The Impacts of Intergovernmental Transfers on Local Governments' Fiscal Behavior in China: A Cross-County Analysis

Abstract

Since the 1994 tax sharing reform, China's intergovernmental fiscal transfers have become huge in size and complicated in kind. More importantly, they have been assigned by the central government a variety of roles due to its changing policy priorities. This paper focuses on an episode, during the years 2000-2005, when substantial transfers were used by Beijing to advance the rural 'tax and fee' reforms. Using a cross county dataset from 2005 we estimate local governments' responses to three major types of transfers, tax sharing or 'tax returns' (TRs), general purpose or fiscal capacity transfers (FCTs), and special-purpose transfers (SPTs), either by mobilizing local tax effort (the stimulation effect) or by reducing local tax burden (the substitution effect). The results of statistical analysis reveal that TRs were highly stimulatory in all forms of local spending and revenue-raising activities; FCTs were moderately substitutive in their effect on local budgetary spending and extra-budgetary revenues, suggesting that the central policy of using transfers to reduce the fiscal burden imposed on peasants achieved some, though very limited, success. SPTs had a stimulation effect only on local budgetary spending, demonstrating the power of local matching requirements by the central government. Overall, central transfers tend to be stimulatory in China, an interesting result from an international comparative perspective. © 2013 National Council of the Institute of Public Administration Australia.