Taxation System, Local Fiscal Autonomy And Economic Development Performance

After more than30years’ rapid growth, it’s a huge challenge for China to maintain sustainable economic growth and make all the people share development fruits, i.e. achieve an inclusive growth. Looking around the world, the key governance problem for a big country is to deal with the relationship between the central (federal) government and the local governments. Usually, there are significant regional differences within a big country, so, with the purpose of overcoming diffculities in collecting information, it is necessary for central government to give autonomy to local governments, so that local governments could make their own decisions and manage local public affairs. However, when dealing with national issues, big countries have the scale advantages which are not available for the small ones. Morever, for political stability considerations, central government needs to limit excessive autonomy to subnational governments to avoid local independent. In a word, any big nation face a basic issue is that making trade-offs between centralization and decentralization.For the central-local relationship, a key part is the division of fiscal decision powers which is directly related to the allocation and use of public resources. A suitable central-local fiscal relations should conducive to providing public services efficiently, and then promoting social welfare with a higher level of satisfaction. For the developing and transition countries, the central government also hopes to motivate local governments to promote economic growth by adjusting central-local fiscal relations. China started a fiscal decentralization process (namely fiscal contract system) in the1980s, the central government decentralized lots of fiscal powers so that local governments attained unprecedented fiscal incentives to promote local economic development, thus, China got a rapid growth during this period.However, with the implementation of the fiscal contract system, the central government gradually lost the fiscal extractive capacity. So the central government started to consider adjusting the central-local fiscal relations. In1994, the central government launched the tax sharing system reform to centralize fiscal resources. Although the new system significantly reduced the fiscal autonomy of local governments, they still have great enthusiasm (even more than in the1980s) to promote regional economic development. As a result, China was still on the road to rapid economic growth. Based on the above context, this paper takes local fiscal autonomy as a perspective, analyzes fiscal behaviors of local governments after the tax sharing system reform, and then investigates its performance both on economic growth and public service provision. Comparing with the existing literatures, this paper has done the following work:First, I argue that the tax sharing system is a reform characterized by fiscal centralization process coexisting with decentralization one, moreover, the centralization factors results in more degree of decentralization. On the one hand, tax sharing system reform directly reduced the budgetary fiscal autonomy of local governments. On the other hand, it also gave extra-budgetary autonomy to local governments. Based on both provincial and prefecture-level juridiction data, the empirical results show that, the more local budgetary fiscal autonomy was reduced in the tax sharing reform, the local governments would form a stronger dependence on extra-budgetary revenues after the reform. The co-presence of budgetary and extra-budgetary system induces local governments’spending bias behavior. Based on the evaluation of the applicability of the existing decentralization measures, I propose the degree of local fiscal autonomy (i.e., expenditure dependence on own revenue) is a suitable indicator to measure local governments’ fiscal autonomous decision-making powers after the tax sharing system reform. In order to scientifically and comprehensively evaluate the fiscal autonomy of local governments, we should measure the indicator both from the budgetary caliber and the extra-budgetary one.Second, I empirically investigate various channels and mechanisms between local fiscal autonomy and economic growth. Based on fiscal decentralization theory and modern economic growth theory, this paper tests how local fiscal autonomy impacts on public capital investment, private capital investment (FDI), human capital accumulation and the total factor productivity (TFP), from the short-term and the long-term perspective respectively.The results show that increasing provincial budgetary fiscal autonomy has adverse effect on public capital accumulation in short term, but has persistent positive effect on the accumulation of human capital, at the same time, it also can improve the business environment (i.e.reduce the effective tax rate of FDI) and TFP in long run. In contrast, more degree of extra-budgetary autonomy is conducive to the accumulation of public capital in short term, and has some positive effect on human capital in a mid-term, but it can not promote the business environment and TFP growth in the long run. In short, more budgetary local fiscal autonomy will not be conducive to short term growth, but it can lead a growth pattern with higher efficient, more innovative and long run growth, while more extra-budgerary local autonomy only can induce an investment-driving and short-term growth.Finally, we empirically test how the local fical autonomy impact on the provision performance of public service. Unlike the usual measurements of public service with input or output indicators, this paper uses the individual satisfactory level to measure the performance of public service. Based on China General Social Survey (CGSS) with a micro sample data nested in local jurisdictions, we examine the county-level government budgetary autonomy impact on individual satisfaction with local public services.Taking basic education and medicaid services as cases, the results show that more fiscal autonomy has a significant effect to raise residents’satisfaction level with public service in probability, this effect is mainly due to the improved efficiency of fiscal resources in those public services, however, there is not such significant effect for increasing the amount of public spending. Therefore, if local governments have greater budgerary fiscal autonomy, it will promote the provision efficiency of public service to meet various demands of residents and improve social welfare.Although this research is mainly about empirical study, it has a stong link to theoretical literatures. So, we are able to systematically test the theoretical mechanisms between fical decentralization and economic performance. According to the existing theoretical model in this field, researchers often use an empirical framwork that just simply establishing an overall relationship between decentralization and growth or public service provision. Actually, there is an obvious flaw of the existing theoretical model, i.e. they can’t cover variuos channels or mechanisms in one model. This paper makes full use of various data structures such as macro panel data model, cross-sectional data, nested data and so on, and then ensure the empirical conclusions reliable through a series of robust checks and endogeneity test.This paper reveals deep policy implications on China’s future improvement in central-local fiscal relations. Comparing with the decentralization reform without rules in the1980s, the tax sharing system is an institution reform based on rules. Undoubtedly, it’s an important step to establish a fiscal system to adapt modern market economic system. However, under the tax sharing system, this paper shows that more local budgerary fiscal autonomy has a positive effect both on long run economic growth and the provision efficiency of local public services. Therefore, there is a big space for China to improve central-local fiscal relations to achieve a win-win situation for economic growth and social harmony. First of all, the central government should give more budgetary own revenues rather than huge amount of fiscal transfers to fill the revenue gap of local governments. According to the unitary regim of China and the existing tax system, I propose a feasible scheme is that raising the proportion of local governments in sharing taxes such as VAT tax, Nevertheless, poor regions may still lack enough fiscal resources to fufill their expenditure responsibilities, under this circumstances,fiscal transfers from the central government are necessary to maintain certain national standards of public services. Meanwhile, local extra-budgetary fiscal resources should be integrated into the budgetary system, or be strictly supervised and constrainted under local people’congress. Lastly, expenditure authorities and responsibilities should be clearly demarcated among government levels, this is very important for a successful reform of intergovernmental fiscal relations, without this, it would not be possible to form a stable and efficienct fiscal system. Owing to the huge regional differences and demands diversity of the population, it is reasonable that local governments bear major responsibilities of local public services. But the key issue is how to demarcate expenditure authorities among government levels so that upper-level governments could not transfer their responsibilities to lower-level ones. All the above three points can be summarized as two aspects, i.e. the correspondence between financial powers and expenditure authorities, and the correspondence between expenditure authorities and expenditure responsibilities. From my point of view, the two correspondences are unfinished business of the tax sharing system reform.