International Studies Program
Working Paper 10-28
September 2010
Expenditure Assignments in China
Jorge Martinez-Vazquez
Baoyun Qiao
International Studies Program
Working Paper 10-28
Expenditure Assignments in China
Jorge Martinez-Vazquez
Baoyun Qiao
September 2010
International Studies Program
Andrew Young School of Policy Studies
Georgia State University
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United States of America
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Expenditure Assignments in China1
Jorge Martinez-Vazquez* and Baoyun Qiao**
* Regents Professor of Economics, Georgia State University
**Central University of Finance and Economics (CUFE) in Beijing, China
Introduction
China has been carrying out a significant fiscal decentralization policy for over three
decades. However, reforms have largely concentrated on the revenue side of budgets,
and generally they have not been coordinated with an explicit strategy for the
decentralization of expenditure assignments. Although significant strides have been
made in the areas of tax assignments and tax administration, other areas—in
particular, the assignment of government functions—have advanced much less. Yet a
stable, efficient, and fair decentralized system of public finance in China will require
an unambiguous and well-defined institutional framework in the assignment of
expenditure responsibilities among the different levels of government. The
assignment of responsibilities is by no means the only condition, but it is the most
important, and it should also be the first in a well-sequenced decentralization reform
effort.2
1
We are thankful to Andrey Timofeev, Bert Hofman, and Dana Weist for helpful comments to
previous drafts and to J. Vernon Henderson for comments provided during the conference.
2
See Bahl and Martinez-Vazquez (2006b) for a discussion of the sequencing of decentralization
reforms.
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This chapter reviews the most important current issues surrounding the
assignment of expenditure responsibilities in China.3 In order to put those issues in
the proper perspective, an overview is provided of the general principles of
expenditure assignments and the common problems encountered in the international
experience. The chapter also provides a road map and practical recommendations for
the reform of expenditure assignments in China.
Principles of Expenditure Assignments in Theory and Practice
The Role of the Public Sector in the Economy
Before the question of expenditure assignment is addressed, it is necessary to define
clearly the roles of the private and public sectors in the economy. Many countries,
especially transitional countries, have undergone massive privatization of state and
local enterprises involved in what can basically be considered private-sector economic
activities. While there has been privatization in China in some cases, it has yet to
begin in earnest in other areas of the economy. Thus, a first step to expenditure
assignment reform in China is to define the responsibilities of the public sector and
ascertain what activities can be privatized. In theory, the role of the public sector
should be limited to those services and activities that private markets will not supply
efficiently—either because of the difficulty of charging a price or because of
joint-consumption benefits—and those with desirable redistributional value.
3
See Bahl and Martinez-Vazquez (2006a) for a wider perspective of decentralization reform in China.
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Expenditure Assignments in China
3
The Primacy of Expenditure Assignment in Intergovernmental Fiscal Relations
Design
Most experts in decentralization policy agree that the first fundamental step in the
design of a system of intergovernmental fiscal relations should be a clear assignment
of functional responsibilities among different levels of government. The international
experience shows that instability, controversy, and, ultimately, inefficiency in public
service delivery can follow when the decentralization laws are silent or unclear about
the competencies and expenditure obligations of different levels of government.
Designing the other important pieces of a system of decentralized finances,
including revenue assignments and transfers, in the absence of a clear expenditure
assignment is to put the cart before the horse. Decentralization initiatives in Latin
American countries (e.g., Colombia, Ecuador, Bolivia, and Nicaragua) over the past
several decades have made this type of mistake. Revenues were assigned to
subnational governments and transfers put in place before it was decided what
functional competencies would be transferred from the central government to
subnational governments. This led to weak decentralized systems and fiscally
overburdened central governments in those countries for years to come.
General Principles of Expenditure Assignments
The theory of public finance suggests some fundamental rules for the assignment
of expenditure responsibilities in a decentralized system. However, these rules do not
provide an absolute best way for deciding which level of government should be
responsible for particular public services. Together with the rules or best principles,
3
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the adequacy of any functional assignment has to be judged in terms of how well it
achieves the goals or objectives set up by the government in its decentralization
strategy.
The critical role of the efficiency criterion. The efficient provision of government
services requires that government satisfy the needs and preferences of taxpayers as
well as possible. In plainer words, government expenditure that does not address the
needs and preferences of citizens is partially or absolutely wasted. The approximation
of needs and preferences is best achieved via the ―subsidiarity‖ principle. 4 What this
principle says is that the responsibility for the provision of services should be at the
lowest level of government compatible with the size of the ―benefit area‖ associated
with those services. The benefit area for sanitation services is clearly the local
community, but for air traffic control the benefit area may be the entire national
territory. The provision of services with smaller benefit areas by smaller governments
makes it more likely that there will be a good match between the services provided
and the local residents’ preferences. However, leaving the supply of public services
with wider benefit areas to smaller units of government is likely to result in the
inefficient underprovision of services in the case of economies of scale in the
production of services or in the presence of jurisdictional externalities (e.g., a tertiary
hospital solely financed by a single municipality but providing regional services).
Further efficiency in the provision of public services can be achieved when service
4
The principle is widely accepted by fiscal decentralization experts and has also been adopted as a
practical guide. For example, the European Charter of Local Self-Government formally adopts the
subsidiarity principle as the most prominent guide for expenditure assignments.
4
Expenditure Assignments in China
5
provision is linked to the costs of service provision via fees, service charges, or local
taxes; the fundamental reason for this is that these ―pricing‖ mechanisms help reveal
taxpayers’ residences to local officials.
