To Reconstruct The Fiscal Relationships Among Local Governments

The implementation of revenue sharing system in China in 1994 is a landmark to the fiscal reform from the administrative separation of powers to the economic ones with the establishment of fiscal framework of revenue sharing and hierarchy. However, in order to decrease the resistances and to facilitate the success of the reform, the vested interests remain in the newly revenue sharing system, which is an expedience. The center government doesn't grant the provincial governments any real decision-making power to impose a tax, but informs the income distribution mechanisms between them. Failures of the center government to construct a framework for the governments below the provincial levels to the income distribution let the provincial governments, in turn, simply make certain the pattern of income distribution between them and the city level governments in term of the traditionally concept of hierarchy. Accordingly, the city authorities independently determine the income distribution mode between them and the counties government who is the local ones directly subordinate to them. It's the same case to the county governments and their subordinate village or town governments. The center fiscal income accounts fro 54.9% of 260 billion Yuan in 2004 from the 28.35% of the 50 million Yuan in 1993, when the reform on the revenue sharing system hadn't began yet. At the same time, the financial capacity of the province and city governments tends to accumulate with the decreasing percentage of incomes from county and village governments. Evidences show that the staff belonging to the county and village governments get close to 30 million people, and accounts for 70% of national fiscal staffs, out of proportion of the fiscal income collected in these 2 levels which is only 17.5% of the total national volume. With the financial capacities centralizing in the upper governments, the duties and responsibilities are undertaken by the lower governments. The Law on Budgets vaguely rules the distributions of expenditure between center and local governments without details on the distributions between province governments and the lower level governments. The upper governments are entitled to determine the expenditure of lower governments in the local government systems. That means, the province governments decide the cities expenditure distribution and cities governments, the counties, and the county governments, thevillages and towns.Then the result is the highly disproportion between expenditure duties and financial capacities below the provincial level governments, especially for county and village governments, who witness increasing debts and deficits. Sources from the ministry of finance says, 32% of the 2860 counties, that is, 906 of them, were run in red in 2002. the administrative debts owned by counties, countries and villages may total at 100 million Yuan. The increasing financial difficulty has affected negatively the economic functions of local governments, threatening the social stability and the governmental prestige in certain areas. Unless the trend is curbed, the financial difficulties of local governments may eventually reduce the state revenue, and further hinder the national economic growth and undermine the regime. Therefore, the paper argues the confusions of the fiscal relationships leads to the financial difficulties among the local governments with the highly disproportion of financial capacities and responsibilities. And the only solution is to reform the fiscal system and to rationalize the fiscal relationships among local governments.Intra governmental fiscal relationships and the fiscal system have long been concerned in the west. In the market economy, the basic economic functions of governments are making up for the market failures, providing public goods, and meeting the demands of the public. Why multilevel government structures are adopted instead of unitary one? The answers mark the logic beginning for the research on fiscal separation of powers. In the literature of public fiscal theories in the west, the scholars proved the necessity of government hierarchy and fiscal separation of powers through the features of hierarchy and space for public goods. Among them, Stigler, Oates, Buchanan, etc, are the leaders. In the past 2 decades, the traditional theories for separation of powers have been developing with the reforms undergoing in various countries. The new theories, conforming to the principles of the traditional ones, expand the methods for analysis. For instance, discarding the original modes of analysis, they adopt the newly achievements of the modern politics, economics and economic managements, use the framework of incentive compatibilities and the mechanism designs, principal & agent theory, and so on, and make progress in the intra governmental fiscal relations with Rosen, McKinnon etc. as the leaders. It's the core of fiscal feudalism to regulate the fiscal functions among governments of various levels, in other words, the fiscalseparations of powers. The policies for the resource allocation are supposed to differ in terms of the preferences of local residents, and the policies of distribution and stabilities ought to be subject to center governments. After the determination of expenditure responsibilities among governments of various levels, the distribution of the tax imposition authority is to be taken into account. Musgrave and Bahl are the most prestigious scholars who engaged in the researches of the subjects. In the separation of fiscal powers, the intra governmental subsidy system shoulders the responsibilities like the uniform leaderships, macro adjustments of intra regional public services and income distribution, promotion of integrity for the national market, and optimization of the resource allocation. It helps local governments supply the public goods and the effective combination of mixed goods to meet the demands of the local residents, bearing the principle of diversification.Compared with abroad, the domestic research began late and therefore achieved a little on the subjects of intra governmental relationships and the fiscal system, especially for the local fiscal one. Those researches, based on the institution of market economy, argue that the main functions of governments are providing public goods to offset the market failures through the 2 couples of relationships of market mechanism and failures, as well as market failures and government interventions. Which justifies the positioning of governments in China.Upon the hierarchy of public goods, the fiscal separation of powers is proposed between center and local governments, and among local