 4.2 percent of GDP in 2004, is outside the budget.
Social Security
The development of social security schemes for people in rural areas, previously neglected, has risen higher on the government's agenda in recent years. Given the urban/rural segmentation in social security provision, immediate priorities are different in rural and urban areas.
Economic Inequality
The index – a mirror image of the percentage ratio between rural and urban income per capita – confirms the steady increase in rural-urban inequality since 1983, coinciding with the shift in emphasis from rural to urban reforms. Second, the state sector's employment share fell steadily, including through massive layoffs, from the mid-1990s onwards.
Looking Forward: Public Finances in the Medium Term
Increasing the efficiency of resource use and stopping further environmental degradation, ultimately reversing environmental degradation. However, given the rapid rate of urbanization, there seems to be enough room to increase the share of personal tax, which should be a rapidly growing source of revenue.
Notes
Di Bao: A guaranteed minimum income in China's cities? World Bank Policy Research Working Paper 3805, Washington, DC. The reform of the tax sharing system in 1994 brought China's intergovernmental fiscal system much closer to international practice.
China’s Fiscal System
In the late 1990s, the richest of the 89 regions of the Russian Federation had a per capita income about 40 times that of the poorest (Martinez-Vazquez and Boex 1998). In contrast, in Indonesia, the richest district government has 30 times more per capita expenditure than the poorest (Hofman and Cordeiro Guerra 2005).
Intergovernmental Fiscal Reforms for a Harmonious Society
The above-mentioned differences in per capita expenditure show that the transfer system has a limited impact on horizontal imbalances. The transfer system as a whole is effectively non-equalizing, in the sense that per capita transfers to the provinces continue to show a positive correlation with per capita income (World Bank 2006).
Expenditure Assignment and Accountability
Thus, China might consider centralizing some responsibilities for government services, or at least centralizing the funding of those services for the sake of fairness and efficiency. A detailed empirical assessment of the fiscal consequences of spending allocations and reallocations is needed.
Enforcing Accountability
Another and complementary approach is a more general benchmarking of the quality of management in different locations. This survey is a variation of "citizen scorecards" that gained popularity in countries such as India, Indonesia and the Philippines.
Conclusion
This chapter examines the reform options and their implementation in the context of the current fiscal framework. The third section discusses the main options for expenditure policy, including the planned strengthening of the provision of social services (health and education) and social security.
The Role of Fiscal Policy in Promoting a Harmonious Society
The reform and introduction of new spending programs will need to be supported by sound institutional arrangements, including appropriate budgeting and reporting mechanisms and the imposition of firm budgetary constraints at all levels of government; these and other public financial management reforms are discussed in the fourth section. With a number of tax reforms in the pipeline that are expected to reduce revenues in the absence of compensatory measures, rationalizing existing spending programs will be key to maintaining a healthy fiscal position while creating fiscal space for new spending pressures.
Options for Creating a More Efficient and Transparent Tax System
In the upcoming common corporate tax law, the ceiling for salary deductions should be removed. In the upcoming joint corporate tax law, the current depreciation system for foreign-invested companies should be adopted for all companies.
Some Issues Affecting Expenditure Policy Reform Options
At the end of 2004, the pension system covered about 123 million urban workers, or 46 percent of the urban workforce. Currently, part of the burden on the provinces is borne by transfers from the central government.
Public Financial Management: Ensuring that Public Resources Are Properly Used
For the country as a whole, about 750 million, or 23 percent of the working population, had pension coverage (Deutsche Bank Research 2006). Consideration may be given to shifting the budget calendar to better reflect the schedule of the National People's Congress.
Conclusions
With such a shift in the definition of taxpayer, small unincorporated businesses would simply be taxed at progressive income tax rates. Currently, tax policy authority rests exclusively with the central government with respect to all but a few minor taxes in China.
Current Expenditure Assignments
It expanded the responsibilities of both central government and local governments for health care. At the same time, the central government is also issuing more and more guidelines for local expenditure management.
Main Challenges Facing the Current System of Expenditure Assignments
According to China's 1994 Budget Law, local governments are prohibited from borrowing in the capital market except with special approval from the central government.8 However, subnational governments can borrow through SOEs. The inability of many local governments to fund the social safety net has in recent years led to large arrears and pension defaults that have forced the central government to step in with subsidies.
