Transcript lecture 6_fiscal reform

Lecture 6
Fiscal Reforms
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1
Pure market economy without a government
Output Market
Firms
Households
Input Market
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2
Market failures

Micro level
 1. Incomplete competition.
 2. Externality.
 3. Insufficient public goods and merit goods.
 4. Incomplete information and high transaction cost.
 5. Risk and uncertainty.

Macro level
 1. Unequal income distribution.
 2. Economic fluctuation.
 3. International trade deficits.
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Circular Flow in a Mixed Economy
Output Market
Households
Government
Firms
Input Market
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4
Government failures

Politicians and bureaucrats are self-interested and they may not act in the
interest of the society.



Public and private sector share some common problems.


Incomplete information, transaction cost, problematic performance
measurement and incentive systems, and risk and uncertainty.
Governmental institutions and political arrangements may not make the
government responsive to the solution of the market failures.



Political business cycle is one example of artificially made fluctuation.
Bureaucratic empire building: absence of bottom line.
For example, the log-rolling process may lead to budget expansion.
Divided government reduces the efficiency of decision making.
Decision making may be controlled by organized interest groups without
reflecting median voter preferences.
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Basics of Public Finance

The general economic goals of a government
 1. Economic growth; 2. Stable price; 3. Balance in international trade; 4.
Full employment.

The major economic instruments of the government
 1. Financial instruments: interest rates, deposit reserve ratio, credit
provision, etc.
 2. Fiscal instruments: taxation, debts, redistribution, spending
 3. Other: industrial policies, regulatory policies, etc.

Public finance serves purposes beyond efficient resource allocation
 1. Providing public goods to overcome market failure
 2. Balance different regions and social groups
 3. Intra- and inter-governmental check and balance
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Sovereign credit rating
by Standard & Poor's Foreign Rating in March 2013


Three major credit rating agencies: Standard & Poor’s, Fitch, and Moody’s.
Dagong, a Chinese rating agency in Beijing.
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How can fiscal policies be used to stimulate economic
growth?

1. Mobilize local initiatives.

2. Facilitate incentives of investment.


Enterprise income tax

Laffer Curve
3. Facilitate capital cumulation

Structural inclination of taxation

4. Facilitate infrastructure construction

5. Stimulate innovation and export
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Pros and cons of centralized fiscal system


Merits
 1) Central fiscal management internalizes the cross-jurisdiction
externality effects
 2) Intergovernmental transfer redistributes wealth.
 3) Restrain excessive local fiscal competition.
 4) Central government grants/transfer payment empower its political
control.
Demerits
 1) Federal grants may lead to overly reliance on federal finance.
 2) The separation of revenue and expenditure creates fiscal illusion and
offsets the policy purpose of the federal government.
 3) Correspondingly, it gets more difficult to motivate local jurisdictions to
match its revenues with local expenditure preferences.
 4) Such system may encourage rent-seeking behavior.
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Pros and cons of a decentralized fiscal system

Merits
 1) Exit model: Tiebout’s model argues that local residents vote by feet
according to their preferences and the local revenue-expenditure patterns.


Decentralized system more directly links the local performances to the
capacity of local officials who are driven by the pressure of local
competition.
When assets are mobile, local governments are reluctant to impose heavy
taxes. This may result in a small government in general.
2) Voice model: local democratic process can help match the financial
arrangements and local preferences.
The demerits of a decentralized system is just the absence of the merits
derived from a centralized system.
 Reduction of public goods supply to the bottom
 Externality problem is not well solved if high transaction cost exists
 Inequality


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The evolution of intergovernmental fiscal
arrangement in China

1. Fiscal arrangement under planned economy

United revenue and expenditure system


A heavy reliance on enterprise profits of SOEs rather than
on tax




Local governments didn’t have fiscal power. They were the agents of
central government, collecting revenues and retaining some for local
expenditures according to central plans.
In 1978, Shanghai had 1.1% of China’s population, but contributed
7.5% of national GDP and 15% of national fiscal revenues.
It collected RMB 16.9 billion revenues, and kept RMB 2.6 Billion. The
contribution rate is 85%.
In 1985, SOE’s profit remittance was replaced by income taxation
Major expenditures were on industry investment and
infrastructure construction