The objectives of redistribution and stability in public service provision. It is
generally agreed that expenditures undertaken by government for equity or income
equalization reasons, such as social welfare programs, should be the domain of the
central government, or at least should be financed by the central government. It is
thought that local or regional governments would have difficulties sustaining
independent programs of this nature because they risk attracting the needy from other
areas and would thus have to tax their (potentially mobile) residents more heavily.
But, while funding for such programs should be a central government responsibility,
implementation can, in many cases, be left to local governments, which may have
informational and other comparative advantages in delivering the service.
Expenditures undertaken for the stabilization of the economy, such as massive
investment or unemployment compensation, are generally ascribed to the central
government because of their scale; subnational governments may be too small to be
effective, and their efforts may be quickly diluted within the rest of the national
economy (Martinez-Vazquez and McNab 2003).
But no matter how the general principles above are implemented, the conclusion
needs to be that there is no single best assignment. What is considered the best
assignment is likely to change over time with changes in costs and technological
constraints, as well as in citizens’ preferences. However, decentralized systems of
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finance work much more smoothly when at any given moment there is a concrete,
clear, and stable assignment of expenditure responsibilities.
Expenditure Assignments in the International Experience
Not surprisingly, the assignment of expenditure responsibilities among different levels
of government varies widely in the international experience. This variety reflects
different approaches to decentralization, as in federal and more decentralized
countries, and unitary and more centralized countries, and differences in policy
objectives. It may also reflect problematic choices of assignments in some cases.
Often, expenditure assignments broadly agree with generally accepted principles.
For example, there is a general correspondence between the geographical dimension
of benefits from a particular service and the level of government responsible for
provision of that service. By and large, the functions allocated to the central
government have a national dimension. These include defense and internal security,
the justice system, foreign relations, and research. Some expenditures with
macroeconomic
and
redistributional
implications,
such
as
pensions
and
unemployment compensation, are often the responsibility of the central government,
as well, and those expenditures are financed by extrabudgetary funds (Wong 1997;
Bahl 2000; Bahl and Martinez-Vazquez 2006a). Correspondingly, most of the
expenditure responsibilities of subnational governments involve services with
regional or local benefit areas, such as tertiary hospitals, primary education, fire
protection, and sanitation. Appearances can be misleading, however, and a number of
countries have several important problems in their expenditure assignments.
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Expenditure Assignments in China
7
Common Problems with Expenditure Assignments
The international experience with expenditure assignments also provides some
valuable lessons in what to avoid, including the following:
Lack of formal assignment. A common problem found in the international
experience, especially in the case of transitional countries during the 1990s, is
the lack of a formal assignment of responsibilities. Although it is true that
highly decentralized countries, such as the United States, lack a formal
assignment of expenditure responsibilities in the law, such countries have a de
facto assignment that has been achieved through many trials and tribulations
over a long period of time—in some cases, centuries. Countries that are newly
decentralizing are better served by adopting explicit assignments of
responsibilities. The preferred vehicle for the assignment of expenditure
responsibilities is the decentralization law or budget code. Some countries list
expenditure responsibilities in their constitutions. Although it may be wise to
put into the constitution some general principles for expenditure assignments
(for example, a general respect for the subsidiarity principle), detailed
expenditure assignments enshrined in a constitution prove difficult to change.
Inefficient assignments. A second common problem in the assignment of
expenditure responsibilities is wrong or inefficient assignments. This is the
case, for example, in the assignment of expenditure responsibilities for social
protection and welfare exclusively to local governments. Other examples
include the assignment of responsibilities for national defense locally or of
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local fire protection services or water and sewerage services nationally. A
more common mistake is the assignment of all capital expenditure
responsibilities to the central level, regardless of the level of government
responsible for provision of the services associated with the capital
infrastructure. Such a decision is typically guided either by assumptions about
the central government’s capacity to finance large projects or by the belief
that only central government officials are qualified to make capital investment
decisions. Dichotomizing the responsibilities for building (by the central
government) and maintenance and operations (at the subnational level) can
introduce ―moral hazard‖ problems leading to a lack of proper maintenance of
capital infrastructure.
Wide cosharing of responsibilities. The cosharing of responsibilities within a
particular public service is likely to cause confusion leading to inefficiencies.
In an ideal world, all inputs for the delivery of a particular service would be
simultaneously decided by a single authority. Fragmentation of duties within a
service is more likely to cause, for example, a relative disproportion of funds
to be spent on salaries and much less on operations; similarly, maintenance
may be reduced to a minimum. On the other hand, the cosharing of
responsibilities for a single service may be necessary given national political
objectives. For example, subnational governments may be responsible for
primary and secondary education, but curricula and textbook production may
be carried out by the national government. The cosharing of responsibilities
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Expenditure Assignments in China
9
becomes less of a problem when particular attributes and tasks (e.g., for
financing, regulation, and implementation) in a common service are clearly
assigned to different levels of government. Problems arise when the
assignment of these attributes is unclear—for example, when two different
levels of government are responsible for financing and regulation for the same
basic service.
Challenges with Expenditure Assignments in China
China is a large and diverse country with no single decentralization law and
seemingly without an explicit decentralization strategy. 5 The current model of
expenditure assignments is roughly based on the role of designing catchment areas for
services. China’s current decentralization system provides subnational governments
with considerable expenditure autonomy (World Bank 2002), but the system may not
necessarily be providing the most desirable mix of public goods and services at the
local level.
