Chinese Government: Structure and Finance

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Chinese Government Structure and Finance

• Lecturer Zhigang Li

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Power of Chinese Government

• Maintaining formal institution
• Legal system
• Financial system
• Crisis management
• Fiscal policy
• Taxation
• Fiscal spending (e.g. infrastructure)
• Direct policy intervention
• One-child policy
• Direct control of production process
• Planning
• State owned enterprises

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Trend of Government Size

• Ratio of fiscal expenditure to GDP (Figure 12.1
  and p. 437)
• 1979 over 30
• 1990 20
• 1996 11
• Current around 20

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Outline

• Governance structure
• Centralized political power
• Dynamics inside
• Decentralized economic decision
• One menu, separate stoves
• Fiscal system
• Centre-local relationship
• Taxing ability
• Spending mechanism (e.g. budgetary process)

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General Features of Chinas Reform and Transition

• Gradualist transition
• A structural break in early 1990s
• 1978-1993 A cautious incrementalism (high
  stability) and lack of policy decisiveness

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First period of transition (1978-1993) Reform
without losers

• Allowing TVEs
• Incentivization
• Dual-track price system
• Dencentralization
• Particularistic contracting

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Second period of transition (1993-now)

• Fiscal reform
• Corporate reform
• Company law
• Foreign trade and investment
• Joining WTO
• Financial reform (banking system)
• Price system
• More stable inflation
• Privatization
• Welfare reform

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Chinas Political System

• Run by the Chinese Communist Party
• Authoritarian and Hierarchical

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The Structure of Power in Different Transition
Stages

• From 1978 to early 1990s
• National power was fragmented with numerous veto
  players.
• Revolutionary vs. conservative elders
• Eight Elders and a handful of younger leaders
• The power to make or block economic policy was
  widely dispersed.
• Central Advisory Commission
• From early 1990s to now
• Less fragmented national power

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Chinas Political System at the Beginning of the
Reform

• A centralized political system that provided
  leaders with abundant patronage to distribute
• Physical goods
• Managerial jobs (nomenklatura system)
• Reciprocal accountability
• No real checks and balances
• Leaders and aspiring leaders compete to promote
  their own clients to responsible posts and
  positions that give them a vote in crucial
  commitees and Party Congresses.

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How did the 1978 reform started?

• Political equilibrium has been broken in the
  cultural revolution.
• The first response of Chinas leaders after 1976
  (Maos death) was to fix up the old economic
  system and rehabilitate the CP political system.
• Great Leap Outward
• The effort failed and this convinced Chinas
  leaders that maintenance of the status quo was
  infeasible.

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Benefit and Costs of Reform for the Leaders

• Costs
• The supply of rents is reduced
• The possibilities of autonomy increase
• Commitment within the hierarchy declines
• Benefits
• New types of patronage resources

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Part 2

• This part follows chapter 10 by Stephan Haggard
  and Yasheng Huang
• This part focus on the interaction between
  governments and the private sector.

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Single Menu, Separate Stoves (Kai Yuen Tsui)

• Single menu
• The centre still exerts a firm grip over local
  bureaucracy through its control over appointment,
  evaluation and dismissal of local cadres.
• A top-down system of incentive contracts, TRS
  (target responsibility system) align the
  interests of local cadres with the preferences of
  (ultimately) the centre.
• Separate stoves
• Local governments can retain part of local fiscal
  revenue and influence local economic activities,
  e.g. investment.
• Fiscal sharing contracts between the centre and
  the provinces limit central-state predation.

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TRS

• TRS is a set of performance criteria (targets)
  that induce local cadres to allocate their fiscal
  resources in the preferences of the centre
• Fertility control
• Nine-year compulsory education
• Environmental protection
• Suppression of inflation
• Level by level, the targets are passed downward
  and are decomposed among subordinate governments
  and cadres.

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Cadre Promotion Mechanism

• The performance of local cadres are ranked in
  accordance with the points based on TRS weighting
  schemes.
• The larger the weight, the stronger the
  incentive.
• Economic construction is often assigned large
  weight (e.g. 60)
• Local cadres have a strong incentive to exert
  efforts on tasks easily measured and heavily
  weighted (causing distortion).

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Do voting-with-feet work in China?

