Intergovernmental Fiscal System Research Articles

Equalization through the People’s Republic of China’s Intergovernmental Fiscal System: The Effectiveness of Central and Provincial Transfers

The People’s Republic of China’s (PRC) fiscal system is characterized by very high expenditure decentralization and heavy reliance on transfers to finance public services. The government’s embrace of inclusiveness and equalization as national goals has raised questions about whether transfers can deliver equalization. This paper seeks to answer this question by analyzing newly available fiscal data compiled from government websites. We find the allocation of central transfers remains strongly region based, resulting in high intra-regional inequality among provinces. Poorer provinces also tend to retain more central transfers at their own (provincial) level. Those provinces with greater pretransfer inequality tend to exert greater equalization efforts, but these are not necessarily proportional to their pretransfer inequality. As a result, some localities are left out of the PRC’s countrywide equalization program. These equalization patterns remained highly persistent during the coronavirus disease shock in 2020. Collectively, the findings highlight that the PRC’s complex intergovernmental fiscal system still poses challenges for equalization.

Anatomy of intergovernmental finance for essential public health services in China

BackgroundThe Chinese government launched health care reforms in 2009 and introduced a national list of essential public health services (EPHS) as an integral part of the plan to deliver health care for all. EPHS was also built into the national plan to promote the equalisation of public services across the country. A national standard was set for financial input to EPHS. As the services are co-funded by the central and local governments, a robust intergovernmental fiscal system is essential to guarantee that the hundreds of thousands of service providers have adequate financing to meet the service commitment.MethodsWe examined the flow of funds through China’s complex intergovernmental fiscal system to see whether the promise of equal funding for EPHS was implemented, and how the costs were distributed across levels of government. Information was collated from funding documents issued by all levels of governments involved, for a sample that includes the central government, 12 provincial governments, eight prefectural governments and 11 county-level governments. For each level of government, we examined: (i) when and how much funding they disbursed or received from higher levels; (ii) when and how much matching funds were made; and (iii) the allocation rules adopted.ResultsOverall, we found the central government met its commitments for the program on time and in full, and good compliance from local governments in passing through funding from higher levels and as well as meeting their own financial responsibilities. However, we also found the following problems: (i) the involvement of so many levels of government resulted in delays in the disbursement of funds; (ii) the use of outdated population data in calculating required funding resulted in some under-allocation; and (iii) localities that needed funding the most were not well targeted by the distribution of funds.ConclusionThis study traces how the 2018 subsidy for EPHS was disbursed from the central government to service providers, focusing on the roles played by intermediate levels of subnational governments—provinces, prefectures and counties. In this way, it identifies gaps in the current intergovernmental financing of EPHS and points to areas for further improvement.

How do fiscal decentralization and intergovernmental fiscal transfers affect energy consumption in China?

Since the reform of the tax-sharing system in 1994, the regulation of the central government to local governments has relied on the mean of intergovernmental fiscal transfers (IFTs) to a certain extent. However, the existing literature has not yet explored the influence of fiscal decentralization (FD) on energy consumption in the presence of IFTs. Thus, this study empirically examines the influences of FD and IFTs on energy consumption by using panel data for 30 Chinese provinces during the period of 1998–2019. Results indicate that FD and IFTs have positive effects on energy consumption. Moreover, the positive influence of FD on energy consumption is strengthened by the improvement in IFTs. In addition, FD and IFTs affect energy consumption through industrial structure upgrading. In terms of policy implications, this study suggests that China may further reduce energy consumption by appropriately reducing the degree of FD, optimizing the intergovernmental fiscal transfer system, and promoting the upgrading of industrial structure.

Perspectives in Fiscal Decentralization: Challenges and the Unfinished Agenda

Fiscal decentralization has received a great deal of academic research attention in the past three decades. Much of this work has been directed toward advising countries on how they should structure their intergovernmental fiscal systems to move government decision making closer to local constituencies. Yet even with all this good work, there are many areas where major questions remain. This paper is about where the next round of research might be focused. It begins with an explanation of why attempts to measure fiscal decentralization are unsatisfactory, and ends with a discussion of what might be done about the equally unsatisfactory state of availability of comparative data. The more detailed discussions in this paper cover tax and expenditure assignments, intergovernmental transfers, debt, and the controversy about whether fiscal decentralization has worked.