The elements of the current system of expenditure assignment in China that
present problems include (1) the mismatch between expenditure responsibilities and
revenue sources at the lowest levels of government (counties and townships), where
many important social services are concentrated; (2) a general lack of clarity of
expenditure assignments aggravated by the lack of formal assignments; (3) several
wrongly assigned responsibilities, such as pensions and unemployment insurance, at
the lowest level; and (4) the lack of horizontal accountability mechanisms, with
5
This section draws on Martinez-Vazquez (2006).
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possibly important undesirable consequences, including the underprovision of basic
public services.
How the System Got Here
The current system of intergovernmental fiscal relations in China is the result of
successive fiscal reforms starting at the beginning of the 1980s. Before that time,
China had been under a central planning system since 1949, when the People’s
Republic of China was created. The recent reforms—of the fiscal responsibility
system, starting at the beginning of the 1980s; the fiscal contracting system, starting
in 1988 (Bahl and Christine Wallich 1992); and the tax sharing system, starting in
1994—have the striking feature of putting almost exclusive emphasis on improving
revenue assignments and transfers and practically ignoring the question of
expenditure assignments.6
This means that the assignment of expenditure responsibilities remained virtually
unchanged until some of the more recent reforms described below. To a large extent,
expenditure assignments in many areas are still a legacy of the Maoist economy, in
which the division of responsibilities was unimportant, as every unit strove to be
self-reliant. For example, to a large extent the current responsibility for providing
social services at the lowest government levels is a legacy of the system of collective
agriculture, under which the communes and brigades of the People’s Republic
financed education, health, and social welfare.
6
See Martinez-Vazquez (2006) for a discussion of the reform stages.
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Expenditure Assignments in China
11
Current Expenditure Assignments
As we have mentioned, expenditure responsibilities in China are highly decentralized.
The budget law confers substantial autonomy and quite broad expenditure
responsibilities on each level of subnational government. However, expenditure
assignments are far from being transparent and clear, mostly because of the lack of
formal assignments and the extensive concurrent expenditure responsibilities among
different levels of government. This conspicuous presence of concurrent
responsibilities can be traced back to the planned economy era. At that time, it was
not considered necessary to separate the responsibilities of different spheres of
government as providers of public services (local governments acted as agents of the
central government, carrying out assigned tasks only), nor was it considered necessary
to separate the expenditure responsibilities of governments from those of state-owned
enterprises (SOEs). The latter fact was due to the cohesive functions of the
government in both the public and private sectors; in fact, government before the
mid-1980s jointly determined fiscal expenditures and the expenses of the SOEs.
As defined by the current legislation, the division of the main expenditure
responsibilities among the central and provincial governments is summarized in figure
2.1.
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Figure 2.1
The Assignment of Expenditure Responsibilities between the Central and
Sub-national Governments
Main expenditure responsibilities of the central government
Defense
Foreign affairs
Operation of the central government
Operational expenses for cultural, educational, scientific and public health
undertakings at the central level
Key capital construction
Technical renovation and new product development in centrally owned enterprises
Agriculture
Subsidies
Macro-economic control and regional coordination of economic development
Social security
Debt
Main expenditure responsibilities of Sub-national governments
Operation of sub-national governments
Operational expenses on cultural, educational, scientific and public health
undertakings at the sub-national level
Sub-national capital construction
Fund for technical renovation and new product development in locally owned
Enterprises
Agriculture
Urban maintenance and construction
Social security
Subsidies
Source: Zhang and Martinez-Vazquez (2003).
In practice the main characteristics of the current assignment of expenditure
responsibilities can be summarized as follows:
A blurred distinction between the public and private sectors. During the
process of transition from the planned economy to the market economy,
government gradually relied more heavily on market mechanisms and gave
up direct intervention in the private sector. However, government’s
expenditure responsibilities are still very wide. Currently, a significant
number of enterprises are still owned by (or belong to) governments at
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Expenditure Assignments in China
13
different levels, and there is still a variety of channels through which
governments can directly or indirectly encroach into private-sector activities
through their SOEs (Qiao and Shah 2006). The low level of development of
the legal framework that regulates the behavior of governments and
government officials has led to high levels of administrative discretion. Thus,
China is still in the process of clearly differentiating between private- and
public-sector activities and aligning the responsibilities of the government
sector to fit the development of the market economy.
Extensive use of concurrent responsibilities and highly decentralized
responsibilities for basic public services. There has been no apparent change
in policy or practice in expenditure assignment between the central
government and local governments and among subprovincial governments
since the initiation of the market-oriented reforms. Most recently, the 1994
tax-sharing system reform restated the pre-reform expenditure assignments. It
is particularly important that the expenditure assignment for subprovincial
governments is still entirely left to the discretion of the provincial
government. To improve the expenditure assignments at the subprovincial
government level, the central government’s Ministry of Finance (MOF)
issued ―Suggestions on Improving Subprovincial Fiscal Relations‖ in
December 2002, with the objective of providing further guidelines on
subprovincial expenditure assignment, but these fall short of an explicit
expenditure assignment.
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Concurrent responsibilities between the central and subnational levels of
government are still the norm, and usually these are ad hoc. Exclusive responsibilities
at the central and subnational levels are few. The central government tends to be
exclusively responsible for national defense issues, and local governments exclusively
provide services on urban maintenance and construction. Other public services show
concurrent or coshared responsibilities. The relative shares of expenditures for
different levels of government in 2003 are listed in table 2.1.
Although there has been a slight trend toward centralization in recent years, the
provision of basic public services is still mainly the responsibility of subprovincial
governments, particularly county-level governments. The three most important
categories of social services are basic education, health, and social welfare.
