The Effects Of Vertical Fiscal Reforms On Local Governments' Behaviors And Economic Development

How does vertical intergovernmental relationship affect the relationship between market and government and the development of market? This paper provides evidence by studying the effects of three fiscal reforms that can represent the fiscal reforms after the tax-sharing reform in 1994 on local governments' behaviors and economic development.The three fiscal reforms are the income tax sharing(ITS hereafter)reform,the abolition of agricultural tax(AAT hereafter)reform and the fiscal provincemanaging-county(PMC hereafter)reform.We simultaneously study the three fiscal reforms for two reasons.First,the fiscal reforms after the tax-sharing reform happened in a coherent way.To systematically study these reforms is helpful to understand the Chinese fiscal regime.Second,the three fiscal reforms share similarities in terms of the mechanisms through which they affect local governments' behaviors and economic development.Both the the ITS reform and the AAT reform affected local governments' behaviors and economic development through their effects on the fiscal pressures of local governments.And the changes of the fiscal pressures of local governments are one channel through which the fiscal PMC reform affects economic growth.To examine the effects of the fiscal pressures of local governments on local governments' behaviors and local economy,I construct a simple theoretical model.The participants of the model include the central government,a local government and a representative consumer.The central government sets the amount of the lump-sum transfer from the local government to the central government.Given the amount of the lump-sum transfer,the local government chooses its policies.And given the policies of the local government,the consumer chooses labor supply and consumption.An increase in the amount of the lump-sum transfer leads to an increase in the fiscal pressures of the local government.To address the fiscal pressures,the local government can raise tax rates or improve services.Define the difference between the output(the revenues)in the case of improving services and the output(the revenues)in the case of rasing tax rates as the output effect(the revenues effect).Then,I reach to the following proposition: when a weighted sum of the output effect and the revenues effect is positive,the local government prefers to improving services;otherwise,the local government prefers to rasing tax rates.In other words,the signs of the effects of the fiscal pressures of local governments on local governments' behaviors and local economy are not unitary.Because both the ITS reform and the AAT reform affect local governments' s behaviors and local economy through their effects on the fiscal pressures of local governments,the signs of the effects of these reforms are not a priori clear.It is an empirical question.I empirically examine the effects of the ITS reform,the AAT reform and the fiscal PMC reform on local govenrments' behaviors and economic development.The literature that studies the effects of the ITS reform is scarce,and the identification of the literature is not convincing.Using the prefecture level data and firm level data,this paper examins the effects of the ITS reform on economic development,industrialization and local governments' behaviors.To be concrete,I exploit the variation in the reliance on income taxes for budgetary revenue prior to the ITS reform to identify the effects of the ITS reform.The results show that the ITS reform boosted economic development.And the results show that the ITS reform boosted industrialization:(1)the ITS reform led to an increase in the per capita output value of above-scale industrial firms;(2)the ITS reform led to an increase in the number of above-scale industrial firms,suggesting that the fiscal pressures of local governments induced local governments to attract the mobile capital;(3)the ITS reform promoted the growths of the output value and the value added for the firms that have already been in the market prior to the ITS reform.In other words,the fiscal pressures of local governments not only induced local governments to boost industrialization in the extensive margin by attracting the mobile capital,but also induced local governme nts to boost industrialization in the intensive margin by promoting the production of the firms that have already been in the market prior to the ITS reform.Moreover,the ITS reform had an impact on local governments' behaviors.The ITS reform led to an increase in the share of the land sold by negotiation.Since the land sold by negotiat io n is mainly industrial land,the results suggest that local governments al ocated a higher proportion of land for industry to attract the mobile capital.Last,the ITS reform had an impact on taxation.The ITS reform led to an increase in the real tax rate,which hindered economic growth.The literature that studies the effects of the AAT reform mainly focuses on the effects of this reform on agricultural production and rural income,but does not take the possible effects of the AAT reform on the non-agricultural sector into consideration.Using the county level data,I examine the effects of the AAT reform on the nonagricultural sector.I exploit the variation in the reliance on agricultural taxation for budgetary revenue prior to the AAT reform to identify the effects of the AAT reform.I find that the AAT reform promoted the growth of the per capita value of the agricultural GDP in the short run,while it hindered the growth of the per capita value of the nonagricultural GDP and the per capita value of GDP in the short run.In addition,I find that the AAT reform resulted in a high level of regional inequality in terms of nonagricultural GDP per capita.These results indicate that the AAT reform promoted agricultural production at the cost of lower non-agricultural output growth and higher regional inequality in terms of non-agricultural GDP per capita.Moreover,I examine the effect of the AAT reform on fiscal transfers.The results show that the increase in fiscal transfers from the upper-level governments was not enough to compensate for county governments' budgetary revenue reduction due to the AAT reform.And the AAT reform influenced the revenues and expenditures of local governments.Following the AAT reform,county governments increased their non-agricultural taxation,and increased the shares of government investment in fixed assets and human capital in their budgetary expenditures.Among these responses of local governments,the increased non-agricultural taxation is a more important channel through which the AAT reform inhibited non-agricultural GDP growth.The literature separately studies the effect of the fiscal PMC reform on the growths of counties and the effect of this reform on the growths of the districts of prefectures.However,the literature does not study this reform's effect on aggregate economic growth.Using the provincial level data,I study the effect of the fiscal PMC reform on aggregate economic growth(provincial ecnomic growth).Meanwhile,I study the gowth effect of the devolution of economic and social powers(DEV hereafter)that was carried out duing the sample period.The growth effect of the DEV reform is also our cocern.And not taking the DEV reform into account may result in an omitted variable problem.Using the diference-in-difference method,I estimate the effects of the two reforms on provincial economic growth.I find that the fiscal PMC reform did not significantly affect provincial economic growth,while the DEV reform significantly promoted provincial economic growth.Moreover,I examine the effects of the two reforms on economic convergence.The results reveal that the fiscal PMC reform did not significantly affect economic convergence,while the DEV reform resulted in economic convergence.Finally,I examine whether the growth effect of the DEV reform relied on the importance of county economy.The results reveal that the growth effect of the DEV reform was larger when the county GDP accounted for a larger proportion of the GDP of a province.