Mi Jianguo & Yan Kun

Research Report No 79, 2001

I. The Necessity of Establishing a Complete Public Finance and Taxation Supervision System

Since the start of reform and opening up, through continuous study and renovation, a preliminary multi-level public finance and taxation supervision system has been set up in China. It has played an important role in maintaining consistency of administrative decrees of finance and taxation, standardising economic order and guaranteeing the implementation of the budget and the normal operation of the public finance system. Along with the gradual establishment and completion of China’s socialist market economy system, the role of finance and taxation in economic and social development has become more and more important. However, the old public finance and taxation supervision system can no longer meet the new requirements of economic and social development and the reform. In the new environment, it has become necessary and pressing to establish and complete a public finance and taxation supervision system and a scientific operation mechanism that are in line with the socialist market economy system and can meet the needs of economic reform and development.

A. Defects of the Current Public Finance and Taxation Supervision System

The multi-level public finance and taxation supervision system was gradually established on the basis of the planned economy system along with economic development and deepening of reform. It has shown eminent incapability to adapt to the new situation. It restricts the authority and the effectiveness of public finance and taxation supervision and weakens the functions of public finance. The main deficiencies include the following:

1. In terms of tasks and methods, supervisionwas most conducted in a direct and rushed manner.

Since 1985, public finance and taxation supervision has been characterised by large-scale finance, taxation and price inspections, which were carried out all over China, known as "guerrilla warfare". In spite of certain achievements, such inspections demonstrate apparent after-event and rushed characteristics. They target only on financial accounting results and demonstrate an obvious lack of a restrictive supervision mechanism to supervise and restrain the impact to taxation of new economic actions and transaction methods (such as enterprise restructuring, asset reorganization and e-commerce), as well as to government purchase and transfer payment. The scales and themes of the supervision are not well focused, unscientific and not far-sighted. Therefore, they seriously affect inspection efficiency and results. In addition, many problems have emerged regarding the standard, severity of treatment and of authority of supervision. Since China abolished the "three major inspections" in 1998, many localities (provinces) have adopted new measures and methods to conduct public finance and taxation supervision (e.g., Hubei Province has established the Public Finance Supervision Division to carry out networked and systematic supervision). However, no fundamental improvement has ever been made. The main reason for abolishing the "three major inspections" is that their concentratedness and rushedness can no longer meet the needs of the market economy. The objective of the abolishment is to standardise public finance and taxation supervision, not to weaken its effectiveness. The key to strengthening public finance supervision is to change people’s ideology and set up, as soon as possible, a scientific and standard supervision mechanism to strengthen pre-and mid-event supervision, cover the whole process of finance and taxation activities under supervision, change after-event handling to process control and reduce the number of concentrated and rushed after-event inspections. At present, the pressing issue is how to set up a highly efficient supervision mechanism which covers all processes and links practically based on the particular characteristics of public finance and taxation supervision.

2. Public finance and taxation supervision lacks legal basis.

In certain sense, market economy means economy governed by law. All activities under market economy must be conducted according to law and all competition must be carried out in line with the state stipulations. One of the major tasks of constructing a socialist country with a legal system is to manage public finance and levy taxes according to law. The current situation shows that the laws and regulations governing public finance management and public finance and taxation supervision are extremely incomplete with lots of loopholes. At present, China only has the Budget Law, the Accounting Law and the Tax Collection and Management Law. It does not have the State-owned Asset Management Law, the Public Finance Management Law, the Public Finance and Taxation Supervision Law and the Financial Affairs Management Law. Moreover, the Budget Law has only specified criterions for the government and the public finance departments to follow during budget formulation and implementation process. It did not specify the limits of authority and the responsibilities of the finance departments to guarantee the implementation of the budget. Therefore, according to relevant provisions in the Budget Law, the Public Finance Management Law should be formulated to further define the limits of authority, responsibilities and scale of work of the finance departments. In addition, the Public Finance and Taxation Supervision Law should also be formulated to define the authority, the methods and the extent of public finance and taxation supervision, so as to standardise and legalise public finance and taxation supervision.

3. Backward means of public finance and taxation supervision restricts the effectiveness of supervision.

The authority and deterrence of supervision come not only from law but also, to a large extent, from the severity and actual effect of implementation. Over a long time, public finance and taxation supervision has constituted a fixed thinking and a custom of targeting on issues rather than people. Inspections ended mostly with economic punishments, which usually targeted on institutions. The 13-Year Inspection did carry certain authority and deterrence because the inspection was focused on enterprise financial affairs where most breaching acts were in fact problems of financial accounting procedures. Meanwhile, it was quite effective because most punishments took the form of fines, which directly affected the immediate interests of enterprises. In recent years, the focus of public finance and taxation supervision on small coffers and extra-budgetary funds has been shifted to the administrative and public establishments. However, there has been no fundamental change in our thoughts, methods, means and treatment of supervision, which still focus on inspection over financial affairs. In terms of treatment, we still rely largely on account adjustments and fines, regardless of the fact that they are non-profit institutions and have financial sources mainly from fiscal appropriation and management income. In particular, as extra-budgetary income is gradually included into budget or into special accounts, with the implementation of the comprehensive public finance budget management, charging fines is like transferring funds between "the left and right pockets" of public finance. Therefore, the restrictive function can hardly play an effective role by relying on fines alone. On the other hand, in terms of the types of regulation-breaching acts of the administrative and public establishments, there are less cases related to financial accounting procedures than to decision-making and administrative actions of their leadership, which includes unauthorised funds, lavish distribution of bonuses, deliberate treasury mix, unauthorised tax reduction or exemption, unauthorised preferential policies and embezzlement of special funds. Obviously, under such circumstances, economic punishment has but limited effect, and its rationality ought to be questioned.

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