Ehtisham Ahmad, Grantham Institute for Climate Change and the Environment, LSE and Pao Yu-Kong Professor, Zhejiang University, PR China*
Sintesi
Le riforme fiscali in Cina del 1993/94 non hanno seguito le prescrizioni “normative”, mentre si sono concentrate sulla generazione di gettito fiscale e sulla fondazione di istituzioni fiscali moderne. Hanno ottenuto un notevole successo nel raggiungimento di un crescita economica a doppia cifra, nella creazione di hub portuali e costieri e nella riduzione molto consistente della povertà. Per quanto riguarda le problematiche connesse alla crescita, occorrono nuove misure fiscali per affrontare (1) crescenti debiti e rischi nascosti, anche a livello subnazionale, (2) forti ineguaglianze a livello personale e spaziale e le rimanenti sacche di povertà, (3) l’inquinamento ambientale e la qualità della vita. Ancora una volta le opzioni relative alle possibilità di riforma devono essere consistenti al modello di governance cinese.
Governance models and Chinese reforms
China has operated under an administrative progression governance model for centuries, under which officials are appointed from the center and enjoy considerable autonomy. The Chinese governance system is evolving, as the economy has undergone a period of extraordinary structural change, and many modern policy instruments relating to taxation and public financial management (PFM) have been gradually introduced since the 1990s. Lessons from US-style governance models based on electoral or Salmon-type “yardstick” competition (formalized by Besley and Case (1995) have to be carefully calibrated as they might not apply to different governance models, including in China, especially where fiscal policies and institutions may not be fully developed.
Since the 1980s, China relied increasingly on local incentives and initiatives with the Responsibility System, focusing on sustainable growth to ensure full employment. The reforms underpinning the Responsibility System initiated by Deng Xiao Ping in the late 1970s, led to increasing reliance on the private initiative in coastal provinces, like Guangdong. There was also an increasing devolution of decision-making power on spending and investment decisions to local officials, and as tax administration was local on upward-revenue sharing, with the center receiving around half of the collections. The Responsibility system led to a reduction in tax rates on enterprises to leave more potentially investable resources in the hands of firms. However, this led to a reduction in the overall revenues generated, with the overall tax/GDP ratio dropping more than half to around 10%, generating pressures at the local level that were transmitted up to the center, with the central share falling to around a quarter of collections (see Chart 1).
Chart 1 Evolution of tax/GDP ratios and central-local shares
Source: Ahmad, Rydge and Stern, China Development Forum 2013.
The standard recommendation, based on normative models (see Ahmad and Brosio, 2015), favored by international agencies, like the World Bank, was to “fix the spending assignments and deal with the tax reforms subsequently.” China, however, chose to bolster the tax system in 1993/4, particularly by creating a central or State Administration of Taxation (SAT) that departed from the upward-revenue sharing model. SAT was tasked with implementing a modern national tax, the VAT, and other central taxes to be developed including the Corporate Income Tax, and eventually the PIT.
The 1993/4 measures were examples of a “positive” or “political economy” approach to major reforms, in that they involved a “package” of measures to offset gainers and losers from the reform. The tax-transfer nexus was particularly important to garner support from the provinces for the reform that ceded tax administration authority to the center (for the first time since the middle ages). This permitted the operation of economy-wide taxes, like the VAT, while at the same time avoiding losses for individual local governments.
The measures were based on origin-based (downward) revenue-sharing mechanism that benefitted well-off provinces from additional revenues generated by the new VAT. An equalization system preserved the interests of the poorer provinces, with more limited tax bases and higher costs of provision of public services. The most innovative measure, given the limited domestic connectivity in China at that time, was a “revenue-returned” transfer that greatly helped in concentrating resources in the coastal “hubs” for rapid export-led growth. The fiscal measures, largely maintained full employment, with significant rural-to-urban and interior to coastal migrations, with the largest reduction in poverty in any country in the past two-decades.
