1. -20-1 Decentralization in China

2. Intergovernmental relations in ancient Chinese dynasties Big country and huge population in ancient China In the 18 th century, Qing dynasty had about 300 million people. Centralized appointment and management of government officials Decentralized public finance and local governance People’s Republic of China (PRC), built in 1949, created unprecedented centralization through its ideology, political control, economic system, and modern technology. -20-2

3. 3 LevelAdministrative UnitsNo. CentralState Council1 Province4 Directly-Supervised Municipalities, 23 Provinces (Including Taiwan), 5 Minority Autonomous Regions, and 2 Special Administrative districts (Hongkong and Macao) 34 Municipality283 Municipalities, 17 Regions, 33 Minority Autonomous Regions 333 County862 Districts, 374 County-Level Municipalities, 1,464 Counties, 117 Minority Autonomous Counties, and 55 Others 2,862 Town36,042 Towns, 5,829 Streets, 1,404 Minority Autonomous Towns 43,275 Self-Government Organizations 625,147 Villager’s Committee, 80,017 Urban Residents’ Committee 705,164 PRC’s governmental hierarchy in 2004

4. -20-4 Centralized fiscal system and decentralized provision of services under the planned economy Fiscal arrangement under planned economy United revenue and expenditure system Local governments didn’t have fiscal power. They were the agents of central government, collecting revenues and retaining some for local expenditures according to central plans. A heavy reliance on enterprise profits of State Owned Enterprises (SOEs) In 1978, Shanghai had 1.1% of China’s population, but contributed 7.5% of national GDP and 15% of national fiscal revenues. It collected RMB 16.9 billion revenues, and kept RMB 2.6 Billion. The contribution rate is 85%. In 1985, SOE’s profit remittance was replaced by income taxation Major expenditures were on industry investment and infrastructure construction In 1978, expenditures on administration and services were only 11.6% of the fiscal expenditures. Services were mostly provided by so-called work units (state employers).

5. -20-5 Fiscal revenue Structure of China: 1970-1993 (100 Million) YearTotal RevenueTax revenueEnterprise income revenueSubsidies to SOEs 1970662.9281378 1973783.94348427 1975815402400 1976 776407338 1977 874468402 1978 1132519571 1979 1146537495 1980 1159571435 1981 1175629353 1982 1212700296 1983 1366775240 1984 1642947276 1985 2004204043-507 1986 2122209042-324 1987 2199214042-376 1988 2357239051-446 1989 2664272763-598 1990 2937282178-578 1991 3149299074-510 1992 3483329659-444 1993 4348425549-411

6. Problems of the highly centralized system Loss of local enthusiasm Lack of competition Lack of entrepreneurial incentives Serious divide between state and nonstate sectors, between industrial and agricultural sectors, and between urban and rural sectors -20-6

7. Decentralization since the 1980s 1. Decentralize fiscal power. 2. Decentralize decision-making power. Delegate lump-sum economic power to special areas. (1) Special economic zone; (2) Coastal, riverside, and border open cities; (3) High-tech development zone; (4) Cities with autonomous planning power. 3. Delegate personnel management power. From two-level down to one-level down 4. Delegate SOEs to local governments. -20-7

8. -32-8 Central government Local government Encouraged categories >USD 100m, CDR; >USD 500m, State Council <= USD 100m, provincial CDR or even local CDR according to provincial CDR Restricted categories>USD 50m, CDR; >USD 100m, State Council <= USD 50m, provincial CDR The authority to approve the investment projects in 2008

9. -20-9 Fiscal decentralization (revenue side) 1978 ~ 1994: discretion-based fiscal Since 1978, decentralized fiscal management was gradually introduced. Fiscal contracts were signed between central and local governments  There were 6 types of revenue-sharing arrangements  Basically, local governments could retain a big portion or even 100% of the surplus revenues after they submitted the quota set by the contract.  This drove local governments to maximize local revenues

10. Fiscal opportunism in 1980s and 1990s Local governments hid their fiscal revenues. Simply concealed revenues Collected less taxes but imposed charges Allowed underground economy Local governments maximized non-fiscal revenues All kinds of funds, levies, charges, fees… The emergence of a weak central government Borrowed money from local governments -20-10