Continuity or Change? Indonesia’s Intergovernmental Fiscal Transfer System under Jokowi

INTRODUCTION In 2001, Indonesia embarked on a far-reaching decentralization reform that devolved core responsibilities such as health, primary and secondary education and infrastructure to the districts. While the centre retained authority over foreign affairs, defence, law enforcement, justice, fiscal and monetary policy, and religion, control of all other functions was transferred to the regions — at least in principle (Sjahrir 2016). This implied a huge shift of expenditure from the centre to the regions (districts and provinces), which now spend around a third of the consolidated state budget. Yet, fiscal decentralization, which was accompanied by political and administrative decentralization, has remained largely one-sided. While local governments have authority over their spending, they rely heavily on transfers from the centre to finance their expenditure (Schulze and Sjahrir 2014). This particularly concerns districts, which received only 10–16 per cent of their revenue from own sources (tax and non-tax) between 2011 and 2016. Transfers to local governments accounted for around 30 per cent of central expenditure in recent years (Figure 4.1), making the design of the intergovernmental transfer system crucial for the success of the decentralization reform. From a normative perspective, intergovernmental fiscal transfer systems should fulfil three basic functions. First, they should internalize externalities created by regional spillovers, such as public goods that benefit people from multiple local jurisdictions (Oates 1999), cross-border pollution or the erosion of tax bases in the presence of interjurisdictional competition (Wilson 1999). Second, they should incentivize local governments to mobilize resources and spend their resources efficiently. And third, they should have an equalizing function through which differences in economic development across regions are counterbalanced (Shah 2006; Boadway and Shah 2007). In the case of a one-sided fiscal decentralization, transfers of course have a major financing function (Boadway and Shah 2007). In short, intergovernmental fiscal transfers are an instrument that allow benefitting from the advantages of fiscal decentralization while minimizing its costs in terms of fiscal inequity or negative external effects (Boadway 2007). Yet, in practice, the allocation of transfers is often determined by political considerations like rewarding core voters or targeting swing voters (Gonschorek, Schulze and Sjahrir 2018; Weingast 2009, 2014). Moreover, transfer systems are often designed as a result of lobbying for regional interests.

The revolutions in China’s inter-governmental fiscal system

There were three periods in the development of China’s inter-governmental fiscal system. In the first period (1950s to 1979), local governments collected tax revenues and remitted upward to the central government. Reforms during the next two periods made revolutionary changes to the system. The tax-sharing system (established in 1994) provides for revenue centralization, spending decentralization, and large central transfers to local governments. This system remains largely in force.

Social Protection for the Informal Sector in Urban China: Institutional Constraints and Self-selection Behaviour

AbstractThe Chinese government has recently expanded the scope of urban social insurance programmes. However, social protection for the labour force of the urban informal sector, which reaches about half the number of urban workers, lags significantly behind. This under-coverage may be due to institutional constraints, particularly the household registration system hukou, and self-selection behaviour related to the limited benefits of social insurance. Drawing on a recent nationwide individual-level survey and city-level statistics, this study examines these two explanations for the under-enrolment on the social insurance programme. First, results suggest that hukou and the intergovernmental fiscal system are major institutional constraints. Second, self-selection behaviour in programme enrolment is verified. Employers in the informal sector are likely to opt out of social insurance. More importantly, employers in the informal sector, with rural or non-local hukou, are likely to opt out of social insurance, which suggests that self-selection behaviour is constrained by institutions. Such findings have important implications for broad theoretical and policy debates on universal social protection.

Looking Beyond Conventional Intergovernmental Fiscal Frameworks: Principles, Realities, and Neglected Issues

Fiscal decentralization and intergovernmental fiscal relations reform have become nearly ubiquitous in developing countries. Performance, however, has often been disappointing in terms of both policy formulation and outcomes. The dynamics underlying these results have been poorly researched. Available literature focuses heavily on policy and institutional design concerns framed by public finance, fiscal federalism, and public management principles. The literature tends to explain unsatisfactory outcomes largely as a result of some combination of flawed design and management of intergovernmental fiscal systems, insufficient capacity, and lack of political will. These factors are important, but there is room to broaden the analysis in at least two potentially valuable ways. First, much can be learned by more robustly examining how national and local political and bureaucratic forces shape the policy space, providing opportunities for and placing constraints on effective and sustainable reform. Second, the analysis would benefit from moving beyond design to considering how to implement reform more strategically.