Table 2.1
Relative Shares of Expenditure at Different Government Levels, 2003
(in percents)
Expenditures
County
Central Provincial Prefecture and
under
30
18
22
30
44
23
22
11
12
46
11
30
8
15
18
60
63
23
9
5
3
22
32
43
11
39
32
18
19
11
22
48
Total
Capital investment
Agriculture expenditure
Education
Scientific research
Health care
Social security
Government administration
Public security & procuratorial
5
25
34
agencies, court of justice
National defense
99
1
0
Foreign affairs
87
13
0
Foreign aid
100
0
0
Other
29
16
25
Source: National Bureau of Statistics of China; Ministry of Finance.
14
35
0
0
0
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Expenditure Assignments in China
15
Education services are divided into basic education, higher education, and
vocational training. 7 Most vocational education is now left to private market
institutions. County-level governments, which include cities and urban districts, are
mostly responsible for basic education services. The role of the central government is
that of policy maker and overall planner. In addition, the central government has
responsibility for teachers’ training and for setting up special education funds for
subsidizing basic education in poor and minority areas. Provincial governments have
the overall responsibility for formulating the development plan for basic education in
their territories and providing assistance to counties to help them meet recurrent
expenditures in education. The responsibility for actually implementing compulsory
education programs, including the financing of basic education, lies with the cities, or
districts of large cities, in urban areas and with counties in rural areas.
The provision of basic education services in rural areas is one of the major
current concerns for the central government because of the generally worse service
conditions there. Some new initiatives, especially ―The Decision on Further
Strengthening Rural Education,‖ issued by the State Council in September 2003, have
expanded the expenditure responsibilities of the central government for basic
education. With that initiative, the implementation of compulsory education became a
central government shared responsibility. The central government’s goal was to
support students from poor families by waiving their textbook, tuition, and
miscellaneous fees and by subsidizing housing expenditures for elementary and
7
See ―Implementation Suggestions of the State Council on the Guidelines for the Reform and
Development of Education in China,‖ issued in July 1994.
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secondary education students. The central government, as well as provincial
governments, started setting up special funds for the support of this program in 2003.
All students who meet the requirements of the poverty standard are supposed to have
been enjoying the listed benefits since 2006.
The assignment of expenditure responsibilities for higher education differs from
that for basic education. In general, private institutions of higher education in China
are few, and they account for a very small portion of these services; private
institutions tend to concentrate on vocational training. Public higher education
institutions are divided into two groups: one belongs to the central government, and
the other belongs to subnational governments. Thus, expenditure responsibilities for
higher education are shared between the central government and the provincial
governments. The central government has responsibility for the national development
of higher education and provides direct support to the higher education organizations
that belong to the central government. The provincial governments have responsibility
for the provincial development of higher education and support the higher education
institutions that belong to the provincial governments.
Health care services are mostly the responsibility of the county level of
government and below. The central government has continued to announce its
commitment to public health care,8 but in practice its responsibility for health care has
been minimal for years. The huge rural-urban divide that exists in many aspects of
8
For example, ―The Decision on Public Health Reform and Development by the Central Government,‖
issued in January 1997, requires that public spending on health care at both the central government and
subnational government levels increase at a higher rate of growth than general budgetary expenditures.
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Expenditure Assignments in China
17
daily life in China—in particular, in access to public services—takes on special
meaning in the area of health services. For this reason, coverage of rural health care
has recently become one of the stated major concerns of the central government. ―The
Decision of the Central Committee of the Communist Party of China and the State
Council to Further Strengthen Rural Health Care,‖ issued by the central government
in October 2002, provided detailed responsibilities for the provision of rural health
care services among different levels of government. The central government now has
the responsibility for designing the overall plan for rural public health care, the
provincial governments have responsibility for its implementation, and the county
governments have overall responsibility for rural public health care delivery. In
addition, the central government is responsible for subsidizing programs for the
prevention and control of highly infectious diseases, endemic diseases, occupational
diseases, and so on in poorer areas; provincial governments are responsible for
subsidizing health programs of county (city) governments and for paying the costs of
planned vaccinations; and county governments are responsible for the delivery of all
rural public health services.
One of the newest initiatives in health services is the rebuilding of the rural
collaborative health care system, which began in January 2003. This program
expanded the responsibilities of both the central government and provincial
governments regarding health care. It established, among other measures, that from
2003 on, in addition to the contribution of RMB 10 per resident every year, the central
government should pay RMB 20 and provincial governments no less than RMB 20 a
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year for each rural resident who joins the rural collaborative health care system. The
provincial governments were given discretion to arrange the sharing of their
contribution among the different subnational government levels in their jurisdictions.
Social security remains mainly the responsibility of subnational governments.
The main component of current social security expenditure is the minimum living
standard paid to urban dwellers. Thus, the expenditure responsibilities in this area are
more concentrated at the provincial and prefecture levels, and less responsibility is
placed at the county level of government and below, the vast majority of whose
population are rural residents, who have much less coverage under the social security
system.
Operation-oriented local expenditure structure. Subprovincial governments have
always given priority to current administrative needs over other spending needs.
Currently, the expenditure pattern in some areas, particularly in poorer areas, is still
regarded as ―feeding finance‖ (chi fan cai zhen) or just meeting government
administration costs. The structure of the components in total government
expenditures at different levels are shown in table 2.2. Typically, subnational
governments give priority to administration spending, local public security agencies,
procuratorial agencies, and courts of justice in their expenditure decisions. By design,
most government personnel are concentrated at lower levels of government; in many
cases these local governments have been acting as employers of last resort. This has
led to the growth of local expenditures on employees.
