Fiscal Prudence and Growth Sustainability: An Analysis of China's Public Debts

• Published date: 01 December 2012
• Date: 01 December 2012
• Author: Gang Fan,Yan Lv
• DOI: http://doi.org/10.1111/j.1748-3131.2012.01234.x

Fiscal Prudence and Growth Sustainability:

An Analysis of China’s Public Debts

Gang FAN1,2† and Yan LV1

1Peking University and 2National Economic Research Institute

This paper analyses and assesses China’s current fiscal system, including its basic institutional

arrangements, the relationship between central and local governments, and the fiscal balance and

public debt. This paper pays special attention to the local government borrowings that have

increased dramatically in recent years, and tries to measure the“overall public debt risk” by includ-

ing all kinds of eligible debts. This paper finds that although the large expansion of local govern-

ment debt during the fiscal stimulation response to the global financial crisis was devastating, the

all-inclusive total public debt to gross domestic product ratio remains under 50%, and as long as

the local debt stops growing, the risk is quite manageable. This paper also points out that more

attention should be paid to improving and reforming the Chinese fiscal system, particularly the

reform of the fiscal relationship between central and local governments, and the legal framework

for local government debt management.

Key words: financial risk, fiscal system, local government borrowing, public debt

JEL codes: H61, H63, H74

1. Introduction

Once upon a time as recently as the late 1960s, under the centrally planned economic

system and during the Culture Revolution, China, as a state, announced with great pride

that it had got rid of all domestic and foreign debts. “We got no debt at all!”

Today, with European and US public debt crises looming around, many people,

Chinese and foreign, are worrying about China’s debt problem. This worry has its

reasons, particularly because local governments’ borrowings increased dramatically in

the one year of 2009 when the central government adopted a drastic stimulus package to

tackle the devastating impacts of the US financial crisis, including a historically loose

monetary policy that allowed the local governments to borrow.

However, to understand China’s public debt issues, we need to understand China’s

basic fiscal and financial system, and the relationship between the central and the local

governments. Therefore, in this paper, we will go through some analyses of the institu-

tional arrangements of government financing first, make a brief summary of the history

of public debt problems in 1980s and 1990s, and then focus on what has happened in

recent times.

†Correspondence: Gang Fan, Peking University, Yiheyuan Road No. 5, Beijing, 100871, China.

Email: fangang@neri.org.cn

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doi: 10.1111/j.1748-3131.2012.01234.x Asian Economic Policy Review (2012) 7, 202–220

© 2012 The Authors

Asian Economic Policy Review © 2012 Japan Center for Economic Research

202

2. A Centralized Regime: China’s Fiscal System

China’s current state system features a centralized regime in both political and fiscal

senses. Politically, all local officials (“party secretary generals,”in particular) are supposed

to be appointed by the central authority, although the appointment process now is more

and more based on references to “opinion polls” among officials and other people. Fis-

cally speaking, it is not a federal system based on the fiscal autonomy of the local states,

like the USA, but a centralized regime where the central government’s collection of the

majority of tax revenues, part of which is transferred to the local budgets, and the central

government’s monopoly of the right to issue debt to the public.

Laws, regulations, and institutional arrangements, which have been put into function

in past years, are now playing key roles in China’s current fiscal system.

2.1 Tax Sharing System (fen shui zhi)

The Tax Sharing System was introduced in 1994. It was a reform of the previous “Tax

Revenues (Remittance) Contract System” between the central and the local governments,

under which a fixed or “contracted” revenues for the central government declined as a

proportion of the total from 40.5% in 1984 to 22.0% in 1993, with the local government

revenues continuously increasing with the strong economic growth1(China Economic

Information Network Statistic Database). The “Tax Sharing” was actually a recentraliza-

tion process, aimed at turning the trend of decline in central revenues around. Under

the new system, taxes were reassigned between the central and the local governments

in terms of both items and sharing ratios.2Under such a system, both the revenues of

the central and local governments are supposed to grow along with the gross domestic

product (GDP), but with bigger proportion goes to the central government, so the

central government can play a roles of transfers among the localities to reduce regional

disparities. From these perspectives, the reform since 1994 has been a great success. The

total fiscal revenues grew steadily in both absolute and relative terms, from 10.8% of

GDP in 1994 to 21.4% of GDP in 2010, and the central government’s share increased

from barely 20% of the total in early 1994 to nearly 60% in 2010 (China Economic Infor-

mation Network Statistic Database).

Local governments took about 40% of national government revenues, while they

spent more than 60% of national government expenditures in recent years, reflecting

first of all the increasing fiscal transfers through the central government’s budget. In

2010, fiscal transfers were 76.1% of the central fiscal revenues and 43.8% of the local

fiscal expenditures (China Economic Information Network Statistic Database).

The Tax Sharing and fiscal transfers make it possible for the government to have a

consolidated state budget balance sheet that may include all items from both central and

local revenues and expenditures in the formal budget. There have been several efforts

since 1994 to include originally “informal budget items,” such as fees,fines, special funds,

and so on into the budget (Fan, 1999a). A recenteffor t to make it as consolidated as pos-

sible was to include all revenues from land sales into the local state budgets (Fan et al.,

2010; p. 102).

Gang Fan and Yan Lv China’s Public Debt

© 2012 The Authors

Asian Economic Policy Review © 2012 Japan Center for Economic Research 203