11. -20-11 1994 ~ Present: rule-based revenue sharing system (A return to centralization) A reclassification of taxes and taxing authorities Fixed Central Revenues: Customs Duties; VAT and Consumption Tax collected by the Customs; Domestic Consumption Tax, Income Tax of Central Enterprises; Income Tax of Local Banks and Nonbank Financial Institutions; Revenues remitted by Railway Department, Headquarters of State-owned Banks and Insurance Companies; Profits remitted by Central Enterprises. Fixed Local Revenues: Business Tax; Income Tax of Local Enterprises; Profits remitted by Local Enterprises; Individual Income Tax; City and Township Land Use Tax; Fixed Assets Investment Orientation Regulation Tax; City Maintenance and Construction Tax; House Property Tax; Urban Real Estate Tax; Vehicle and Vessel Usage Tax; Stamp Tax; Slaughter Tax; Agriculture Tax; Animal Husbandry Tax; Farmland Occupation Tax; Deed Tax; Inheritance and Donation Tax; Land Appreciation Tax. Shared Revenues:  a. Domestic VAT (17%): 75% for central government and 25% for local governments;  b. Resource Tax: the part for the central government is the tax paid by offshore oil enterprises, and the rest is for local governments;  c. Security Transaction Tax: Split by half between central and local governments  d. In 2002, individual income tax was shared (1:1), in 2003 3:2.

12. -20-12 Fiscal structure of revenues and expenditures

13. -20-13 Fiscal decentralization (expenditure side) Social services provided by work units and new social services were provided by local governments. Central government basically took care of national security, diplomacy, custom, and central agency operation costs…with a small central government of 400 thousand employees Central revenues were basically transferred back, not spent by central government for services. For example, social security system was basically operated by counties, even not at the provincial level.

14. -20-14 Fiscal structure of revenues and expenditures Considering the huge off-budget revenues and land sales revenues collected by local government, local government spent about 90 percent of the revenues.

15. The new decentralized system 1. Central and local incentives were aligned. Local governments had a strong incentive to expand tax bases for shared revenues. 2. Local governments developed strategic interests in local revenues Fiscal transfer was problematic Land revenues were huge Debts increased fast -20-15

16. -20-16 Land sale revenues became the “second public finance” in China since the late 1990s Year19992000200120022003 Revenues11.434.649.296.9293.8 Year20042005200620072008 Revenues589.4550.5760913960 Land sales revenues in China 1999-2009 (RMB billion) In 2009, land revenues reached RMB 1500 billion, with a yearly increase of 56%. In 2009, the national fiscal revenues reached RMB 6570 billion. The ratio of land revenues and fiscal revenues was 23:100

17. -20-17 Urban governments are especially dependent on land revenues. The top 4 cities in land revenues in 2009 (RMB billion) Land revenues Fiscal revenues Land/fiscal revenues Hangzhou105.450211% Shanghai> 100254>39% Beijing92.820046% Tianjin73.218041% Local governments have built keen stake on the development of real estate industry and made itself a hostage of real estate price.

18. -20-18 Outstanding Debts of Central Government (100 million yuan) Year Total Domestic Debts External Debts 2005 32614.2131848.59765.52 2006 35015.2834380.24635.02 2007 52074.6551467.39607.26 2008 53271.5452799.32472.22 2009 60237.6859736.95500.73 2010 67548.1166987.97560.14 Local debts? They were estimated to be 11 trillion in 2010.

19. Race to the bottom Control over local governments Personnel management as the key Performance measurement Highly quantified, with GDP as the focus Economy-driven local governments Low provision of public services to reduce taxation High-welfare local governments could avoid new service burden due to household registration (hukou 户 口） system -20-19

20. More centralization? Nationally united social service system requires more transfer-based redistribution and may cause disaffection of developed areas. Centralized spending system may reduce local incentives. Central government is not experienced in providing direct services. Direct transfer to counties may be tried first. -20-20