In 1978, expenditures on administration and services were only 11.6%
of the fiscal expenditures.
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Fiscal revenue Structure of China: 1970-1993 (100 Million)
Year
Total Revenue
Tax revenue
Enterprise income revenue
1970
662.9
281
378
1973
783.94
348
427
1975
815
402
400
1976
776
407
338
1977
874
468
402
1978
1132
519
571
1979
1146
537
495
1980
1159
571
435
1981
1175
629
353
1982
1212
700
296
1983
1366
775
240
1984
1642
947
276
1985
2004
2040
43 (income tax began， 595 this year)
-507
1986
2122
2090
42
-324
1987
2199
2140
42
-376
1988
2357
2390
51
-446
1989
2664
2727
63
-598
1990
2937
2821
78
-578
1991
3149
2990
74
-510
1992
3483
3296
59
-444
1993
4348
4255
49 (582 tax submission this year)
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Subsidies to SOEs
12

2. 1978 ~ 1994: discretion-based fiscal contracting and
revenue sharing system

Since 1978, decentralized fiscal management was gradually
introduced.

Fiscal contracts were signed between central and local
governments

There were 6 types of revenue-sharing arrangements

Basically, local governments could retain a big portion or even 100% of
the surplus revenues after they submitted the quota set by the contract.



This essentially removed central government’s responsibility to
provide local services.
This drove local governments to maximize local revenues: LSC
The emergence of a prosperous
economy and a weak state
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
3. 1994 ~ Present: rule-based revenue sharing system (A return to
centralization)

A reclassification of taxes and taxing authorities



Fixed Central Revenues: Customs Duties; VAT and Consumption Tax
collected by the Customs; Domestic Consumption Tax, Income Tax of Central
Enterprises; Income Tax of Local Banks and Nonbank Financial Institutions;
Revenues remitted by Railway Department, Headquarters of State-owned
Banks and Insurance Companies; Profits remitted by Central Enterprises.
Fixed Local Revenues: Business Tax; Income Tax of Local Enterprises;
Profits remitted by Local Enterprises; Individual Income Tax; City and
Township Land Use Tax; Fixed Assets Investment Orientation Regulation
Tax; City Maintenance and Construction Tax; House Property Tax; Urban
Real Estate Tax; Vehicle and Vessel Usage Tax; Stamp Tax; Slaughter Tax;
Agriculture Tax; Animal Husbandry Tax; Farmland Occupation Tax; Deed
Tax; Inheritance and Donation Tax; Land Appreciation Tax.
Shared Revenues:




a. Domestic VAT (17%): 75% for central government and 25% for local
governments;
b. Resource Tax: the part for the central government is the tax paid by offshore oil
enterprises, and the rest is for local governments;
c. Security Transaction Tax: Split by half between central and local governments
d. In 2002, individual income tax was changed to be shared half by half, in 2003 the
central government began to share 60% percent.
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

Restructure the tax administration system

Removal of local discretion in making tax breaks
The banking sector reform in 1998