governments too, to facilitate the supply of different public goods by governments of different levels. Then, the distribution of responsibilities among center, local and intra local governments can serve as the criterion to rationalize the financial capacities in terms of the expenditure duties. That means the gap between the income and expenditure can be compensated by transfer payments, aiming at the supply efficiency for the public goods. So, the research on the fiscal relationships among local governments is supposed to adopt a framework conforming to the chain that the definition of governments functions, the rationalization of expenditure duties among local governments, to the distribution of their financial capacities. Only when the financial rights fit in with the responsibilities and duties, will the governments of various levels provide the public services efficiently.In recent years, some Chinese scholars joined the local fiscal system to thegovernment fiscal reform when study the local fiscal relations with the purpose to regulate the local fiscal relations and solve the financial difficulties for the county and village governments by way of reducing the government fiscal hierarchy. The readjustment reform aiming to maintain the existing government fiscal hierarchy has to be taken place by fundamental revolutions because of the pressures burdened by the local finance. The methods directing the institutional problems have opened a new field for the research of intra local governmental fiscal relations. However, with only an introductive framework, the studies remained in the superficial level, inadequate to guide the practical reform on how to regulate the responsibilities and financial rights among governments.Resting on the market economy, the paper aims to re-construct the fiscal relationship among local governments to deal with the financial difficulties encountered by the grass root governments from the perspective of reforms on the governmental fiscal hierarchy. And theories from institution economics, administration, coupled with the public fiscal and choice theories, are adopted in the analysis with both the normative and positive methods.The paper tries to achieve breakthroughs in the following 4 points.First, the methods to solve the financial difficulties are not unique since the causes are various. The paper argues that the irregularity of the fiscal system directly leads to the problem that appears as the disproportion of duties and the financial rights for the grass roots governments. Therefore, to renew the local fiscal system can alleviate the financial difficulties for the local governments. Second, to renew the local fiscal system cannot be confined to the simple adjustment of duties, financial rights and transfer payment systems. Instead, the fiscal hierarchy of . government is to be taken into account. The reform of the government system, which is the determinant of the fiscal system, necessarily bears the changes of the latter. That means that the local fiscal relationships will be in chaos regardless of the background of the changing government system. The paper concerning the tendency appearing in the structure of government hierarchy, suggests a new system in which the counties are subordinate to the provinces instead of the current cities. Simultaneously, eliminating the government hierarchy of villages and towns, the town halls act as the agents for the original county governments. Therefore, a 3 level hierarchy of center, province and county or city is formed. The simplified fiscalhierarchy is conducive to regulate the local fiscal relationships, and is of practical significance to reform the administrative and fiscal systems within a same framework. Third, the 3 level government hierarchy can be viewed as a final ending for the reform while it cannot be achieved recently since the reforms involve major adjustments of the vested interests. The paper proposes to reduce the fiscal hierarchy to facilitate the future reforms on government hierarchy. To be exact, the fiscal system of counties subject to provinces is to replace the current one in which the counties are subordinate to the cities, and thus the counties and cities are in the same fiscal hierarchy. At the same time, the fiscal hierarchy of village is to be eliminated, and the finance of villages is taken over by the counties. Thus, it is easier to re-distribute the duties and financial rights among local governments according to the 3 level hierarchies than to change the fiscal system overnight. This will help to alleviate the fiscal burden of the counties and villages. The fiscal hierarchy surely needs to cope with the government hierarchy in the long run. And any change in the former will definitely propel the reform on the latter. That means, the government hierarchy, needs to turned into a 3 level one according to the 3 level'fiscal hierarchy. Last but not least, the 3 level fiscal hierarchy designed in the paper can serve as a lamp to the improvement for the reconstruction of the intra local fiscal relationships. The paper suggests that the reform on the local fiscal system, accommodated in the framework of 3 level fiscal hierarchy, aims at the integrity of financial rights and the duties. After dealing with the relations between governments and markets, local governments are supposed to design the main taxes for themselves and strengthen their financial rights. Moreover, a regular local transfer payment system needs to be established.An introduction and six chapters comprise the paper.The introduction firstly discusses the background and the purposes of the subject to show the value of the research. Secondly, the theoretical foundation for the research has been expanded to elevate the academic value of the paper. Last, the paper tells a story of the development concerning the subject, and the breakthroughs are mentioned.The first chapter is the positive analysis of intra local governmental fiscal relations. After the paper introducing the overall condition of local governmental incomes and expenditures, a basic conclusion is drawn that the county and villagelevel financial status has been in great trouble, with the prevalence of delayed payments of salaries, burdens of debts, and growth in the scale of deficits and local governmental financial crisis. This may attribute to the imperfect local governmental fiscal systems, in which, below the provincial level, deficiencies exist- in the assignation of duties and obligations, the allocation of fiscal capitals and the subsystem of transfer payments. Therefore, innovations in the local governmental fiscal systems are needed to solve the problems in the grassroots governments.Chapter 2 aims at constructing a 3 