Fiscal policies for coordinated urban-rural development and their relevance for China.

Author:Shah, Anwar

    International experience shows that uncoordinated exercise of urbanization and rural development policies often result in serious negative consequences for quality of life and economic and social outcomes. Unbridled urban sprawl could lead to urban encroachment of productive agricultural land and pose a threat to food security. It could lead to worsening urban-rural inequalities in income and access to public services as well as creating social unrest in rural areas. Industrial promotion without adequate consideration of urban-rural linkages and without adequate safeguard of environmental protection could lead to incomplete linkages for industrial competitiveness, excessive migration to urban areas, rural underdevelopment, degradation of environmental quality, high rural unemployment and low productivity and at the same time creating urban blight and high incidence of crime in urban areas. Rural development policies without adequate consideration of urban-rural linkages could create white elephants requiring perpetual subsidies (see World Bank, 2014, World Bank and Development Research Center, PRC, 2014).

    The recognition of these linkages for coordinated development are often recognized too late when the negative consequences of such neglect become all too obvious. While these linkages have broader policy implications, this paper deals exclusively with the singular role of fiscal policies to overcome the above mentioned fallouts through creating positive incentives for coordinated development and negative incentives to discourage actions with negative social externalities. To this end, both the principles and better practices are highlighted.

    The paper is organized as follows. First fiscal policies for urban development are reviewed. The following sections takes stocks of fiscal policies and practices for rural development. Policies and practices to ensure synergistic urban-rural development are then examined. A final section draws some lessons from the international experience and highlights their relevance for the People's Republic of China (PRC).


    The allure of urban areas especially large metropolitan areas is irresistible: the promise of good job, good homes, a good life, good times for the young and the young at heart, and dreams of prosperous future for all. In an information age with a borderless world economy where economic success is closely tied to competitive advantage, urban areas are at the core of the future prosperity of a nation. Urban areas serve as the innovation and cultural centers. They can also serve as a tool to overcome a lack of trust and restore confidence in government through their commitment to improve social and economic outcomes. Their compactness serves to enhance reaping benefits of research and development, agglomeration economies and knowledge sharing and connectivity while lowering transportation and transactions costs for individuals and firms.

    These great expectations are however, critically linked to fiscal policies that promote compactness and discourage urban sprawl and ensure fiscal health of urban areas to deliver quality public services at affordable tax prices. Therefore, fiscal health and compactness is tied to the fiscal regimes available to urban especially the taxing, spending regulatory functions that can be exercised as well as availability of grant and bond financing options. The following paragraph present a reflection on both the principles guiding such fiscal regimes as well as examples from the practice.

    Key Considerations in Local Finance

    The overall objective of local governments is to maximize social outcomes for residents and provide an enabling environment for private sector development through efficient provision of public services. This requires that local financing should take into count the following considerations:

    * Local government should limit self-financing of redistributive services.

    * Business should be taxed only for services to the businesses and not for redistributive purposes.

    * Current period services should be financed out of current year revenues and future period services should be financed by future period taxes, user charges/fees, and borrowing.

    * Residential services should be financed by taxes and fees on residents.

    * Business services should be financed by site/land value taxes and user charges. Profit, output, sales, moveable asset taxes may drive business out of jurisdiction.

    Tools for financing local government services and possible applications

    The above-mentioned considerations in local finance yields the following broad guidance for the use of specific tools in financing local services:

    * Local taxes for services with 'pubic' goods characteristics--for example, streets, roads, and street lighting. Also local taxes for 'public bads' such as congestion and pollution.

    * Differential site/value taxes to encourage compact urban development and discourage encroachment of productive agricultural land.

    * To provide incentives for local economic development, tax land at higher rates than structure and equipment.

    * User fees for services with 'private' goods characteristics e.g., water, sewer and solid waste.

    * Conditional non-matching output-based grants (grants with no input conditionality but expectations regarding maintenance of agreed upon standards and achieving expected results in service delivery) for merit goods such as education and health.

    * Conditional matching grants for spillovers in some services such as transportation with matching rate consistent with benefit spill-outs.

    * Equalization grants to ensure that all local governments have the fiscal capacity to provide reasonably comparable levels of basic local services.

    * Capital grants for infrastructure if low fiscal capacity.

    * Capital market finance for income generating infrastructure if higher fiscal capacity.

    * Public-private partnerships for infrastructure finance if feasible but keeping public ownership and control of strategic assets.

    In the following paragraphs, brief reflections on the use of land, property and environmental taxes by local governments are made.

    Land and property taxes

    Land taxes are considered an efficient instrument to tax location rents as such taxation encourages most profitable use of land and also discourage holding land for speculative purposes. These taxes also considered equitable as the incidence falls on landowners. Suitably designed land taxes can also facilitate compact urban development and forestall tendency of urban areas to encroach upon productive agricultural land. Such taxes if assigned to local governments can also be important source of local finance. Tax rate per square meter of land can be determined based upon total revenue requirements of local governments from land taxes and seeing what tax based upon existing land values would yield that revenue. Note for compact urban development, it is important to impose a much higher tax rate at the periphery than at the center of the urban area and to impose a much higher tax rate on vacant land than land with structures. In general land should be taxed at a higher rate than structures and other improvements to encourage local economic development.

    The real property tax (comprehensive tax on land and properties) has a potential to raise revenues equivalent to about 1-3% of GDP when introduced nationwide (Kelly, 2005). It can be an important instrument to finance property related local services such as roads, lighting, water, sewer etc. It also creates incentives for better land use. It can have a positive impact by dampening the speculative purchases in the housing market. It will also enhance accountability of local government to local residence. It can be an equitable tax as its design is able to accommodate ability to pay principle. The introduction of property tax is nevertheless a gigantic undertaking as it requires a huge institutional edifice to support implementation of such a tax.

    Environmental taxes and charges

    Environmental taxes at the local level offer triple dividends by discouraging environmental bads (congestion and pollution), reducing health costs and also raising additional revenues to finance local public services enhancements. Such taxes can also help mitigate climate change If local governments are allowed to piggyback on national carbon taxes. Congestion tolls that vary by location and by the time of the day help alleviate urban traffic congestion. Emissions and effluent charges help reduce pollution without undermining business autonomy and flexibility in technological choices.

    Grant Financing of Local Governments

    Instruments of intergovernmental finance have important bearings on efficiency, equity and accountability in governance. These are discussed below.

    Tax Base, Tax Yield and Revenue Sharing Mechanisms

    Tax base sharing (metropolitan areas levy supplementary taxes on national bases), tax yield sharing and revenue sharing mechanisms are customarily used to address fiscal gaps or mismatched revenue means and expenditure needs arising from constitutional assignment of taxes and expenditures to different levels of governments. Tax base sharing means that two or more levels of government levy rates on a common base. Tax base determination usually rests with the higher-level government with lower orders of government levying supplementary rates on the same base. Tax collection is by one level of government, generally the central government in most countries, with proceeds shared downward or upward depending on revenue collection arrangements. Metropolitan Bangkok levies a surcharge on central value added taxes, excise taxes, business taxes, liquor, gambling and horse racing licenses and taxes. Tax base sharing is quite common in Eastern Europe and East Asia but almost nonexistent in most developing countries in Asia and Africa.

    A second method of addressing the vertical fiscal gap is tax yield sharing. Typically the central...

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