Chinese Urban Finance Reform

The planning challenges of modern urban China are both familiar and less so. In part, they include the generic problems associated with financing fast urban growth, including managing change and the various constituencies of that change. There are also the few million details specific to the Chinese situation, ranging from the specifics of market reform and fiscal reforms to housing/employment reforms. This post outlines the main points of a paper on some key issues prepared for a volume being prepared for the Lincoln Institute China Program. (There is a companion paper by Weiping Wu examining urban infrastructure finance in more detail.)

1. Financing rapid urban growth
Among a large set of complex issues, consider two: (a) The challenges of planning with respect to the pace, scope and scale of change. Rapid urban growth brings changes in local government functional responsibilities, their revenue bases, and their decision/governance frameworks. (b) At the same time, the client changes as rural migrants urbanize and urban residents suburbanize. Thus there is the challenge of identifying the customer on the one hand, and communicating with them on the other.

2. Chinese particulars
Even if you only hear about China on the Fox News Network, you are probably aware of a number of planning environment distinctions, among others:

• Due to the household registration system, and its large associated “floating population,” together with the problematic statutory definitions of what is and is not urban, there may well be substantial undercounting of municipal service demands.

• The transition to a more market-oriented economy suggests several issues associated with the regulation/management of land, project competition, privatization, and design/development processes.

• So-called off-budget public finance, on both the revenue and expenditures sides of the budget.

• Transfers from the center to local governments remain somewhat ad hoc, and thus nontransparent, unpredictable, and perhaps out of sync with both local demands and top-down mandates.

3. Example: Fiscal decentralization

With the advent of “socialism with Chinese characteristics” and the relaxation of many Mao-era practices in the 1980s and since, central-local relations have been reformed substantially a number of times. Analysts such as Bird, Bahl, Martinez-Vasquez and Wong have identified at least 4 important stages.

In 1980, a new system of revenue and expenditure assignments to local governments were implemented. These were modified in 1985 by adding clearer revenue targets, above which provinces could keep the “surplus” or below which would be filled by central transfers. This too was not felt to send the right incentives, so was modified around 1988 with a “fiscal contracting system” that explicitly factored in expected growth rates in revenues. This didn’t work out quite as planned either, however, with the central share of national public revenues falling markedly from nearly 40% in 1985 to more like 20% by 1993.

So in 1994 the system was revised again to the so-called tax shared system, which included a modernization of the administration of the tax system. This reversed the decline in central revenues but largely at the expense of local own-source revenues. However, central transfers filled the gap.

More uniquely to China, many local governments are also addressing this gap via off-budget methods, often can involve evolving land markets in a way that affects the urban form and footprint like so: Urban land belongs to local governments, which they can lease for large up front fees when in demand. There appears to be a strong incentive, then, to use eminent domain-like powers to take possession of agricultural land, perhaps at compensation levels somewhat below market value, in order to provide this land for private developments. I’ll postpone discussion of research issues surrounding this behavior for another post, but there is evidence that this has been a major revenue source in some areas.

4. Reform issues
Some fiscal decentralization principles seem to apply pretty much everywhere, and so we once again find problems with a system that does not adequately stimulate own-resources (such as the property tax) while relying heavily on central revenues for local spending purposes. There is no problem with exploiting the ability of the center to raise public funds more efficiently and fairly than localities, but these should be redistributed to those localities in a way that does not distort local revenue or spending behaviors, and in a transparent, predictable manner. The current somewhat ad hoc nature of transfers does neither. It also seems that local expenditures assignments are vague in many respects. Reforms on both the spending and tax side of the system would promote more rational urban planning.