CHAPTER 3. FISCAL DECENTRALIZATION AND SOCIAL
3.1 The Process of Fiscal Reform in China
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CHAPTER 3. FISCAL DECENTRALIZATION AND SOCIAL SECURITY IN CHINA
In this chapter, several reforms of fiscal system between the central and provincial governments are illustrated, especially the TSS implemented after 1994.
Then, a measurement of fiscal decentralization is defined and calculated. This study uses this measurement to compress and analyze the degrees of fiscal decentralization in China and lets them be the primary independent variable. In the last section, the statement and some relevant policies of social security are introduced.
3.1 The Process of Fiscal Reform in China
According to fiscal system, this study divided the process of fiscal reform in China into three stages as follows. The first stage is before the 1978 period, the implementation of “conventional fiscal system”, which is the revenue remittance and redistributed to provincial governments by the central government. The second stage is during the 1979-1993 period, the implementation of “fiscal contracting systems”.
The third stage is after the 1994 period, the implementation of “tax sharing system”.
The following are the details of these reforms by order.
3.1.1 Before the 1978 Period
In the early 1950s, the Soviet model of central planning shaped the relationships between the central and provincial governments in China. The central authority exercised direct administrative control over provincial governments through three central planning mechanisms, which were the physical planning of production, centralized allocation of materials, and budgetary control of revenues and
expenditures.15 Although concentration of power at the central government moved to
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decentralization in 1958, recentralization began in the early 1960s. Later a new movement of decentralization started in 1971. However, because of the economic destroy during the Cultural Revolution period, this decentralization reform still failed.
As a matter of fact, before 1979, China’s budgetary policy essentially consisted in generalized tax collection and profit remittances controlled by the central government and then redistributed as needed to the provincial governments. This fiscal system was so-called the system of “eating from one pot” (chi da guo fan). This system was based on the “conventional fiscal system”, which was a central planning system. The main characteristic was that all fiscal policies were based on the national programs.
Thus, the intervention of the central government was more serious to provincial governments. This resulted in an equal fiscal capacity among provinces, but provincial governments had no incentives and low efficiency to develop their local economies due to lacking enough fiscal autonomy.
3.1.2 During the 1979-1993 Period
There were three primary reasons that China started to proceed the fiscal reform under market mechanism. First of all, more and more non-national operated
enterprises grew up rapidly, such as town and township enterprises, joint enterprises, and private operated enterprises. Also, there were more and more national operated enterprises which undertaken a great loss and resulted in the large national fiscal burden. Second, the economic reform enlarged the powers of provincial governments and made provincial governments submit requests of fiscal decisions. Third,
economic benefits affected the decisions of governments and promoted provincial governments to increase fiscal revenues and develop their local economies. Therefore, the fiscal change of centralization into decentralization was urgency.16
16 According to Lin and Liu (2000).
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Staring from 1979, China virtually began its fiscal decentralization reform, involving changes concerning how revenue is divided among the central and provincial governments through a major institutional innovation called the “fiscal contracting system (FCS, hereafter)” (cai zheng fen bao zhi), introduced between 1979 and 1993. From then on, the central and provincial governments each began to
“eat in separate kitchens” (fen zao chi fan). In 1985, Chinese authority implemented the system of dividing the tax categories, appraising and ratifying the revenues and expenditures, and grading contracts. Furthermore, the FCS gradually formed into six contracting categories by 1988.17 During the period, the FCS gave the sub-national governments more and more powers to finance their needs, encouraged them to develop a regional economy and collect revenues, and gradually built up their accountability.
However, disadvantages of the FCS were mainly: (1) the fiscal contracting system caused the central revenues regressed,18 and (2) the different contracting methods were too complicated and unjust, widening the fiscal gap between different provinces.19
3.1.3 After the 1994 Period
In 1994, China experienced another fiscal decentralization reform, called the “tax sharing system (TSS, hereafter)” (fen shui zhi). It fundamentally changed the way revenues were shared among the central and provincial governments. The TSS
asserted that the income item that was relatively easy to identify belonged to either the
17 The six categories were as follows: incremental contracting, basic proportional sharing, proportional sharing and incremental sharing, remittance incremental contracting, fixed remittance, and fixed subsidy.
