Beijing should learn a lesson from its history that the ideal share of fiscal income between central and local governments is around 6:4 as it was from Han Dynasty (206 BC-AD 220) to Song Dynasty (AD 420-479), the most prosperous times of China. Anything above that level proves precarious as it was from Yuan Dynasty (1271-1368) to Qing Dynasty (1644-1911). Although how the division is calculated between Beijing and local governments now remains unknown, sizzling complaints from grass roots just tell how much pressure the whole governance framework is undertaking.
Fiscal relation between central and local governments is a tricky paradigm to understand Chinese governance in history. Socialism China is no exception either. The planned economy before 1980s concentrated both fiscal revenue and power of decision-making to central government. Local officials gained more initiatives from the reform of early 1980s. They were entitled to some tax income and enjoyed more freedom to design the route of local economic development. On the other hand, local governments replaced central authority as main providers of public products and service from then on.
This flexible model of job and fiscal division between central and local governments came to an end in 1994 when the tax sharing reform was carried out from top down. Beijing started take 75 percent of the value added tax of all local enterprises, leaving 25 percent to locals, who assumed all costs and risks of poor performance of local entrepreneurial tax payers. That’s why township enterprises closed down in batches in late 1990s when local politicians became reluctant to promote the much less lucrative growing point.
Then, the focus of local public finance experienced an obvious diversion from enterprises’ value added tax to business tax which was actually monopolized by local taxmen. Different from value added tax, business tax is mainly collected from building trade and tertiary industry. And construction industry is the biggest tax payer. It can explain why large scale city building campaign picked up its steam from the beginning of the 21st century accompanied by land finance.
Beijing enlarged the scope of shared taxation in 2002. Sixty percent of entrepreneurial and individual income taxes, which used to be enjoyed by local governments solely, were taken by central government. Losing a huge hack of income, local politicians relied on business tax further. No wonder land transfer and infrastructure construction sped up after 2003 with substantial government supports and tacit permission.
Land transfer fee, accounting for almost half of some local governments’ income, has not yet been classified as a shared profit with central authority. Land prices are understandably maintained at an insufferable level by local politicians who complain about the lack of income to provide increasingly refined public services in medical care, education, transportation, social security and maintaining stability.
The essence of tax sharing system is sharing taxing powers, rather than sharing tax. After securing sufficient and stable fiscal income sources, local governments are expected to be greatly inspired and confident of their ability of governance. It seems up to the central authority if it is willing to decentralize its long cherished taxing powers to local governments according to their responsibilities.
But Jia Kang, director of Institute of Fiscal Science of Ministry of Finance, says the condition to decentralize taxing powers to governments below provincial level is far from mature. The absence of accountability system and check and balance of powers can do nothing but make grass-root corruption even worse. He may be partly right in pointing fingers at local level, while be blinded to the defect institutional design of higher level authorities.
Transfer payment from Beijing has long been regarded as an effective way to fund local governments as a return to income from local taxation. Admittedly, a large host of infrastructure construction projects and national public wellbeing affairs, such as poverty lifting, are funded by transfer payment of central government. However, what accounts for 57 percent of transfer payment from 1994 to 2006 in China is special transfer payment (STP). The share is 52 percent in 2009.
As a legacy of planned economy, STP, an exclusion from public finance and budget, is conducted by ministries and commissions of central government. It is easier to understand why local governments attach great importance to maintaining close relations with various ministries and commissions in Beijing, who controls trillions of STP funds. The ministries, nicknamed as God of Wealth, are independent in spending STP from supervision of national financial authorities and National People’s Congress.
Moreover, Chinese government fiscal revenue only covers the money involved in public financial budget, says Gao Qiang, director of budget commission of National People’s Congress. In contrast, as international convention, International Monetary Fund (IMF) prescribes that government fiscal revenue include incomes from tax, social security, service, administrative fees and fining, property incomes of government and its affiliated organizations as well as transfer incomes.
That is to say Chinese government’s revenue should have ben much higher if Beijing applies international standards. Gao estimates Chinese government revenue accounts for about 35 to 40 percent of GDP in 2010 actually, instead of 20.9 percent as it was declared. An Tifu, professor of finance in Renmin University echoes Gao’s voice, the majority revenue of modern governments comes from tax. But Chinese government revenue is made up of receipts covered by state budget, such as tax, and receipts uncovered by state budget, i.e. land transfer fees and administrative fees.
Liao Xiaojun, vice minister of Ministry of Finance, is justified to complain it is difficult for Chinese government to improve its education input to 4 percent of GDP, because only about half of government’s actual revenue is budgeted for the public affairs. The other half of government receipt is spent without third-party supervision and budgets.
Governance modernity is based on the rationality of fiscal system. Wang Shaoguang, professor of political science at Chinese University of Hong Kong, suggests building up real public fiscal institution is not only an effective way to release social tension in China, but also an optimum entry point to push the envelop of political reform. Public fiscal institution reform, bound to produce sensible changes soon, is more pragmatic and workable than any idle talk on political democracy.