level governmental finance with a view of the reform on the hierarchy structures. Government system accounts for the fiscal systems. Accordingly, governmental hierarchy determines the structure of fiscal hierarchy, when the fiscal relationships among local government are dealt with in certain governmental hierarchy structures. Thus, a proper governmental hierarchy becomes the foundation for assigning various levels of local fiscal relations. After referring to the experience abroad, the chapter sums up that a 3 level system, mainly adopted overseas, may be a key to the current problems in China. Reviewing the history of governmental hierarchy structure, the 5 level system in use in China now results in redundancy of management level, and thus high management costs and low efficiency, making the reduction of the governmental hierarchy inevitable. Then a 3 level government system is suggested in which there is central government, the province and the city or county levels. And 2 major reforms are required. First, the system of counties subordinate to the cities is to replaced by the one that the counties to the provinces, elevating the counties to the same level as cities in the government hierarchy. Second, the level of village government is to eliminate to propel the reform on the village system. Thus, creating the 3 level government hierarchy and fiscal relations, and further re-construct a new fiscal relationship among local government.The third chapter is to construct a 3 level governmental finance with the . development of local governmental fiscal system. It can't be attained in the near future since the decrease of the governmental hierarchy will break the vested interests any require further reforms in depth. But reductions on the fiscal hierarchy may be the start point and then the new fiscal hierarchy can serve as the base of fiscal system assignation. The current 5 level fiscal systems have many weaknesses, which the redundancy of governmental fiscal hierarchy blurs the borders of dutiesand obligations among various governments, resulting that the income rights centralize in the upper governments while the duties and responsibilities the lower governments. The financial crises in grassroots governments are thus inevitable. Then 2 reforms are supposed to accomplish the establishment of revenue sharing system to simplify the original 5 level fiscal hierarchy into a 3 level one, in order to specify the local governmental fiscal relationships. One is to adopt the fiscal system in which counties subordinated to provinces, referring to the experience from Zhejiang and Anhui provinces. This can reduce one level of fiscal hierarchy with the counties in the same level as the cities. The other is to promote the fiscal system in which the counties take over the income rights of the villages, following the pilot project in Anhui province. That will eliminate the fiscal level of villages in the end.The fourth chapter re-defines the duties and responsibilities among local governments. The vertical allocation of duties and responsibilities dominates the governmental fiscal relationships, and acts as a basis to distribute the fiscal incomes and then the structure and scale of transfer payment among governments. The duties and obligations of intra local governments needs to re-arrange corresponding to the 3 level governmental fiscal hierarchy as planned in the former chapters. The real function of governments is to provide public goods whose beneficial regions and levels determine the distributions of 3 governmental functions between the center and local authorities, and so the functions of the local governments are defined. After the chapter introducing the basic theories for assignation of duties and obligations among governments, a framework is suggested in which the duties and obligations be linked to the payments. And, some experience can be withdrawn when comparing the assignations of duties and payments from different countries ranging from federal to unitary ones. Then, the 3 level governmental fiscal hierarchy is adopted to optimize the vertical allocation of intra local governmental duties, and determined the fiscal payment obligations below the provincial governments.The fifth chapter plans to regulate the fiscal distributions among local governments. After the arrangement of local governments' duties and payments obligations, the governments of various levels must have correspondently undertake income rights accordingly in order to undertake the normal operations, and to provide requisite public services. The chapter begins with the analysis the distribution theories of local tax duties. Several characteristic countries have beenpicked up to generalize some rules after discussing the situations, features of their local tax system and the distributions of local tax duties. Then the chapter brings forward the measures to specify the distributions of local tax duties among various level governments. This mainly includes things like perfecting the legislation system of local taxes to grant certain tax legislative rights to the local governments, optimizing the central tax variety with tariffs and consumption taxes as the main taxes and the security transaction taxes and resources taxed as the supplementary ones, designing revenue sharing system properly which temporally comprises added value taxes, Corporate and Individual Income taxes, and Social Security taxes, and all of which will be eventually distributed into center or local tax systems. Constructing the main tax system fro the local government, such as the Sales taxes designated as the main tax in the provincial level finance, supplemented with the added value tax, corporate and individual income taxes and social security taxes whereas the property taxes system in the cities or counties level finance like real estate taxes, license taxes for vehicles and vessels, inheritance tax and gift tax.The sixth chapter goes on to specify the transfer payment system among local governments. Though the distribution of duties and taxation rights have been designated according to the 3 level government hierarchy, there's great likelihood that asymmetry remains between the duties and tax rights in every level of government hierarchy, leading to the unbalance of intra local government finance both horizontally and vertically. Thus, a regular transfer payment system is indispensable to ensure that various local governments enjoy proper income rights and provide the correspondent public services. The experiences drawn from some countries suggest that the establishment of the general and special transfer payment from provincial level to the cities or counties level can optimize the transfer payment system in China.