The success of the strategy has led to new challenges, including considerable imbalances between coastal and interior provinces, and the appearance of significant interpersonal inequalities. Further, the growth of mega-cities along the coast has led to increasing congestion and pollution, putting living standards under stress. Local governments depended on land sales to finance investments in infrastructure—leading to urban sprawl and loss of agricultural land around major metropolitan areas, as well as proliferation of off-budget accounts that also facilitated rent-seeking behavior (Wang, Wu and Ye, 2018). The limited local tax handles, together with the prohibition of direct borrowing by subnational governments, led to hidden borrowing, including by Urban Development Investment Corporations (UDICs).
The early focus of reforms was to consolidate revenues, and generate resources for redistribution and investment. Consequently, the VAT implemented in 1994 was of the “investment type” that did not provide credit for taxation on capital goods, and the business tax largely on services was left in the hands of local administrations. A decade later, the focus turned to efficiency, with the move to a consumption-type VAT and rationalization of the CIT with a 25% rate. The VAT reforms were continued in 2016, with the absorption of the business tax largely on services. This measure was designed to reduce the cost of doing business, and to facilitate the refund of the full VAT along the value-chain on exports. However, the removal of the last tax handle under the control of the local governments makes them entirely dependent on transfers and shared revenues, which are no different in this respect—with no room to raise additional resources in case of need, for example, to pay for any liabilities incurred. This reduces the “accountability” of local officials for decisions that they take as liabilities become the responsibilities of other jurisdictions.
Since the late 1990s, there has been a progressive improvement in public financial management instruments and generation of information on budgets and spending, such as treasury single accounts and the use of international standards for budget classification and accounting and tracking public spending. This involved the adoption of the IMF’s Government Financial System Manual (GFSM) 2001/14 standards, including accruals and balance sheets at all levels of government. While significant and possibly better than in some other G20 countries, this process, is far from complete, especially at the lower levels of government where most of the spending transactions take place—particularly for utilities and local SOEs, and accounts payable (see Ahmad and Zhang, 2018).
This evolution of policies and institutions since 1993 has implications for the governance model. The first relates to the overall incentives facing local officials, and whether the risks and opportunities of their actions can be linked to their relevant jurisdictions or whether these are likely to spread to higher levels, particularly to the central government (Liu Shangxi and Li Chengwei, 2018, who examine the links and transmission mechanisms between financial, fiscal and social risk). This is critical in establishing hard budget constraints and ring-fencing liabilities, and in addressing the new challenges of rebalancing of the economy and generating sustainable and equitable growth.
Full information on sources and uses of public funds and possible risks associated with public policy are critical in the effective operation of the administrative progression model. However, both own-source taxes and improved governance are critical in establishing proper incentives for local officials, also to prevent the buildup of liabilities and rent-seeking behavior. Indeed, transplanting measures from the US, such as the issuance of local bonds, while desirable as a tool in the medium-term, might not function as expected and shift risk to higher levels of government if not linked to own-source revenues and ability of the relevant sub-national jurisdictions to service debt.
A combination of national infrastructure policies with local connectivity and improved public services is critical in generating incentives for sustainable local “hubs” away from the coastal metropolitan areas. One of the consequences of the Belt and Road Initiative (BRI) is to change relative costs and opportunities in lagging regions, and generate incentives for sustainable growth, especially in the Western and interior regions of China. While the nationally financed physical infrastructure is a necessary condition, a package of measures, including subnational taxes and transfers and improved local services in less well-endowed areas, will be needed if the experiences with infrastructure investment in Europe is a guide (Ahmad, Bordignon and Brosio, 2016).
Guangdong provides a very useful example of the sorts of measures needed for the rebalancing agenda—both within provinces and within China (Luo 2018, Xiao 2018). The wider realization of substantially expanding production possibility frontiers depends both on new technologies that will be greatly influenced by the tax reforms as well as the investment in connectivity infrastructure implied by the BRI.
Managing risk: clean cities, inclusive and sustainable growth
A sustainable development agenda for China in the immediate future, and in keeping with the governance model, must manage risk, address poverty and inequality, and enhance the quality of life and the environment. These form a formidable albeit interlinked policy agenda that focuses on clean cities that provide high quality employment opportunities, taking advantage of new trading patterns and value chains due to innovations and new technological advances and trading patterns, including with the BRI. We focus here mainly on options for developing the tax and governance agenda, as this provides the enabling environment for the structural changes.