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Expenditure Assignments in China
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Table 2.2
Composition of Budget Expenditure at Different Government Levels, 2003
(in percents)
Expenditures
Central Provincial Prefecture County and
Under
Total
100.0 100.0
100.0
100.0
Capital investment
20.5
17.4
14.1
5.0
Agriculture expenditure
1.8
11.6
2.4
4.7
Education
3.2
9.4
9.7
23.8
Scientific research
2.6
1.5
0.5
0.2
Health care
0.3
3.8
4.7
4.5
Social security
1.9
10.9
7.5
3.0
Government administration
5.4
4.7
8.5
13.4
Public security & procuratorial
1.0
7.3
8.4
6.1
agencies, court of justice
National defense
25.4
0.5
0.0
0.0
Foreign affairs
0.9
0.2
0.0
0.0
Foreign aid
0.7
0.0
0.0
0.0
Other
36.2
32.6
44.1
39.3
Source: National Bureau of Statistics of China; Ministry of Finance.
Basic public services do not represent a significant share of local expenditures. In
particular, in the total expenditures of county-level governments, which are the main
providers of basic public services, the sum of education, health care, and social
security counts for approximately 30 percent, as shown in table 2.2. In subnational
government aggregate expenditures, the same services count for around 25 percent on
average, while in some provinces it counts for less than 17 percent (table 2.3).
On the other hand, it appears that in provinces where the services are more
decentralized, service delivery outcomes are improved. For example, in provinces
where the provincial government remains the main spending authority, infant
mortality rates are higher than in provinces where counties have the main spending
authority (Uchimura and Jütting 2007).
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Table 2.3
Aggregate Expenditure Composition at the Subnational Level, 2005
Expenditures
Max. Min. Avg.
Capital construction
30.41 4.81 11.60
Agriculture
4.76 1.49 3.57
Education
18.80 10.99 14.72
Public health
6.20 2.80 4.08
Subsidies for social security programs
16.62 1.72 6.86
Government administration
15.07 4.19 9.75
Public security & procuratorial agencies, court 10.11 4.42 6.58
of justice
City maintenance
11.77 0.23 4.50
Underdeveloped areas
2.57 0.00 1.05
Source: National Bureau of Statistics of China; Ministry of Finance.
C.V.
0.49
0.22
0.15
0.21
0.55
0.22
0.20
0.52
0.75
Hierarchical expenditure managing model. Nowadays each subnational
government has its own budget, but practically speaking, the budget of each
government includes both its own budget and the consolidated budget of all the
governments under it; of course, for the lowest government, the township
government, its own budget is equivalent to a consolidated budget. The government
budget at each level is approved by the People's Congress at that level, which also
checks the consolidated budget. The approved budget of each subnational government
is submitted to the next level of government, and so on up to the MOF, for the record
and for the compilation of the upper-level government’s consolidated budget and
eventually the national consolidated budget. The national budgets are the last to be
approved. The main issue with this approach is that local residents’ input into the
shape and content of local expenditure budgets is limited. Instead, local expenditure
management is conducted mostly through the bureaucratic hierarchy.
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Expenditure Assignments in China
21
Significant administrative autonomy for local expenditure decisions. Currently,
subnational government officials still practice ―administrative autonomy‖ to increase
their effective autonomy and go beyond the confines and constraints imposed by the
local budget and related regulations. In general, the management of funds is through a
―distributive model,‖ whereby various government agencies and divisions of the
finance department make their own expenditure decisions, and some expenditures
may not be included in the budget. One manifestation of the administrative autonomy
at the subnational level is the prevalence of extrabudgetary funds. It is important to
note that a significant portion of subnational government expenditures do not go
through the regular budget channels. Fundamentally, extrabudgetary expenditures do
not differ that much from ordinary budgetary expenditures. As shown in table 2.4, the
largest share of the officially recorded extrabudgetary funds is spent on government
administration (72 percent for 2004). Other uses of extrabudgetary funds overlap
considerably with those of ordinary budget items.
Table 2.4
Most Important Extrabudgetary Expenditures, 2004
Item
Capital construction
Public administration
City maintenance
Township expense
Other
Percent of Total
6.6
72.0
4.5
4.7
12.2
Source: National Bureau of Statistics of China 2006.
As the central government has taken various measures to transform its
extrabudgetary expenditures into budgetary expenditures (Wong 1998; 2000),
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extrabudgetary funds at the central government level have decreased dramatically
(Qiao and Shah 2006). In contrast, extrabudgetary expenditures still play a very
important role at the subnational level, despite the central government’s long effort to
reduce their use and importance and transform extrabudgetary funds into ordinary
budgetary funds. As a matter of fact, the ratio of extrabudgetary to budgetary
expenditures for subnational governments was still around 20 percent in 2004.
The use of revenues from the sale of land in off-budget funds is another
manifestation of administrative autonomy. In addition, soft-budget constraints are still
a problem in China’s system. One manifestation of a soft-budget constraint is in the
dealings between SOEs and government. Some SOEs are generally not very
competitive and rely heavily on government to survive; however, they also help the
interests of local governments.9
In recent years the central government has taken steps to improve expenditure
management processes, including the creation of budgeting departments, according to
which each government agency and public service unit has a single budget that
combines all budgetary and extrabudgetary funds; the introduction of a treasury
system and the centralization of payment administration, by which all expenditure
funds for each government are controlled in a single account of the central bank; and
the standardization of governmental procurement practices.