18 The central government was trapped by the fiscal contracting system, leading to the ratio of central governmental revenues to total revenues continually declining. According to statistics, the percentage of central governmental revenues to total revenues fell from 38.4% in 1985 to 22% in 1992.
19 The rich provinces with more bargaining power (such as Guangdong) benefited more than others
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central or provincial governments. In fact, the system of fiscal decentralization was based on the jurisdiction that gave the corresponding government the right to impose tax. The major goal of the TSS implemented in 1994 was to construct a new fiscal system between the central and provincial governments by demarcating the different tax categories. As pointed out by Qiao et al. (2002), the key measures in the TSS included the introduction of a value-added tax (VAT, hereafter) as the major revenue source and the setting up of uniform tax-sharing rates for major taxes, including VAT.
The uniform tax-sharing rates replaced the previous fixed-amount remittance scheme adopted in the FCS.
Under this new system, the central and provincial governments each had clearly assigned their “own revenues”, and all transfers become more transparent and
objective by a rule-based method, rather than a negotiated percentage as before (Wang, 1997). Therefore, each provincial government now had a greater
responsibility for its provincial fiscal balance. Also, the tax structure was greatly simplified.20 In addition, this reform achieved some notable successes: improving the
“two ratios”, which are the ratio of tax revenues to GDP and the ratio of the central governmental revenues to the total governmental revenues. This result simplified the intergovernmental finance system and tightened fiscal control.21 Since the TSS replaced the previous six categories taxes of fiscal contracting system, which makes the fiscal system much easier. Meanwhile, the practical measure is that provincial governments must have an adequate level of revenues which are either raised by
20 The value-added tax replaced the turnover-based product tax, and has been implemented basically at a uniform rate of 17 per cent. The corporate income tax was unified to include all domestic enterprises, and the top rate has been reduced from 55 per cent to 33 per cent. Consumption taxes on tobacco, liquor, and other luxuries were introduced. The previous system of profit and tax contracts, under which SOEs negotiated annual transfers to the government budget, was largely eliminated (Ahmad et al., 2002; Wong 2000).
21 The establishment of National Tax Services (NTSs) in 1994 and 1995 offered a better control over general tax collection and local tax exemption policies. The interference of local authorities in tax administration and collection of central and shared revenues was substantially restrained.
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provincial governments or transferred from the central government and are deducted by payments from province to central. In addition, the details of the TSS policy are illustrated in Table 3.
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Table 3: The Contents of China Tax Sharing System Reform in 1994
Process Contents
Dividing the jurisdictions and expenditures between the central and provincial
governments
1. The central government is in charge of national security, diplomacy, the necessary expenses of central organizations’ operations and the expenses of adjustments in economic structure, regional development, and macroscopic control.
2. Provincial governments are in charge of the necessary expenses of provincial organizations’
operations and the expenses of development in economy and society.
Dividing the revenues between the central and provincial governments
1. All taxes are divided into three kinds of taxes, which are the central tax, the shared tax between the central and provincial
governments, and the local tax, respectively.
2. Establishing two kinds of tax institutions which are the central and local tax institutions. The central tax institution levies the central tax and the shared tax between the central and
provincial governments. The local tax institution levies the local tax institution.
Establishing the fiscal transferring system between governments
1. The payment, transfer, and subsidy are remained from the previous system.
2. Because of the range and amount expansions of the central fixed fiscal revenue, the central government established the fiscal transferring system from the central government to provincial governments.
Establishing the plan of budgets and the arrangement of funds
1. After the implementation of TSS, the central government and provincial governments plan budgets according to the new tax rates.
2. Let the payments of provincial governments subtract from the transfers of the central government. Assign a rate of arrangement of funds, which is the proportion of the net amount to the expected revenue of the central
consumption tax and the value added tax in the current year. According to this rate, the central
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Table 3: The Contents of China Tax Sharing System Reform in 1994 (Continued) government distributes the central consumption tax and the value added tax to provincial governments.
Source: Cheng (2005).