The first set of issues relates to own-source revenues for hard budget constraints. The options are different for provinces and large metropolitan areas on the one hand and smaller cities on the other. The easiest source of own-revenues for the former group lies in “piggy backed” taxes or surcharges on national taxes and with SAT administration. The most prominent is on the personal income tax, and also provides the possibility of an expansion of the base to non-wage income—particularly from assets and cross checked with information on lifestyles that is available at the local level. The gap in the revenue performance of the Chinese PIT with other middle income and OECD countries is considerable, and provides a basis for tapping the fastest growing revenue base with attendant benefits for anchoring borrowing and liabilities of all sorts, including PPPs. Another option, that also applies to smaller cities, is a surcharge or piggy back on a national carbon tax. This yields immediate benefits to reduce emissions and congestion, with the possibility of the most congested cities having a higher marginal tax without the fear of a race-to-the-bottom competition.
The US-style property-tax based on ownership and valuation has not worked in China in the experimentation in Shanghai and Chongqing. This model has also not worked well in most emerging market economies with complex ownership structures. Options include a simple tax based on occupancy, with relatively manageable bands indicating relativity and linked to the cost of local service delivery—this is akin to a “beneficial tax” as outlined by Alfred Marshall over a century ago. A variant has been operating in the UK since the early 1990s, and is being experimented with in other emerging market economies. Of course, this option would have to be linked judiciously with user-charges, and would also form the basis for local borrowing, including liabilities arising from PPPs.
Many of the required PFM measures have already been introduced in China, including the GFSM2014 framework and associated balance sheets at all levels of government. This will also entail the development of integrated financial information systems, and Treasury Single Accounts. However, the development of local government balance sheets will take time to implement through all relevant lower levels of government. However, given that the identification of risks is a matter of priority, in the short-run, information from PBC’s monetary survey could be used to identify cities or regions with above normal credit usage—to pinpoint problem cases and the need for further audit.
In conclusion, a “package” of measures at the local and city-level will be needed to build on the national and cross-border investments in connectivity, including the BRI. We have identified several options to deal with risks, distribution and the environment. Additional work will be needed to make them operational.
References
Ahmad, E, J. Rydge and N. Stern, 2013, “Structural change leads to tax reforms leads to structural change,” China Development Forum 2013.
Ahmad, E. and G. Brosio, 2015, Handbook of Multilevel Finance, Elgar.
Ahmad, E., M. Bordignon and G. Brosio (2016) Multilevel Finance and the Eurocrisis, Elgar
Ahmad, E., G. Brosio and J. Gerbrandy, 2017, Property taxation: Economic Features, Revenue Potential and Administration in a Development Context, European Commission Project FED/2016/380/048.
Ahmad, E, M. Niu and K. Xiao, 2018, Fiscal Underpinnings for Sustainable Development in China. Rebalancing in Guangdong, Springer.
Ahmad, E. and Xiaorong Zhang, 2018, “Towards monitoring and managing subnational liabilities in China: lessons from the balance sheet for County K,” in Ahmad, Niu and Xiao (2018), op cit.
Besley, T. and A. Case (1995), “Incumbent behavior, vote-seeking, tax-setting and yardstick competition,” American Economic Review, 85, 25-45.
Liu Shangxi and Li Chengwei “Public Services Evaluation from the Perspective of Public Risk Governance,” in Ahmad, Niu and Xiao (2018).
Wang, W., A. Wu and F. Ye, 2018, “Land use reforms: towards sustainable development in China,” in Ahmad, Niu and Xiao (2018).
Xiao, Kezhou (2018), “Managing Subnational Liability for Sustainable Development: a case study of Guangdong Province,” in Ahmad, Niu and Xiao (eds), op cit.
*Helpful comments from Xubei Luo, Meili Niu, Nick Stern, Kezhou Xiao and Zhikai Wang and participants at Seminars at Sun Yat-Sen, Zhejiang and Peking Universities and CAFS are gratefully acknowledged. The usual disclaimer applies.
Newsletter n. 9 | May 2018 - download pdf
