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Roy Bahl:

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The choice of the "right" fiscal relationship between central, provincial, and local govern­ments depends on how a government weighs the benefits of decentralized economic development policies against the costs of having less effective central fiscal management. Three strong forces justify more fiscal centralization in China's highly decentralized fiscal system at the present time:

  • Bouts of inflation and recurrent fiscal deficits can be seen as calling for more central control over the budget.
  • Reform of an economic system relies heavily on the use of tax policy as an allocative instrument to influence economic decisions. Local control of the implementation of the tax system can and probably has compromised some objectives of the central government's tax policy. Gaining tighter control over the revenue system will probably require reducing, if not eliminating, local government discretion in providing special tax concessions.
  • If the center wants to move ahead with price reform and to encourage enterprise reform, it needs a more centrally controlled revenue sharing or assignment system that reduces the dislocating effects of such reforms.

Centralizing the fiscal system nevertheless reduces the potential for vesting more budgetary decision-making powers in local governments and can erode local and provincial governments' incentives for raising revenues, another goal of system reform. Moreover, there are major problems with introducing fiscal centralization in a country with a heterogeneous population of 1 billion and relatively little tradition of central government fiscal administration.

Bahl and Wallich conclude that a reformed system of intergovernmental finance must meet the center's needs for stabilization and the provinces' needs for revenue and equalized spending capacity. They argue that such equal­ization should be based on objective indicators of need and that a formula-based grant system best meets this latter objective. A reformed system must also underpin price and enterprise reform -and should be designed so as not to require major recalibration or adjustments while such reforms are taking place.

Bahl and Wallich also conclude that reform of the relationship of central and local governments should be supplemented by an improved system of financing local capital expenditures through borrowing, a system of benefit charges, and improved financial planning and tax administration.


Originally published in Bahl, Roy W., and Christine Wallich. Intergovernmental Fiscal Relations in China. The World Bank, Country Economics Department, February 1992.

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