Lec 13 Fiscal reforms

fiscal system under the command economy

centralized revenue, centralized expenditure

revenures : came largely from industrial profits raised from the soe

expenditures

• determined by the central government, but responsibilities for day to day public administration and social services delegated to local government

→ no professional formal tax administration system

adventages of centralized system

the central government has high authoriitu and can balance the regional distribution of expenditures

challenges of centralized system

1 incentive challenge ; local governments lacked on the effort side, and the autonomy to make regional development related decisions, and the right to claim residual fiscal returns

2 knowledge challenge : local governments are often more aware of local economic characteristics and opportunities

1987 Fiscal responsibility system

the central government introduced a system of fiscal contracts with local government

these contracts stipulated a lump sum remittance to the center from each rpovince, to increase annually by an agreed rate, with any additional revenues accruing

in return the privinces accepted responsibility for meeting their expenditure requirements from retained revenues

step 2: local governments as political entrepreneurs

since the fiscal contracting reform, local governments have gradually transformed from administrative implementers to active organizers and coordinators of local economic development

local governments have gerater flexibility in making economic decisions

have begun to proactively cultivate entreprises, attract investments, and improve local infrastructure

what specific efforts did the local government do (political entrepreneurs)

• supporting local firms →favorable policiees, supporting finance, talent recruitment, allocating land,

• leverage local endowment recourses → using local knowledge for development → transformation : geographical location, mineral resources, local specialities, scenic spots

• attracting foreign and domestic investors → preferential land and tax policies

• request projects from central ministries → funding, project approval,

• seek other preferrential policies: depending on the region which is determined by the central government

new challenges after the first wave of reforms

declining : central governments revenue / total revenue

declining : total fiscal revenue / GDP

• the local governments hide fiscal revenues by shifting the revenues to extra budget revenues

1994 reform : recentralize the fiscal system

• tax modernization : symplifying the tax structure, eliminating distortiuonary elements, and increasing transparency

• tax sharing system → taxes are assigned to central governmlent, local government or shared

• tax administration : national tax administration in China → previously tax bureaus were split into two distinct offices : shared and central VS local, → later merged

tax modernoization

• Value Added Tax VAT 17%

• business tax : applied services 5%

• entreprise profit tax = 33% for SOE, collective and privte entreprises

• personal income tax

• luxury/ excise tax : cigarettes, alcohol,

fiscal expenditures pre reform era

mostly spent in investments : ordinary facilities, steel mills, machinery plans rather than public goods

fiscal expenditures during the reforms

the budgetary expenditure for social welfare outlays subsequently grew rapidly → education, pension,

local government plays an important role

the new structure

central vertical transfer

• the center government collects the majority share of revenue, and local governments are dependent on the center for budgetary transfers

how can the local government raise money post reform (outside of te vertical transfer)

raising revenue from land

• sell the land use rights to developers

local government financing vehicles : local governments could borrow egainst expected future revenues

seeking revenue through growth : keep expanding the local economic base