Fiscal Reforms and the Relationship of Central-Local Governments in China

In 1978, China started its economic reforms, and the main characteristic of Chinese economic reforms is fiscal decentralization. This means that the central government wanted local governments to develop the local economies with their fiscal autonomy. By and large, this strategy was successful. However, it also brought many structural problems such as the increase of government deficits and instability of macroeconomic policy. As a result, the central government was increasingly concerned with the potential political and economic consequences of its weakening fiscal power. The ceter finally introduced a new fiscal reform program (the tax-sharing system) in 1994. The main objective of this reform was to reverse the declining two ratios - the ratio of government revenue to GDP and the ratio of center's revenue to total government revenue.

Under this background, this study situates the 1994 tax-sharing reform program in its historical context, outlines the salient features, and discusses some of its major problems and political implications.

The main research questions of this study are the following three issues: (i) `Has there been a real fiscal decline in terms of international accounting standard as well as the Chinese definition?' This study shows that there has been a real decline in both accounting practices and the main contributor to this decline is the poor performance of stat-owned enterprises. However, the decline is true just within Chinese official statistical reports. In other words, unofficial fiscal activities at local levels are increasingly expanded in China as a reaction to the center's effort to recentralize the fiscal power. (ii) `To what extent has the 1994 tax-sharing reform overcome the institutional drawbacks of the old system?' This study gives a negative answer to this question, because the 1994 reform includes some fatal structural problems such as tax rebate scheme, and consequently, it makes regional disparities worse than before. (iii) `What are the effects of the 1994 fiscal reform?' The tax-sharing system has given rise to enlarge non-budgetary funds by illegal ways at both levels.

The conclusion of this study is that the structural problems occurred in transition to a market economy are more important in fiscal relations in China than budgetary decline itself. This also means that it is problematic to draw direct links between China's budgetary trends and the decline of the state power many scholars have pointed to the decline in central revenue as a primary cause of the reduction in central state capacity.