Main Issues with Expenditure Assignments
9
According to China’s 1994 budget law, subnational governments are forbidden from borrowing on
the capital market except with special approval from the central government; however, they can
effectively borrow through SOEs.
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Expenditure Assignments in China
23
Little has been done to reform policy and clarify expenditure assignments over the
past several decades. This is especially true at the subprovincial level. The main
challenges facing the current system in expenditure assignments include the
following:
A mismatch of expenditure responsibilities and revenue sources at the lowest
levels of administration. Local governments (especially county and township
levels) have very heavy expenditure responsibilities in education, health, and
social insurance that are out of line with international practice. While the
tax-sharing system reform has recentralized revenue assignments, there has
been considerable devolution of expenditure responsibilities to local
governments. More important, the vertical imbalances caused by revenue
centralization and expenditure decentralization have not been adequately
offset by intergovernmental transfers (Jia 2004).
Significant regional disparities in fiscal performance. The current system of
decentralized finance in China yields significant horizontal fiscal disparities
(Qiao, Martinez-Vazquez, and Xu 2008). These disparities occur across
provinces but also within provinces, especially between urban and rural areas,
and there is evidence that they are expanding. The expanding disparities in
expenditure per capita and in service delivery are likely to be harmful for
cohesion of the country. The increasing trend in expenditure disparities, which
was temporarily stopped for several years starting in 1998 as several
intergovernmental transfer programs were newly introduced by the central
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International Studies Program Working Paper Series
government,
has
continued
since
2000.
Since
2003,
reforms
in
intergovernmental transfers to improve rural basic public services have
slightly decreased the disparity. (See table 2.5.) In 2005, public expenditures
per capita in the best-off province were 7.9 times larger than those for the
worst-off province, and the coefficient of variation across provinces was 0.73.
These disparities are very large by international standards.
Table 2. 5
Per Capita Expenditure Disparities Across Provinces, 1990–2005 (in RMB)
Year
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Max.
613
664
729
958
1,452
1,837
2,348
2,806
3,211
3,620
3,635
4,387
5,307
6,361
7,936
9,259
Min.
99
102
112
122
157
226
278
308
347
409
225
532
655
741
905
1,165
Avg.
251
280
296
372
444
538
632
698
811
943
1,075
1,383
1,620
1,792
2,082
2,538
C.V.
0.57
0.56
0.56
0.57
0.69
0.71
0.72
0.77
0.76
0.76
0.70
0.73
0.75
0.77
0.75
0.73
Source: National Bureau of Statistics of China for the years cited.
C.V.: coefficient of variation
Serious underprovision of basic public services in poor jurisdictions. For
county governments that have only limited revenues, the ability to spend on
local public goods depends heavily on intergovernmental transfers (Uchimura
and Jütting 2007). But without adequate resources at the lower levels of
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Expenditure Assignments in China
25
government, the current levels of intergovernmental transfers and the budget
priority decisions taken by the local governments have led in many cases to
the underprovision of basic public services (Martinez-Vazquez, Qiao, and
Zhang 2008). China’s system of intergovernmental finance is far from
achieving the goal of providing all citizens with similar access to basic public
services. While the average per capita educational expenditure is RMB 352,
the poorest jurisdiction spends only RMB 171, less than half of the national
average and less than one-sixth of what the richest jurisdiction spends. The
underprovision in some areas of public health services and social security are
even more significant. The poorest jurisdiction spends RMB 39 per capita on
health care, which represents 37 percent of the average and only 9 percent of
what is spent by the richest jurisdiction. In the case of social security
programs, the lowest jurisdiction spends RMB 29 per capita on subsidies for
social security programs, which represents 19 percent of the average and 7
percent of what is spent by the richest jurisdiction (table 2.6).
Lack of horizontal accountability mechanisms. An important question is
whether local governments are prioritizing local budget expenditures
according to the needs and preferences of their residents (Oates 1972; 2005).
The generally low horizontal accountability of local government officials to
their residents has likely exacerbated problems with the delivery of services.
Accountability of government officials to residents has been further reduced
because an increasing number of people have migrated internally without the
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International Studies Program Working Paper Series
official documents and are ―illegally‖ residing in urban areas, especially in the
eastern provinces, without a right to access basic services. But even in the
poorer areas, the limited fiscal resources have not prevented local
governments from expanding into areas with heavy overhead expenditures that
in many other countries are left to the private sector. In China there continues
to be no clear delineation for government responsibilities between the public
and private sectors.
Table 2.6
Subnational Expenditures per Capita, 2005 (in RMB)
Expenditures
Total
Max.
Min. Avg. C.V.
9,259 1,16 2,538 0.73
5
Capital construction
2,077 76
358 1.35
Agriculture
216 38
82 0.49
Education
1,029 171
352 0.59
Public health
427 39
105 0.80
Social security programs
405 29
156 0.69
Government administration
1,009 118
231 0.71
Public security & procuratorial agencies, court
549 70
162 0.70
of justice
City maintenance
499 16
117 1.03
Underdeveloped areas
152
0
24 1.26
Source: National Bureau of Statistics of China; Ministry of Finance.
C.V.: Coefficient of variation.
The undesired consequences of lacking a clear assignment of responsibilities.
The lack of explicit expenditure assignments at the subprovincial level has led
to considerable overlapping of responsibilities and eventually lower
accountability because of the difficulty of identifying what level of
government should be accountable for the delivery of particular services.