Policy Options
This has resulted in serious constraints on the central government's ability to implement macroeconomic and redistributive policies. Continued VAT reforms (switching to a consumption basis and expanding the scope of services) and income tax reform (addressing coverage and rate-setting powers) will affect sub-national (called local in China) revenue sources.
The 1994 Reforms and Their Aftermath
Most of the personal income tax contribution to the desired distribution considerations comes from the initial exemption limit. There is considerable debate as to whether part of the VAT should be considered a subnational personal tax in the sense described above.
Central and Shared Taxes
A significant disadvantage of the turnover return formula compared to simple division is that it is not transparent. The benefit of the turnover return formula as decreasing over time should therefore not be oversold.
Control of Tax Revenues by Subnational Governments
The taxpayer pays the sum of the two tax rates (20 percent 5 percent 25 percent) times the tax base. In a tax-sharing arrangement, the local government takes the tax, τ, and the distribution rule, s, set by the central government as given.
Governments in Canada and the United States, 2002 (percent)
A further reason may be that the coverage of the tax is not very broad. This may make sense for some of the more advanced municipalities, such as Beijing and Shanghai.
Recommendations for Reform
Reform Options for Intergovernmental Transfers in China.” IMF Working Paper WP/04/98, International Monetary Fund, Washington, DC. Reform of the Agricultural Tax System in China.” In Governance, Decentralization and Reform in China, India and Russia, ed.
The Current System of Central-Provincial Transfers
Subnational governments in China receive 25 percent of value-added tax (VAT) revenue and 40 percent of corporate income taxes and personal income tax from the central government. Note: Provincial governments in China receive 25 percent of sales tax revenue and 40 percent of corporate and personal income tax revenue from the central government.
Structure of Provincial-Local Fiscal Transfers
Impact of Fiscal Transfers: Empirical Evidence
Grants for specific purposes show a negative correlation with provincial gross domestic product per capita and provincial income per capita. Ad hoc grants tend to be negatively related to provincial gross domestic product per capita and provincial income per capita, and they have an equalizing effect on provincial income, lowering the Gini coefficient from 0.365 to 0.283.
Designing Fiscal Transfers: Conceptual and Practical Considerations
Efficiency. Grant design should be neutral with respect to subnational governments' choices of resource allocation to different sectors or types of activity. Equalization of fiscal policy needs should be achieved through output-based per capita (per service population) national minimum standard grant.
Review of the Existing Structure of Intergovernmental Transfers in China
The complexity of China's program and several design flaws, described below, make it impossible for the program to achieve regional fiscal equity. In conclusion, China's fiscal equalization is very complex, but it lacks the basic ingredients of a good equalization system, namely, that there should be a clear equalization standard on which there is broad social consensus and this standard agreed upon by the other should determine both the total group and the allocation to the provinces that will approach the national average standard.
Principal Limitations of the Current System
Lack of central coordination and transparency. Due to the way China approves and consolidates budgets (bottom-up), the size of transfers is unknown until the central budget is approved. As a result, subnational budgets are unable to reasonably estimate intergovernmental transfers before the implementation of the central budget starts.
Pathways to Reform
A key feature of China's economic reforms, which began in 1978, is the transfer of control from the central government over the economy to subnational governments. The next section briefly describes the evolution of China's intergovernmental fiscal relations during the reform period.
The Process of Reform in China
SAT collects the shared taxes and shares the revenue with the central and provincial governments. While maintaining the central government's exclusive right to corporate tax revenues in a limited number of sectors, including railways.
Improvement of the Transfer Payment System
In recent years, the state has been obliged to slow the growth of transfers for specific purposes and increase the resources made available through general tax transfers. Transfers for specific purposes also place more emphasis on areas inhabited by ethnic minorities and areas with weaker fiscal capacity.
Policy Lessons Learned
The percentage of civil servants employed by the central government is also much lower in China (6 percent) than in the entire world (33 percent) (Figure 8.13). Due to this expenditure structure, many tasks that should be performed by the central government are transferred to local authorities.
