Reform of the intergovernmental transfer system in China

WPS4100 The Reform of the Intergovernmental Transfer System to Achieve a Harmonious Society and a Level Playing Field for Regional Development in China By Anwar Shah and Chunli Shen , World Bank1 World Bank Policy Research Working Paper 4100, December 2006 The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the countries they represent. Policy Research Working Papers are available online at http://econ.worldbank.org. 1 The authors are Program Leader, Public Sector Governance and consultant, World Bank respectively. They are grateful to Professor Baoyun Qiao, Shanghai University for comments and inputs. Please address all comments to Anwar Shah (ashah@worldbank.org). 1  "Get at the root of the problem while solving current issues." Chinese Proverb Introduction Central-provincial and provincial-local fiscal transfers are the dominant source of revenues of provincial and local governments in China. In 2003, they financed 67 percent of provincial, 57 percent of prefecture and 66 percent of country and lower level expenditures (Qiao and Shah, 2006). In China, most of the service delivery responsibilities are assigned to the subnational governments. Yet, for reasons of efficiency in tax collection and administration the central government collects revenues far in excess of its expenditure needs. In 2003, the central government collected 70 percent of consolidated revenues but accounted for only 30 percent of consolidated expenditures. The initial fiscal surplus of the central government enables it to use its spending power to provide financing to subnational jurisdictions for the achievement of national objectives and to influence local priorities. This paper examines the incentives associated with the design of such transfers and their implications for the efficiency and equity of public service provision and accountable local governance in China. The paper is organized as follows. Section 1 presents an overview of the structure of central- provincial fiscal transfers. Section 2 provides a summary of the existing provincial-local transfers. Section 3 examines the economic impact of these programs empirically. Section 4 highlights conceptual and practical design considerations in designing fiscal transfers. Section 5 presents a review of the existing structure of intergovernmental transfers. Section 6 identifies principal issues for an agenda for restructuring. Finally, section 7 presents some ideas on possible options for a reform of the existing system of fiscal transfers to further national objectives. 1. The Existing System of Central-Provincial Transfers The fiscal system in China is based upon a layer cake model where there is a strict vertical hierarchical relationship among different orders of government. Therefore, the 2  central government only determines transfers to provincial level governments2 and there are no direct central grants to prefecture, county, or township governments. It is worth mentioning that county governments get transfers directly from provincial-level governments in seven provinces (Anhui, Fujian, Heilongjiang, Hainan, Hubei, Ningxia, and Zhejiang) and four metropolitan areas (Beijing, Shanghai, Tianjin, and Chongqing) as well as in the five separately planned cities where the "province managing county" model has been implemented by the year 2005 (see Figure 1). The sub-provincial transfer design is similar to that of central transfers to provincial governments, though the grant composition varies significantly across provinces due to the diversity of regional fiscal resources. Central transfers in China can be classified into two broad categories: general purpose and specific purpose transfers. The general purpose transfers consist of (a) revenue-sharing transfers (b) the tax rebate designed to return a fraction of revenues by origin (province of collection), and (c) the equalization transfer established in 1995 in an effort to ease the widening regional disparities. The equalization transfer was called "transitory period grant" until 2001 and then renamed "the general-purpose grant" since 2002. These three transfers constituted 63.8 percent of total central transfers in 2004. The equalization grant has grown rapidly in size from only 2.07 billion yuan in its initial year to 74.5 billion yuan in 2004. Specific purpose transfers include (a) grants for increasing wages (b) grants for rural tax reform (c) grants for minority regions (d) prio-1994 subsidies (e) other ad hoc transfers. About 200 plus ad hoc grants, termed the earmarked grants (Zhuanxiang Zhuanyi Zhifu) by the Ministry of Finance, China, are used to subsidize a wide variety of spending projects such as capital constructions and social relief for calamities. In 2004, the largest central-provincial fiscal transfer was the revenue sharing transfers (469.5 billion yuan), followed by the tax rebate (404.97 billion yuan) and earmarked grants (322.33 billion). These three transfers combined accounted for more than 80 percent of the total central-provincial transfers. The 2004 equalization transfer was 74.50 billion yuan, amounting to 5 percent of the total central-provincial transfers (see Table 1). 2The five separately planned cities, Dalian, Qingdao, Shenzhen, Xiamen, and Ningbo, are treated as provincial governments fiscally 3  Figure 1 The Intergovernmental Grant Flow in China (2006) Table 2 (see also Figure 2) presents an overview of various transfer programs in 20043. For the total central transfers, Shanghai, the richest province, was the highest per capita recipient province (5,079 yuan) and Henan the lowest (646 yuan) with the national average of 1117 yuan per capita. When it comes to revenue sharing transfers, Shanghai obtained the national highest per capita transfers of 2,830 yuan; Hainan received the lowest within the eastern region (179 yuan); Shanxi and Xinjiang were the highest recipients in the central and western regions respectively; and Tibet received the lowest in the western China and also in the nation. As for the tax rebate, Shanghai, Jilin, and Yunnan received the largest amount in the eastern, central, and western China respectively. For obvious reasons, the six coastal provinces