Inefficient underprovision of services is more likely in the presence of
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Expenditure Assignments in China
27
extensive concurrent responsibilities. The lack of explicit assignments has also
meant considerable murkiness as to which level is responsible for financing
expenditures and how the financing responsibilities are divided. This has
facilitated the convenient offloading of responsibilities down the hierarchical
structure of government. In education, for example, despite the fact that in
many cases resources are inadequate, counties have been called on in recent
years to finance basic education reform. Some of these upper-level
government measures can be considered as unfunded government mandates.
The lack of explicit assignments has also led to significant differences in the
distribution of responsibilities among local governments across provinces.
Although in theory there is nothing wrong with variety in approaches to
expenditure assignments, the absence of a holistic approach to expenditure
(and revenue) assignments means that matching revenue sources with
expenditure functions at each local level is made more difficult, as is targeting
pass-through transfers from the central government to lower-level local
governments. The absence of a unified approach to expenditure assignments
also makes the tasks of setting standards for the provision of public services
and monitoring performance harder, and it can be expected to contribute to
wide variation in the standards of services.
Several inefficient expenditure assignments. Several of the current expenditure
assignments are problematic. The most conspicuous example is the
responsibility assigned to city- or county-level governments for pensions,
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unemployment, and income support schemes. Such assignments are hardly
replicated anywhere else in the world;
general pension schemes,
unemployment insurance, and other social security measures tend to be central
government responsibilities. Either provincial or national pooling would seem
to be the correct approach to the assignment of these services. These types of
social security schemes require a level of risk pooling and redistribution that
cannot be matched at the level of county governments.10 Whereas welfare
benefits are almost nonexistent in rural areas, in urban areas there is often a
lack of redistribution because poorer communities with the highest needs are
least financially able to fund these expenditures. The inability of many local
governments to finance the social safety net has led in recent years to
widespread pension arrears and defaults that have forced the central
government to intervene with subsidies.
A Roadmap for Reform
Setting up formal and stable expenditure assignments to clarify the responsibilities of
all government levels must become a priority for reform. A clear and explicit
assignment of expenditure responsibilities at all levels could (1) facilitate a more
efficient organization and provision of basic public services; (2) significantly improve
the accountability of public officials to residents; (3) help eliminate government
encroachment in the private sector; and (4) help address the issues of vertical and
horizontal fiscal disparities.
10 <FNTX>See, for example, Ahmad (1995) and the references therein.
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Expenditure Assignments in China
29
In the past two decades, China has made considerable progress in separating
government from SOEs and redefining the functions and responsibilities of
government in the economy. But there are still significant problems from an
expenditure assignment perspective (Martinez-Vazquez 1998). In particular, a stable
and transparent expenditure assignment at all levels of government, emphasizing
exclusive over concurrent responsibilities, is desirable.11
The other option is to continue with the current system and muddle through until
an acceptable system presents itself through piecemeal reforms. Practice can
substitute for explicit assignments in the law, but relatively younger decentralized
countries like China may avoid costly transactions through more explicit and clear
assignments. When concurrent responsibilities are desirable, assignments should be
clarified by explicitly assigning the multidimensional array of attributes that go with
each function, including (1) actually producing a good or delivering a service; (2)
providing or administering the service; (3) financing the service; and (4) setting
standards, regulations, and policies for the provision of services. In addition to
clarifying assignments, it will be important to improve coordinating institutions across
levels of government to address different interpretations and conflicts arising from
concurrent assignments.12
But the question is how to proceed with comprehensive reform in expenditure
11
For example, in many decentralized large countries, including Australia, Brazil, Canada, the Russian
Federation, and the United States, a number of responsibilities are exclusively assigned to local
governments.
12
For example, Australia, Canada, and New Zealand use periodic formal meetings of elected officials
and bureaucrats at different levels to discuss mutually important expenditure assignments and other
fiscal issues.
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assignments. The rest of this chapter provides practical guidelines that can be
followed in this reform process. Among the most important steps to accomplish
reform is the appointment of a high-level intergovernmental reform commission
charged first with mapping out the current de facto expenditure assignments and
providing a blueprint for reform options. Further below, we list the steps for
comprehensive reform. However, first, because comprehensive reform can be
politically difficult, some worthwhile reforms that can be made piecemeal follow:
Reassign selected expenditure responsibilities. The financing and provision of
social security services (pensions, disability and survivor benefits, and
unemployment) should be recentralized, at the provincial or central
government level. The recent policy measures assigning more responsibility
for social security at the central level are steps in the right direction.
Address the existing large fiscal disparities and align the decentralized fiscal
system more properly to ensure that all citizens have access to basic public
services regardless of where they happen to live. Addressing the existing fiscal
disparities will require, at a minimum, significantly enhancing the role of
equalization grants in the current intergovernmental system. This will require
at the center an increase in the pool of funds dedicated to equalization, the
consolidation of many existing small transfers with equalization objectives,
and a distribution formula that takes into account fiscal capacities and
expenditure needs. At the subcentral level, clear guidelines for the provinces,
prefectures, and counties (if applicable) would need to be legislated to
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Expenditure Assignments in China
31
introduce (1) sufficient funding for equalization grants for the governments
immediately below; and (2) distribution formulas that capture, to the extent the
data allow, the differences in fiscal opportunity and expenditure needs of
subordinate local governments. A small set of conditional sectoral grants
could also be considered in order to guarantee some minimum standards of
service throughout the national territory. In this regard it may be worth
considering the use of national minimum standards for basic public services
and the use of conditional grants to ensure that all subnational governments
have the means to finance them.
