By Xie Fuzhan

Research Report No 307, 2006

In recent years, the Chinese government has attached much emphasis to the reform and construction of public fiscal system. With economic development and the increase of financial power, the macro regulationcapability of the central government has been continuously improved; the government is more capable of addressing market default; the transfer payment size has noticeably increased and the horizontal fiscal imbalance has being mitigated; governments of various levels have improved both the awareness and the ability of providing public goods and public services. Generally speaking, we have made certain achievements, but problems still exist such as the unreasonable division of government administrative power and financial power and the mismatch between administrative power and financial power for local governments, and the provision of public goods and services could not meet the demand. I would like to share with you some of my personal views on the division and matching of the inter-governments’ financial power and administrative power.

I. The Implications of Decentralization and its Relationship with the Administrative Power and Financial Power

During the past two decades, decentralization has become a global trend. It involves two concepts: the administrative power and the financial power. The administrative power usually refers to expenditure responsibility, i.e. which level of government should shoulder what kind of expenditure. The financial power consists of two parts, namely the self-owned income and the transfer payment. Therefore, decentralizationcan refer to either the administrative power or the financialpower, or both. If it refers to administrative power, it means that the expenditure responsibility is delegated to the lower government and the transfer payment scope is expanded. If it refers to financial power, it means that the proportion of self-income (self-owned taxation) is increased so as to change the vertical fiscal imbalance.

Either type of decentralization requires matching of the administrative power and financial power. But how to reach this goal? One way is by adjusting the administrative power among governments, and the other is by adjusting the self-owned income, which often means greater taxation power for lower-level governments. The third way is through transfer payment. Countries differ in their choice of solutions or combination of solutions. Studies show that the expenditure responsibility in countries is on an obvious decentralization trend, while the revenue is in an evidently more centralized pattern. In view of experiences of other countries, we have not found any case that the lower-level government has the self-owned taxation power that can completely match its expenditure responsibility. It is common inWestern countries that the central governmentcontrols most of the financial resources.Besides considerations of scale economy, external effect and tax incentives, this practice also enables the central government to have better control over local governments. This institutional arrangement is an important guarantee forpower stability and effective economic operation. With regard to China, from 1979 to 2005, the average annual fiscal revenue increase was 13.1%, of which, the central revenue increase was 18.3% annually and local revenue increase was 10.8% annually. During the same period of time, the annual increase of national fiscal expenditure was 13.4%, of which, the central expenditure increase was 10.9% and local expenditure increase was 14.9%. In 2004, central fiscal revenue accounted for 54.9% of the total revenue and the local took up 45.1%, while for the expenditure, the central expenditure accounted for 27.7% and the local took up 72.3%. This situation is similar to the international trend and pattern. Therefore, the crucial issue in China is to address the horizontal imbalance of fiscal capacity and the match of financial power and administrative power.

II. A Clear Definition on the Relationship between Government and Market Is the Prerequisite for the Governments to Make a Proper Division of Financial Power and Administrative Power

It is most important to clearly define the role of government and market before dividing the administrative power among governments. Only after having a clear understanding of the government functions, can we discuss the division of the administrative power among governments at different levels. In recent years, there have been quite a few arguments on the government functions and responsibilities in public fields. Some hold that in such areas as education and medical care, the reform has been too commercialized, and government functions are in default. Others believe that the government is unable to pay the bills for all public goods and services, since China has a huge population and is relatively weak in economic strength and its development is unbalanced. Both views have reasonable factors. The key to the problem is that there is no clear definition of what are public goods andwhich level of government should be the provider, and these goods are provided accounting to what standard and level. Obviously, even education or medical care are not totally public goods, and some part of it should surely be provided by the market. If the government shoulders some functions that belong to the market, it would suffer absence of other due functions. Thus the key is to define the relationship between the government and the market clearly, and to build the expenditure responsibility on the basis of public finance, that is to say, according to the internal requirement of market economy, let the public finance shoulder responsibilities that are required by the public but unable to be provided by the market.

III. ProblemsRelated toExpenditure ResponsibilityDivision among Governments

1. The division of administrative power among governments is vague

China is a country with a centralized system and had implemented the planned economic system for a long time. It has quite a few problems in the division of the financial power. Firstly, the division of expenditure responsibility is not clear enough among the governments at the central, provincial, and local levels. Secondly, the legal stipulation on the division is neither strict nor practical. Thirdly, the governments at upper levels often make arbitrary changes on the division. Fourthly, the grassroots governments are burdened by too much expenditure responsibility, since the governments of upper levels may assign tasks in an arbitrary way without giving sufficient corresponding funding.

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