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Analysis of China’s Financial Power-Based Transfer Payment System and Suggestions on its Improvement
2006-03-15
By Ni Hongri & Hong Ting
Research Report No 188, 2005
The transfer payments made from China’s central revenue to regional revenues comprises three forms: the financial power-based transfer payment, the special transfer payment, and the tax rebate and former institutionalized subsidy (one view argues that the tax rebate and former institutionalized subsidy should not be regarded as a form of fiscal transfer payment). The financial power-based transfer payments are fiscal subsidies for promoting regional governments’ financial power, and are designed mainly to balance inter-regional financial disparities and equalize the inter-regional levels of public services. This paper attempts to offer a positivist description and analysis of this form of transfer payment.
I. The Items Contained in the Financial Power-Based Transfer Payment
1. General transfer payment
General transfer payments are designed to balance regional budgets and meet the basic spending requirements of regional governments in fulfilling their functions. They are an effective tool to realize equality in public services across regions. The central revenue began introducing a transitional transfer payment method for regions with weak financial power in 1995. This changed into a general transfer payment in 2002. The basic idea was that standard fiscal revenues and standard fiscal expenditures for various regions were worked out in accordance with the principles of being standard and fair and on the basis of objective factors. The gap between standard fiscal revenues and expenditures for various regions would be used as the basis of distribution. The more fiscally constrained a region, the higher its level of subsidization. In recent years, the method of distributing the general transfer payment fund has constantly improved and the size of the fund has risen rapidly from 2.1 billion yuan in 1995 to 74.5 billion yuan in 2004.
2. Transfer payments for ethnic regions
In order to support the strategy of developing China’s western regions and supporting the development of ethnic regions, transfer payments for ethnic regions were introduced in 2000. The recipients of the transfer payments for ethnic regions are ethnic provinces and regions and ethnic autonomous prefectures in non-ethnic provinces and regions. There are two sources of funding for this. The first is the 1 billion yuan policy-oriented transfer payment for ethnic regions that was specially introduced in 2000 and is increasing progressively with the growth rate of the value-added tax shared by the central revenue. The second is the value-added tax revenue of eight ethnic provinces and regions and the ethnic autonomous prefectures of the non-ethnic provinces and regions. 80 percent of the year-on-year increase in their added-value tax revenue is transferred to these ethnic regions and half of the increased amount is returned to the place of origin so as to stimulate regional enthusiasm to increase revenue. At the same time, as there exist both objective disparities in levels of economic development across different ethnic regions as well as financial power inequalities between different regions, the other half is distributed to regions (including the Tibetan Autonomous Region) in the form of transfer payments by using the factoring method in order to embody the principle of equity. The remaining 20 percent of the increased value-added tax revenue is owned by the central government and does not participate in the tax rebate made by the central government to regional governments based on the 1:0.3 coefficient. From 2000 to 2004, the transfer payment for ethnic regions rose from 2.553 billion yuan to 7.687 billion yuan.
3. Transfer payments for wage adjustments
In order to cope with the Asian financial crisis and ease the insufficiency of effective domestic demand, the state decided to pursue a proactive fiscal policy starting from 1998. Accordingly, the government introduced a series of policies to raise the income levels of low and middle-income earners while intensifying its own investments. From 1999 to 2003, the government raised the wages of those working in government and public institutions as well as the pensions of retirees four times, and introduced the policies of giving lump-sum year-end bonuses to employees and offering allowances for those working in harsh border and remote areas. As the fiscal conditions of different regions varied considerably from one to another and as different regions had different capacities to bear increased wage expenditures, the central government decided that the governments of Beijing, Shanghai, Jiangsu, Zhejiang, Guangdong, Fujian and other coastal developed regions would bear the increased spending arising from the implementation of these policies and that the central finance would give appropriate subsidies to the old industrial bases and the central and western regions that were in fiscal difficulty. From 1999 to 2004, the central finance provided 367.1 billion yuan to regional governments as transfer payments for wage adjustment.
4. Transfer payment for reforming rural taxes and fees and for abolishing agricultural tax
During the period of reforming rural taxes and fees, the central revenue gave appropriate subsidies to various regions through transfer payments to offset their reduced revenues. The decision was taken after taking into account the revenue-growing factors such as raising the agricultural tax after the "three retained fees and five overall planned fees" were abolished and incorporated into the agricultural tax and the revenue-reducing factors such as lowering the agricultural specialty tax rate, abolishing the slaughtering tax and adjusting the revenue-withholding methods. All these transfer payment funds were distributed in accordance with the principle of unified standard, justice, fairness, openness and transparency and in favor of the major agricultural provinces, leading grain producing regions, ethnic regions and regions with fiscal difficulties.
After 2003, the central revenue intensified transfer payments after abolishing the agricultural specialty tax and lowering agricultural taxes. While the coastal developed region bore the reduced fiscal revenue arising from the abolition of the agricultural tax, the leading grain producing regions and the central and western regions received appropriate transfer payments from the central finance. The reduction in regional fiscal revenue was calculated on the basis of the actually collected amount (including surcharge) of the agricultural specialty tax and the agricultural tax using 2002 as the base year. The ratio of the central subsidy was 100 percent for the leading grain producing regions in central and western China, 80 percent for the non-leading grain producing regions, and 50 percent for the leading grain producing regions (including Fujian) in eastern China. Statistics indicate that from 2001-2004, transfer payments from the central revenue for rural tax and fee reform rose from 8 billion yuan to 30.7 billion yuan.
In 2005, more regions abolished the agricultural tax and intensified agricultural tax relief. All 592 key counties slated as national poverty reduction targets were all exempted from the agricultural tax on an experimental basis. The provinces that cut the agricultural tax by 1 percentage point in 2004 cut another 4 percentage points again in 2005. And the provinces that cut the agricultural tax by 3 percentage points in 2004 cut another 2 percentage points. The livestock tax was exempted nationwide. The reduction in regional fiscal revenue was handled in accordance with the policy designed in the previous year. In other words, the coastal developed regions bore the burden single-handedly, and the leading grain producing regions and the central and western regions continued to receive appropriate transfer payments from the center. The coefficient for the transfer payment remained largely unchanged.
5. Transfer payments for county and township fiscal rewards and subsidies
In light of the fiscal difficulties of county and township governments, the central finance issued the Opinions on Easing the Fiscal Difficulties of County and Township Governments in 2005. The document contained integrated measures on improving systems, innovating mechanisms and tightening management, aiming at easing the fiscal difficulties of county and township governments. It planned to greatly ease their fiscal difficulties in about three years. As a core measure for this, the central finance earmarked 15 billion yuan in 2005 for the establishment of a "three rewards and one subsidy" stimulation and control mechanism for counties and townships in fiscal difficulty. The aim was to further ease fiscal difficulties at the two administrative levels.
6. Fiscal subsidy for year-end account settlement
This subsidy refers to the fiscal subsidies issued for handling year-end account settlements. It includes the subsidy for the reduced fiscal revenue arising from the suspension of the regulatory tax for the reorientation of the investment in fixed assets, the subsidy for the reduced regional fiscal revenue arising from the implementation of the natural forest protection project, the subsidy for the reduced fiscal revenue arising from retiring farmland for tree and grass growing, and other relevant subsidies.
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