Frozen in time: the much needed reform of expenditures assignments in China.

Author:Liu, Yongzheng
Position:Report
 
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  1. INTRODUCTION

    China has been carrying out significant reforms on intergovernmental fiscal relations for over three decades. However, these reforms have largely concentrated on the revenue side of the budgets, and generally have not been coordinated with an explicit strategy for the reform of expenditure assignments. Although significant strides have been made in the areas of tax assignments and tax administration, other areas and, in particular the assignment of expenditure responsibilities, have seen much less progress. And yet, a stable, efficient and fair decentralized system of public finance in China will require an unambiguous and well defined institutional framework that provides clarity and certainty in the assignment of expenditure responsibilities among the different levels of government. The assignment of responsibilities is by no means the only condition, but it is the most important and it should also be the first to be tackled in a well sequenced decentralization reform effort. (2)

    This paper reviews the most important current issues surrounding the assignment of expenditure responsibilities in China. (3) The rest of the paper is organized as follows. In section 2, we discuss in some detail the current practices of expenditure assignments among different levels of government in China. In section 3 we analyze the main issues and problems with current assignments in China. In section 4 we provide a road map and practical recommendations for the reform of expenditure assignments in China. Section 5 concludes.

  2. AN OVERVIEW OF EXPENDITURE ASSIGNMENT IN CHINA

    An important feature of China's vertical structure of government is the strong hierarchical link between the different levels of government. Currently, there are five levels of governments in China. Starting from the top these levels are: the center, provinces, prefectures and prefecture-level cities (hereafter, cities), counties, and townships. Under the current hierarchical system, each subnational level of government is wholly subordinate to the next higher order of government, and so the intergovernmental fiscal relationships are typically defined and implemented between that government and its immediate upper level of government (see Figure 1). (4)

    The reforms in the fiscal arrangements over the last three decades mainly involved the fiscal relations between the central government and provincial governments. The latter act as representatives of the entire sub-national government sector in each provincial jurisdiction and engage directly in negotiations and bargaining with the central government. The provinces continue to play a fundamental role in balancing the fiscal relations between the central government and all sub-national governments. In contrast, the fiscal relations between the provincial level and all other sub-national governments have been much less developed, and it is mostly determined at the discretion of the provincial governments.

    2.1 Extensive Government Responsibilities: Differentiating between Private and Public Sector Activities

    One question prior to the assignment of expenditure responsibilities among different levels of government is the role of government in the market economy. The lack of a clear delineation between the roles of the private and public sectors in China significantly complicates the issue of expenditure responsibilities. While many countries, and especially transitional countries, have undergone in recent decades massive privatization of state and local enterprises involved in what can be considered private-sector economic activities, this has 5 not been generally the case in China. Even though there has been some privatization in China, this process has yet to begin in earnest in many areas of the economy.

    On the other hand, there have been some visible efforts in government to redefine the role of the public sector more along the conventional lines commonly seen in market economies. For example, in 1998, the State Council initiative to build a Public Finance Framework for government focused on the encouragement of the fundamental function of markets in the allocation of resources in the economy while it provided more space for fiscal policies to meet the demand for public goods and services while gradually decreasing the role of fiscal inputs in the competitive sectors of the economy. Along these same lines, in 2006, the Communist Party proposed the equalization of basic public services across the country as a way to further build the Public Finance Framework. This initiative resulted in the allocation of additional fiscal resources to the social security system, education (particularly through the rural compulsory education program), health care, and rural support. The central government has also begun to use fiscal policies for macroeconomic management. In particular, with the experiences of the 1998 Asian financial crisis and the 2008 global financial crisis, the central government increasingly has paid more attention to macroeconomic management issues. (6)

    2.2 Highly Decentralized Responsibilities for Basic Public Services with Wide Concurrent Expenditure Responsibilities

    On the more specific subject of expenditure assignments, the Budget Law confers quite broad expenditure responsibilities and substantial autonomy to each level of sub-national government. However, expenditure assignments are far from being transparent and clear, mostly because of the lack of formal assignments and the presence of extensive concurrent functions among different levels of government (World Bank, 2002). This pervasive presence of concurrent responsibilities can be traced back to the planned economy era. At that time, it was not considered necessary to separate the responsibilities of different spheres of government as providers of public services (as local governments acted as agents of the central government--only carrying out assigned tasks), nor was it considered necessary to separate the expenditure responsibilities of governments from those of state-owned enterprises (SOEs). The latter was due to the cohesive functions of the government in both the public and private sectors; in fact, before the mid-1980s government jointly determined fiscal expenditures and the expenses of the SOEs.

    The recent reforms, including the "Fiscal Responsibility System Reform'" starting at the beginning of the 1980s, the "Fiscal Contracting System"" starting in 1988, and the "Tax Sharing System Reform"" (TSS) starting in 1994, offer the striking feature of having put almost exclusive emphasis on improving the revenue assignments and transfer system. But these reforms have practically ignored the question of expenditure assignments. (7) This means that there has been no apparent change in either the policy framework or the practice of expenditure assignments between the central government and sub-national governments or among sub-provincial government since even before the start of the market-oriented reforms in the late 1970s.

    More in particular, the 1994 TSS reform restated the pre-reform expenditure assignment practices and provided only basic guidelines for defining expenditure responsibilities between central and sub-national governments. These guidelines illustrate that both the central government and local governments not only have extensive expenditure responsibilities, but that these responsibilities widely overlap and that additionally are only vaguely defined. For example, The State Council Regulations on the Implementation of the TSS define expenditure responsibilities of central and local governments as follows:

    "Central budgets are mainly responsible for national security, international affairs, the running costs of the central government, the needs for adjusting the structure of national economy, coordinating regional development, adjusting and controlling the macro economy, and others. Detail items include: national defense, cost of military police, international affairs and foreign aid, administration costs of the central government, central financed capital investments, the technical renovation of central enterprises and new product development costs, the costs of support to agriculture, debt, and the costs of central culture, education, and health, price subsidies and other expenditures.

    Local budgets are mainly responsible for the running costs of local government, and the needs for local social economic development. Detail items include: running costs of local government, the needs of local economic development, a part of the running costs of the military police and militia, locally financed capital investments, the technical renovation of local enterprises and new product development costs, the costs of support to agriculture, urban maintenance and construction, and the costs of local culture, education, and health, price subsidies and other expenditures. "

    Fundamentally, responsibilities exclusive to the central government and exclusive to the sub-national governments are few. The central government tends to be exclusively responsible for national defense issues and local governments provide basically all local public services, such as urban maintenance. Moreover, as the sub-national governments are treated in some ways as the agents of the central government, this has allowed the decentralization to sub-national governments, particularly at the county-level, of public services such as social security or food safety, that in other countries are typically reserved as central government responsibilities. Meanwhile, the central government, by constitutional design, can be involved in any sub-national function. Thus, as long as a local issue--for example, the rural toilet reconstruction program--is brought up to the central authorities, this responsibility instantly can become a central government's responsibility.

    Although all sub-national governments at different levels have many overlapping...

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