The Evolution of Fiscal Decentralization in China and India: A Comparative Study of Design and Performance

In this article, we compare and contrast the design and performance of China and India’s intergovernmental fiscal systems. We find that there are remarkable similarities in the design and performance of China and India’s intergovernmental fiscal systems. More specifically, both countries have highly decentralized expenditures assignments and highly centralized revenue assignments. As a result, sub-national governments in both countries must rely on fiscal transfers to finance their assigned functions. Finally, there is considerable off the books and hidden borrowing by sub-national governments in both countries. We also find that there are considerable and growing disparities in the rate of expenditure decentralization among sub-national governments within each country. Lack fiscal discipline and growing fiscal disparities among sub-national governments create risks to future economic growth and to social cohesion, absent policy reforms to address these issues.

The economic consequences of a fuel levy reform in South Africa

This paper assesses the economic effects of a hypothetical fuel levy imposed by South African provinces. The welfare effects of increasing the fuel levy by 10 per cent are negative but very small. Similarly, the marginal excess burdens for efficiency and equity (poverty) are quite low, suggesting much smaller impacts of the intervention on both economic activity and equity. Furthermore, a fiscal policy reform that raises fuel levy by 10 per cent is progressive as it has stronger negative effects on higher income households than the lower income households. A potential source of instability for the macroeconomy and total government revenue is the negative effect on economic activity induced by the fuel levy increase. The remedies suggested are that policymakers should make tax room elsewhere in the intergovernmental fiscal system to accommodate the fuel levy increase.

Rebuilding Government for the 21st Century: Can China Incrementally Reform the Public Sector?

AbstractAfter three decades of spectacular economic successes, China is facing a significant challenge. The string of recent scandals – environmental degradation, melamine-tainted milk powder, fake drugs and chemicals – have all pointed to government weakness in protecting public safety, exposing an enormous gap between China's growing economic prowess and its capacity to govern. With the leadership now focused on improving the regulatory regime, will China “catch up” and build the public institutions needed? This article argues that the reactive, incremental retrenchment of government in the 1980s and 1990s, combined with inadequate finance, had broken the intergovernmental fiscal system and created large distortions in the incentive structure facing government agencies and public institutions (shiye danwei事业单位). Until the intergovernmental fiscal system is repaired and incentives are fundamentally reformed for the public sector, the top-down programme to redirect China's development and build a service-oriented government will have limited effect.

Analisis Kapasitas Fiskal Daerah: Studi Kasus di Kabupaten Gunung Kidul

Intergovernmental fiscal transfers are critical elements of public finance in decentralized countries. In the context of Indonesia’s decentralization reforms, their design and implementation have significant impacts on the potential revenue and fiscal capacity of basic public service provision. The case of Indonesia’s 2001 Big Bang decentralization illustrates the challenges associated with implementing significant reforms in the intergovernmental fiscal system. The practice of decentralization policy in Indonesia since the time has not generally improved local development performance yet. This study evaluates fiscal decentralization, focusing on fiscal capacity as the impacts of the intergovernmental fiscal equalization transfers, in the case of Gunung Kidul, Yogyakarta. The study shows a low percentage of its own revenue compared to its total budget. It indicates the failure of fiscal decentralization policy in improving local government fiscal capacity.

CHINA: REGIONAL DISPARITIES IN POVERTY DISTRIBUTION

China's remarkable poverty alleviation is quite uneven across regions in the last quarter of the century. It is important to explore why China has such huge disparity in poverty distribution in spite of overall dramatic economic growth and the vast improvement in per capita income. The aim of this paper is to fill the literature gap by focusing exclusively on the issue of regional disparities in poverty distribution in China. It finds an increasing concentration of the rural poor in south-western provinces and the urban poor in northern China. Behind the scene, political choices and public polices, particularly barriers restricting the flow of labor, and fiscal rules that provides the disadvantaged population and regions less access to the fruits of division of labour, have a critical impact on how the effects of endowment and geography play out in the country's poverty distribution. In efforts to fight against skewed poverty concentration and build a harmonious society, further policy actions are required to promote agricultural development and off-farm employment, enhance infrastructure investment in poor regions, lower fiscal disparities and promote equitable public services provision, and address the regressive inter-governmental fiscal system.