• The proliferation of predatory charges suggests
  that a voting with feet scenario may be too
  optimistic.
• Household registration or hukou system together
  with other administrative controls might hurt
  labor mobility

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Why inflation was higher when China grew faster?
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Decentralization and Growth-Inflation Comovement
(Brandt and Zhu, 2000)

• A Cyclical Stop-Go Pattern in China since 1978
• Rapid growth and accelerating inflation
• Then prolonged contractions with low growth and
  inflation rates
• A Widening State-Nonstate Output Gap
• The state industrial sectors share fell from 78
  in 1978 to 34 in 1995

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The Brandt-Zhu Story

• Decentralization draws bank credits away from the
  state sector to the more efficient non-state
  sector ? Widening State-nonstate gap and
  increasing growth rate
• The central government makes up for the loss in
  credit by printing money to finance the state
  sector ? High inflation
• The central government introduces
  recentralization ? More credit to state sector,
  low aggregate growth rate, less printed money and
  lower inflation rate.

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Decentralization, Growth, and Inflation Time
Series Evidence (Feltenstein and Iwata, 2004)

• Decentralization plays a fairly important role in
  a model of growth and inflation.
• The pattern of the relation does not appear to be
  restricted to the post-reform period, but rather
  characterizes the entire postwar economy in China
• Between 1949 and 2001, the Chinese economic
  policy shifts frequently between decentralization
  and recentraliztion programs.

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Main Features of Fiscal Decentralization in China

• Intergovernmental Fiscal contracts
• Fiscal contracts between successive levels of
  governments define rules not to trespass on the
  tax rights of local governments.
• Local governments have ownership rights over
  their off-budget resources.
• Extra-budgetary revenue (charges levied by
  administrative and institutional units) grew at
  27 per year during 1982-95, reaching similar
  amount as the budgetary revenue.
• Extra-system revenue (e.g. profits from TVEs) is
  also significant.
• Unstable centre-state fiscal sharing contract
• No independent enforcer of fiscal contracts
  (things have changed much since the 1994 tax
  reform)
• Off-budget revenues are not secure either

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Chinas Fiscal System

• Before 1994
• No formal tax system
• Revenue came mainly from industrial profits
• Particularistic fiscal contracts between
  successive levels of governments
• After 1994
• A formal tax system with broader tax base (Table
  12.1)
• Uniform revenue sharing between centre and local

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Current Revenue Structure
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Centre-Local Sharing of Major Tax Revenues

• Fully owned by the central government
• Taxes collected by customs
• Income tax from financial institutions
• Shared between the central and local government
• VAT 75 for the central
• Taxes on foreign firms
• Income tax (for individuals and firms)
• Fully owned local governments
• Business tax (mainly service sector, excluding
  financial industry)
• Why?

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Tax Incentives for Local Governments

• Incentives for helping and protecting local
  economy remain but are weaker than in the
  pre-1994 period.
• Economy-intervening policy by local governments
  may be distorted by the sharing scheme.
• Service sector may be more attractive than the
  manufacturing sector

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Centre-Local Fiscal Relationships (Figure 12.3)

• Local share of expenditure
• Continuously rising
• Local share of expenditure
• Generally decreasing (except for the 1983-1993
  period)
• Transfer
• Before 1983 Upward transfer
• 1983-1993 Approximately balanced
• After 1993 Downward transfer

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About Transfer

• Why do the fiscal system shifts towards the
  large-downward-transfer scheme?
• Concern for interregional inequality
• Different roles of local governments in
  expenditure and revenue collection
• Efficiency of transfer

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Power of the Agency of Fiscal Revenues

• Ratio of tax revenue to GDP continues to rise
  since late 1990s.
• High variant local tax collection system
• Tax collection costs
• Tax competition
• Tax collection effort

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The Case of Personal Income Tax

• Official tax scheme
• Individuals with wage income under a certain
  threshold do not need to pay personal income tax
• The line was 800 yuan/month in 2004 and increased
  to 1600 in 2006.
• Progressive personal income tax
• Tax rates are uniform across China

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Personal Income TaxFour cities
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Efficiency of Public Spending

• Poor budgeting
• Passive and incremental budgeting
• Inadequate time for preparation
• Little focus on strategic priorities
• Ineffective monitoring
• Huge extrabudgetary spending

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Extra-budgetary Funds

• Huge
• Fees and levies 8-10 of GDP
• Quasi-fiscal spending through the banking system
  6-8 of GDP
• Distorting
• Over-use of land and over-investment in physical
  infrastructure
• Temporary

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Summary

• A flexible system of controlling China
• Centralized political and personnel control (e.g.
  policy mandates and targets)
• Decentralized economic decision (e.g. effective
  tax schemes)
• Advantages
• Powerful incentives for local government
  officials to put in efforts
• May be an important source of Chinas successful
  reform (e.g. facilitate the trial-and-error
  reform approach)
• Disadvantages
• Distorted incentives (due to asymmetric
  information on performance measures)
• Short-sighted policies due to short tenure of
  high-level local officials
• The system itself is not well controlled (e.g.
  EBF)
• Potentially low efficiency of intergovernmental
  transfers