Chinese Reforms Seek to Balance Revenue and Decentralization Goals

• Pages: 397-399

Page 397

Ideally, fiscal decentralization promotes economic efficiency and budgetary discipline, but it does so best when certain conditions are in place-notably a clear and relatively stringent delineation of central and local government responsibilities. In a recent IMF Working Paper, Intergovernmental Fiscal Relations: The Chinese System in Perspective, authors Vivek B. Arora and John Norregaard examine the evolution of this relationship in China. The country's fiscal decentralization accelerated between 1978 and 1994, with local governments assuming greater control over taxation and with bargaining increasingly characterizing fiscal relations between central and local governments.

In the absence of clearly assigned revenue and expenditure responsibilities, China's fiscal decentralization has tended to spur the growth of off-budget activities and to constrain the central government's ability to use fiscal policy as a tool in furthering macroeconomic stability. Fundamental fiscal reform in 1994 addressed revenue concerns and succeeded in substantially raising-at least initially-central government revenue. Related reforms in expenditures and transfers-and the buoyancy of central government revenues-remain to be undertaken, however.

Decentralization in China

Alongside its rapid growth and transformation to a market economy after 1978, China experienced a steady evolution in its intergovernmental relations and a growing fiscal decentralization- most markedly on the revenue side. Before 1994, China had no centralized tax administration system. Local authorities carried out tax collection, with revenue distribution effected through an elaborate, and negotiated, system of revenue sharing.

Expenditure responsibilities were not similarly decentralized. The central government assumed authority for capital outlays, national defense, and government debt servicing. And although local governments were responsible for social welfare, administration, agricultural development, and budgetary subsidies, the central government retained the authority to assign additional expenditure responsibilities. A key by-product of revenue decentralization and unpredictable expenditure responsibilities was a sharp increase in the growth of extrabudgetary funds. These off-budget funds largely comprised the retained earnings of local state-owned enterprises, public utilities surcharges, public housing rental...