Building 9 branches of the Central Bank
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Improved extractive capacity
60%
50%
40%
30%
20%
19
78
19
79
19
80
19
81
19
82
19
83
19
84
19
85
19
86
19
87
19
88
19
89
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
10%
0%
Revenue Share of Central Gov
Total Revenue Share in GDP
Expenditure Share of Central Gov
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The two ratios of China’s fiscal revenues 1978-2007
Year
GDP
(RMB billion)
Ratio 1
1978
364.52
0.31
1979
406.26
1980
Ratio 2
Year
GDP
(RMB billion)
0.16
1993
3533.4
0.12
0.22
0.28
0.20
1994
4819.79
0.11
0.56
454.56
0.26
0.25
1995
6079.37
0.10
0.52
1981
489.16
0.24
0.26
1996
7117.66
0.10
0.49
1982
532.36
0.23
0.29
1997
7897.3
0.11
0.49
1983
596.27
0.23
0.36
1998
8440.23
0.12
0.50
1984
720.81
0.23
0.41
1999
8967.71
0.13
0.51
1985
901.6
0.22
0.38
2000
9921.46
0.14
0.52
1986
1027.52
0.21
0.37
2001
10965.52
0.15
0.52
1987
1205.86
0.18
0.33
2002
12033.27
0.16
0.55
1988
1504.28
0.16
0.33
2003
13582.28
0.16
0.55
1989
1699.23
0.16
0.31
2004
15987.83
0.17
0.55
1990
1866.78
0.16
0.34
2005
18386.79
0.17
0.52
1991
2178.15
0.14
0.30
2006
21087.1
0.18
0.53
1992
2692.35
0.13
0.28
2007
249530
0.21
0.54
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Ratio 1
Ratio 2
17
Tax revenue structure 1978-2008
Domestic
Value-added
Tax
1978
1980
1985
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
519.28
571.70
2040.79
2821.86
2990.17
3296.91
4255.30
5126.88
6038.04
6909.82
8234.04
9262.80
10682.58
12581.51
15301.38
17636.45
20017.31
24165.68
28778.54
34804.35
45621.97
54223.79
59521.59
73210.79
147.70
400.00
406.36
705.93
1081.48
2308.34
2602.33
2962.81
3283.92
3628.46
3881.87
4553.17
5357.13
6178.39
7236.54
9017.94
10792.11
12784.81
15470.23
17996.94
18481.22
21093.48
Domestic
Consumption
Tax
487.40
541.48
620.23
678.70
814.93
820.66
858.29
929.99
1046.32
1182.26
1501.90
1633.81
1885.69
2206.83
2568.27
4761.22
6071.55
Business
Tax
211.07
515.75
564.00
658.67
966.09
670.02
865.56
1052.57
1324.27
1575.08
1668.56
1868.78
2064.09
2450.33
2844.45
3581.97
4232.46
5128.71
6582.17
7626.39
9013.98
-3011157.91
Corporate
Income
Tax
696.06
716.00
731.13
720.78
678.60
708.49
878.44
968.48
963.18
925.54
811.41
999.63
2630.87
3082.79
2919.51
3957.33
5343.92
7039.60
8779.25
11175.63
11536.84
12843.54
Individual
Income
Tax
413.66
659.64
995.26
1211.78
1418.03
1737.06
2094.91
2453.71
3185.58
3722.31
3949.35
4837.27
Tariffs
28.76
33.53
205.21
159.01
187.28
212.75
256.47
272.68
291.83
301.84
319.49
313.04
562.23
750.48
840.52
704.27
923.13
1043.77
1066.17
1141.78
1432.57
1769.95
1483.81
2027.83 18
National Government Revenue and Expenditure
Revenue
(100 million yuan)
1978
1980
1985
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1132.26
1159.93
2004.82
2937.10
3149.48
3483.37
4348.95
5218.10
6242.20
7407.99
8651.14
9875.95
11444.08
13395.23
16386.04
18903.64
21715.25
26396.47
31649.29
38760.20
51321.78
61330.35
68518.30
83101.51
Expenditure
(100 million yuan)
1122.09
1228.83
2004.25
3083.59
3386.62
3742.20
4642.30
5792.62
6823.72
7937.55
9233.56
10798.18
13187.67
15886.50
18902.58
22053.15
24649.95
28486.89
33930.28
40422.73
49781.35
62592.66
76299.93
89874.16-30-
Revenue growth (%)
Yearly balance
(100 million yuan)
29.5%
1.2%
22.0%
10.2%
7.2%
10.6%
24.8%
20.0%
19.6%
18.7%
16.8%
14.2%
15.9%
17.0%
22.3%
15.4%
14.9%
21.6%
19.9%
22.5%
32.4%
19.5%
11.7%
21.3%
10.2
-68.9
0.6
-146.5
-237.1
-258.8
-293.4
-574.5
-581.5
-529.6
-582.4
-922.2
-1743.6
-2491.3
-2516.5
-3149.5
-2934.7
-2090.4
-2281.0
-1662.5
1540.4
-1262.3
-7781.6
-6772.7
19
Individual income tax
Taxable income = income – pension deduction – medical insurance
deduction – unemployment fee – housing accumulation fund
Tax = (Taxable income-3500) * tax rate – fixed deduction
Taxable income
Tax rate
Fixed deduction
1
0-4500
5
0
2
4500-7500
10
75
3
7500-12000
20
525
4
12000-38000
25
975
5
38000-58000
30
2725
6
58000-83000
35
5475
7
>83000
45
13475
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Outstanding Debts of Central Government (100
million yuan)
Total
Domestic
Debts
External
Debts
2005
32614.21
31848.59
765.52
2006
35015.28
34380.24
635.02
2007
52074.65
51467.39
607.26
2008
53271.54
52799.32
472.22
2009
60237.68
59736.95
500.73
2010
67548.11
66987.97
560.14
Year
Local debts? It is reported that in 2010 local governments had 11
trillion debts. Shanghai by Jun 2013 had debts RMB 845 billion,
including 519 direct debts, 52 debt guarantee, and 273 with some
-30obligation to rescue.
21
SOEs and their profits