Improve the accountability and quality of local expenditure management. A
significant feature of China’s decentralization system bearing on the issue of
efficiency is that the accountability of subnational government officials to
local residents is weak; the direct appointment of officials tends to make them
mostly accountable to the upper and central government authorities. The
system needs to introduce adequate accountability mechanisms to provide
incentives to subnational governments to properly weigh spending on
economic development and construction and other public services, especially
those in the social areas. Besides local elections, different approaches are used
internationally to better empower communities. For example, local governance
in some countries is reinforced by institutions that facilitate the involvement of
civil society in the delivery of public services.13 For example, in the education
13
For example, in Canada, Local Boards are not-for-profit, community-based organizations composed
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International Studies Program Working Paper Series
sector, there is now evidence that community-managed schools can lower
teacher absenteeism and improve schooling outcomes.
Important Preliminary Questions
What should be the scope of the reform in expenditure assignments and
privatization? A benefit of extending the scope of the reform to all activities
within the fiscal system is that we can identify activities at the central and
subnational levels that do not serve a public function and that by their nature
can be better provided in the private sector. The reform of expenditure
assignments provides an excellent opportunity for the privatization of
activities that do not belong in the public sector.
Should
assignments
be
distinguished
as
“delegated”
or
“own”
responsibilities? In determining expenditure assignments we may want to
make a distinction between voluntary (or ―own‖) responsibilities and
mandatory (or ―delegated‖) functions of subnational governments. A decision
needs to be made as to whether it is desirable to differentiate between what
subnational governments can do and what they must do. However, doing this
is not a requirement for a clear assignment of expenditure responsibilities.
Delegated responsibilities are typically paid via conditional or tied grants.
How far should “exclusive” (as opposed to “concurrent”) assignments be
taken? Exclusive responsibility is more conducive to accountability and
generally a more efficient provision of services; however, in practice,
of volunteers from business, labor, education, and community groups that support local governments in
a variety of ways. Similar institutions exist in the United States.
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Expenditure Assignments in China
33
exclusive responsibilities are not always possible, and they may not be
desirable in some cases.
Which general approach—“general competence” or “closed list”—should be
used for expenditure responsibilities? Here the choice is between a ―general
competence‖ approach followed by some exclusions or exceptions and a
―closed list‖ of competences. A closed-list approach is more cumbersome, but
it can offer more protection to subnational governments from encroachment by
central or upper-level governments. Typically, the question boils down to what
level of government may have ―residual powers,‖ in case a particular (new)
function does not appear in the law in the closed list of any one level of
government.
What legal instrument should be employed to specify expenditure
assignments? Because an assignment should be stable over time, especially
given the time needed for strategic planning and capacity building, it should
be in the law—for example, in the decentralization law or the budget code. It
is less preferable to introduce expenditure assignments in the constitution.
How much needs to be specified in the law, and how much can be left to
coordination or even interpretation by the courts? No expenditure assignment
can ever be detailed enough to preempt the need for dialogue and coordination
among different levels of government, but there is the matter of the level of
specificity in the law. That is, how much should we rely on the legal text and
implementation rules vis-à-vis a more general text that will be subject to
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interpretation as we go, by practice and coordinating institutions, and
ultimately be left for interpretation and rulings by the courts of law?
Should expenditure assignments be determined at all levels or just between the
central and the “aggregated” subnational level? When there is a single tier of
government below the central government, the assignment of functions must
cover all government levels. However, when there are two or more tiers of
government at the subnational level, there are several choices of approach. An
explicit assignment at all levels is more transparent and efficient but, of
course, less flexible in adapting to specific characteristics of subnational units.
Deciding between uniform versus asymmetric responsibilities? Some local
jurisdictions may be too small to realize economies of scale in the delivery of
public services; they may lack adequate fiscal capacity and tax base and also
lack administrative and managerial capacity. Although there are some ways to
get around the small scale, such as privatization of services, the creation of
special districts, or associations of local governments, the most preferable
solution to the problem is the amalgamation of smaller local governments into
larger units with adequate size and capacity. If amalgamation is not politically
feasible, the solution could be an asymmetric assignment of expenditure
responsibilities, in which more or less responsibilities are assigned according
to the capacity of local governments.
Identifying Who Should Be Involved
It may be assumed that in the case of China, the determination of expenditure
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Expenditure Assignments in China
35
assignments is the prerogative of the national or central authorities. As mentioned
earlier, leadership of the reform should be assigned to an intergovernmental reform
commission with wide representation of the most important stakeholders at the central
and subnational levels. The commission, with support of a technical secretariat or
working group, would need to establish the general strategy and scope of the reform,
as well as an implementation plan with an explicit time schedule. If there is no
commission, perhaps the Ministry of Finance could take the lead in the reform effort.
However, that is likely to be less than ideal.
Determining What Information Is Needed
Setting up to conduct comprehensive reform of expenditure assignments will require
significant amounts of data on actual and potential expenditures and expenditure
needs associated with the reassignment. Getting all of this information on a timely
basis may be one of the most significant hurdles to expenditure assignment reform.
But it will be important that adequate resources are dedicated to this task.
Enforcement
One of the big difficulties with expenditure assignments, and in other policy areas, as
well, is that there may be significant differences between what the assignments are in
practice and what is specified in the law and regulations. These problems will tend to
be minimized if the process of reform is highly participatory, involving all
stakeholders, and the reforms are well publicized. The added clarity to the assignment
of expenditure responsibilities by the reform should also contribute to reducing
differences between practice and law. Intergovernmental institutions for cooperation
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and dialogue among the different levels of government can also work well in this
context.
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