Federalism and the Market: Intergovernmental Conflict and Economic Reform in the Developing World

Federalism and the Market: Intergovernmental Conflict and Economic Reform in the Developing World. By Erik Wibbels. New York: Cambridge University Press, 2005. 276p. $85.00.In this book, Erik Wibbels explores the “federal collective action problem” (pp. 47, 62). Because in federal countries national and regional leaders answer to different constituencies, their electoral interests and preferences toward socially costly reforms might conflict. Market economic reforms constitute one type of such measures. As Wibbels argues, in crisis-ridden federations, “economic reforms takes [sic] on the quality of a public good requiring the individual regions to cooperate, whereas it is more rational for each career-oriented politician to avoid the costs associated with austerity” (p. 27). National leaders concerned with macroeconomic stability want market economic reforms implemented in the regions, but regional leaders have an incentive to free-ride and adopt fiscally expansionary policies. The book suggests that “many market reform policies are a function of a constant process of bargaining between national and regional leaders struggling for political survival” (p. 5). Moreover, it argues that “[t]he degree to which the two sets of actors [national and regional leaders] conflict depends on four crucial factors: the electoral interests that each brings to the game, a shared intergovernmental fiscal system, the manner in which regional interests are represented in national policy making, and the levers of partisan influence national leaders have over subnational politicians” (pp. 5–6). The author proposes that fiscally autonomous regions with competitive party systems are more likely to converge with the national government's interests on market economic reforms; and that national electoral coattails are a more effective means for disciplining regional leaders than partisan harmony through centrally dispensed carrots and sticks (pp. 38–39).

India's Intergovernmental Transfer System and the Fiscal Condition of the States

India's fiscal deficit and steep deterioration in state finances is a source of concern. The literature abounds with references to the combined fiscal deficit of the center and the states currently at over 10 per cent of GDP. During no other eight year period has the debt-GDP ratio rose by more than 10 percentage points where the ratio of outstanding debt to GDP increased from 21 per cent in 1996-97 to 35 per cent in 2004-05 (Budget Estimate). In this paper, we contend that the lack of State fiscal discipline is due in large part to a flawed intergovernmental fiscal system that fosters fiscal profligacy at the state level. Specifically, the States are highly dependent on transfers from the Union Government, which breaks the Wicksellian link between costs and benefits. There is a lack of transparency and accountability in the system because of extensive use of inadequate revenue assignments, lack of sufficient decentralization to local bodies, and a poorly designed intergovernmental transfer system. Finally, the States are operating under soft budget constraints which encourage fiscal profligacy. In this paper, we concentrate our discussion on issues related to the intergovernmental fiscal transfer system. We contend that the high transfer dependency of the states has weakened accountability and fiscal discipline. The transfer system is also very complex and lacks transparency and coordination among the institutions in charge of implementing transfers, which together produce a cycle of distorting incentives. If the fiscal behavior of the States reflects the incentives created by the intergovernmental system, as we contend, then, absent structural reform of the intergovernmental fiscal system that addresses the perverse incentives of the current system, the fiscal trends described above are likely to persist. Although the Twelfth Finance Commission (TFC) has addressed some of the issues related to the intergovernmental fiscal system and soft budget constraint, there is still an urgent need to tackle other issues in the intergovernmental fiscal system that create perverse incentives and soften budget constraints. This emphasizes the need for the State and Union Governments of India to strengthen and accelerate the reform of India's intergovernmental system.

Significance and Determination of Fees for Municipal Finance

The idea of fiscal decentralisation has become increasingly fashionable world-wide. But every country has unique features of the intergovernmental fiscal system. In general municipal expenditures are rapidly growing in European countries. On the other hand local tax increases are not easily enforceable at present, whereas the local fiscal autonomy is unlikely to be guaranteed as long as municipalities are strongly dependent on down-flow grants. In such a fiscal-stress situation an improvement of local fiscal capacity can be achieved from the increase of fees. Four European countries were chosen to survey the recent development of municipal finance: Britain, Germany, Poland and Switzerland. This paper firstly identifies and highlights the similarities and differences in municipal finance in an international context. Secondly it theoretically examines the possibility of enhancing fiscal autonomy of local governments through determining optimal fee level which leads to an increase of revenues from this revenue item.

Dry Rot: The Corruption of General Subsidies in Japan

Within a few short years, Japan's over ¥20 trillion system of general subsidies has gone from being a sacred cow to a salient item on a menu of reforms. This development reflects the rise of reformist forces, notably Prime Minister Koizumi Junichiro, and their critique of the Liberal Democratic Party old guard's extraordinary mismanagement of the Japanese economy. The delegitimation of general subsidies has, however, a longer trajectory as well. It derives from excessive fiscal centralization and the spread of wasteful subsidies throughout the intergovernmental fiscal system. Japan's extensive fiscal reforms in the mid-1980s anticipated a very different scenario. They saw the expansion of general subsidies and locally initiated public works as important means for overcoming the clearly debilitating politics of specific subsidies. What was generally overlooked was the great scope for moral hazard that the reforms entailed. And no one could have foreseen the 1990s, when the central government increasingly force-fed the locals public-works funding as part of its fiscal policy. This paper therefore retraces the political economy of Japan's general subsidy regime and its increasing delegitimation through pork-barrel incentives. It also sketches the current debate over how to reform the system.