In 2009, SOE made a profit of RMB 1339.22 billion, with
an annual increase by 9.8％.
Central SOEs made a profit of RMB 944.54 billion, with
an increase by 10.3％; local SOEs made a profit of RMB
394.68 billion, with an increase of 8.4％
Since 1994 tax-assignment reform, SOEs were in general
not required to submit profits to the government.
Now major SOEs only submit less than 10% of their
profits to the state.
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China’s giant companies




In 2008, 35 Chinese (Mainland)
companies got into Fortune 500,
according to revenues.
These firms are many SOEs or
stated controlled stock company.
These firms are mainly in oil,
gas, banking, electricity,
railway, airline industries.
Profits were concentrated to few
super-large enterprises.
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

In 2011, Mainland
China had 61
companies on the
list
Three were among
the top 10.
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Are they making or losing money?




A report by Unirule Institute of Economics
Between 2001 and 2008, compared to private companies,
SOEs were waived interests of RMB 2.85 trillion, land
rents of RMB 3.09 trillion, resource rent of RMB 0.5
trillion, and got RMB 0.12 trillion subsidies from
governments.
These lead to a cost saving of RMB 6.48 trillion.
In the same period, SOEs made a profit of RMB 4.92
trillion.
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Fiscal control and efficiency

Adjustment of the revenue structures.



Budgetary reforms





Extra-budgetary spending decreased from about half of the overall
spending, to 32.6% in 1996, and 14.4 percent in 2003
Land sales revenues are still not incorporated into the budgetary
system
Increase the engagement of NPC in making and monitoring the budget
The growing role of the Auditing Office
Centralize the budgetary function of MOF
Harden the making and implementation of budgets
Strengthening the taxation system




Modernize and enhance taxation institutions
Increase the tax base but focus on taxation capacity
Lower the taxation cost
Cultivate the notion of tax-payer
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
Use of public
money is still
weakly monitored.
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Spending management

Change of spending focus: from efficiency to justice and
social equality
 Introduction of governmental procurement
 Introduction of program performance management
 Clear definition of spending responsibilities
 The emphasis on the equalization in basic public services
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More active use of fiscal policies
Anti-crisis fiscal expansion policy
Since late 2008, the central government made a huge investment plan to
stimulate domestic demands.

The total investment plan reaches RMB 4000 billion, and is to be
administered up to the end of 2010.

Central government directly covers RMB 1180 billion, leaving the rest
to the local governments.

Many investments are earmarked, for example, for educational projects,
central and local governments will invest with a 2:1 ratio. For building
of low-rent housing, central and local government offer subsidy of RMB
300 and 400 for every squared meter.

These investments suppose to create a big leverage/multiplier effect,
although that may not be easy…(infrastructure, SOEs…)
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Areas of investment
Urban livelihoods projects
security-oriented housing like low-rent housing, renovation of old houses
Rural livelihoods projects
Planned
Expenditures
(RMB billion)
4000
3700
water, electricity, road, gas, housing
Infrastructure
15000
railroad, highway, airport, irrigation, etc
Public services
1500
education, health, culture, birth control, etc
Energy preservation and anti-pollution
2100
Adjustment of industrial structure and technical upgrading
3700
Reconstruction of earthquake area in Sichuan
10000
Total
40000
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