The Principles of Parallel Development of Fiscal Capacity between State and Municipalities as Useful Benchmarks for the Determination of the Inter-governmental Grants in Germany

The conventional theoretical and empirical references related to the inter-governmental fiscal transfer system in Germany appear to heavily concentrate on the issues surrounding the measurement of local expenditure needs of a municipality and their coverage through the down-flow grants when the municipal tax revenue is insufficient to match the needs. This study introduces additional important research fields in this context. Firstly, it attempts to analyse the role of the development of tax revenue and fiscal power of the grant provider (the State) as well as the joint financial relationship between the State and (different types of rural and urban) municipalities in the determination of inter-governmental grants. Secondly, when the total volume of the State grants is determined, this study examines in the next step under the particular consideration of different tax capacities in varied categories of municipalities, how this amount should be horizontally distributed among these groups to achieve the equal growth of hypothetical per capita fiscal capacity.

The challenge of design of intergovernmental relations in economies in transition

The governments of Eastern Europe and the former Soviet Union are at a crucial juncture in their movement from highly centralized command economies to more decentralized market economies. While there is a belief in these countries that decentralization brings greater economic efficiency, the reality is that such a transition is a difficult process. This paper examines what types of administrative reforms are needed for the decentralization process, how far along the countries are with respect to these reforms, and what reforms are missing. As we discuss, many of the necessary administration reforms are missing and we argue that more attention must be paid to these elements for successful decentralization of these governments. This paper examines the recent experience and reform needs of the key administrative aspects of the design of intergovernmental relations in countries in transition in Eastern Europe and in the former Soviet Union. There is a widespread realization in all of these countries that decentralizing government will help increase efficiency in the public sector just as privatization will improve efficiency in their economies. Decentralization of government operations is also attractive as a way to cement a democratic form of government. Despite the appearances of the existence of an already decentralized system, such as in the case of the Soviet Union, this experiment started in practically all cases with a lack of institutions and experience on how decentralized government operations should be organized. As different as these countries are, there are many similarities in the reform process they are following in order to decentralize government structure. While the basic components of a decentralized system of government are emerging in many of these countries the structure of government has not fully evolved in a manner that can support such a decentralized system. Often, governments remain structured along a vertical hierarchy: information, budgetary authority, and revenue pass from the central government down to subnational levels of government while little communication or interaction exists at a horizontal level. In general, the assignment of revenue and expenditure has not been clearly defined among the two or three levels of government, central government transfers continue to occur in a relatively ad hoc manner, and the entire budgeting system still rests in many cases on more or less formal system of negotiations and bargaining among the different levels of government. There has been some change in this structure in certain countries. Over the last three years, both Poland and Hungary have legally increased the automony of subnational governments. In 1994 in Russia a new and more transparent system of intergovernmental grants has been established between the federal government and the regions. In 1994 also, Latvia introduced a more transparent formula-driven, transfer formula for the regional and municipal governments. The focus of this paper is to develop a “blue print” for necessary changes in organization and administration of intergovernmental relations in countries in transition. While many experts have recently been discussing the public finance policy components of this new, evolving relationship among levels of government, less attention has been paid to the structural and administrative challenges and the information design issues that must be met in order to develop and support a system of intergovernmental relations. The paper is organized as follows: First we review the major responsibilities and their allocation among levels of government, the assignment of revenue sources, and the system of transfers. We then turn to a discussion of the current experience of Eastern European and NIS countries in the context of the structural components of an intergovernmental fiscal system. Next, we analyze the organizational reforms that are necessary for the efficient functioning of a decentralized system of government in the economies in transition. Finally we “rate” the transition economies in relation to their current design of the system of intergovernmental relations and support mechanisms.

Local Finance and Economic Reform in Eastern Europe

Extensive decentralization, both political and fiscal, is taking place in many of the countries newly emerging from behind the socialist veil. Decentralization represents both a reaction from below to the previously tight political control from the center and an attempt from above to further the privatization of the economy and to relieve the strained fiscal situation of the central government. Although there are of course many variations in this process from country to country, some important common elements arise from the similar institutional starting point in all countries and the common transitional problems most of them are facing. The on-going reforms of subnational finance in the transitional economies are more important than seems generally to be recognized. The design of a well-functioning intergovernmental fiscal system is key to many of the major reform goals of the transition economies—macroeconomic stability, privatization, and the social safety net.