Fiscal Decentralization, Local Government And Environmental Pollution

China’s fiscal decentralization and political centralization system has brought this country remarkable growth in the past decades. However, the competing local governments tend to relax the environmental standards and thus generate more pollution. This paper studies the impact of fiscal decentralization on environmental pollution by developing a theoretical model to divide the impacts on pollution into scale, technology and structure effects, and adding the fiscal decentralization into this model. Then we test the theory using provincial panel data from China. The empirical results show that the scale effect increases pollution while the technology effect reduces pollution, and the structure effect is not significant in our sample. We also find that pollution haven phenomenon does exist in China and the pollution rises with higher ratio of industrial product in GDP. Fiscal decentralization’s impact on pollution is closely related to local characteristics, in provinces with lower relative income level, higher fiscal decentralization level brings more pollution, while in areas with high income it improves environmental quality. The gross effect of decentralization depends on its effect on economic growth because the scale effect may worsen the situation. Moreover, in middle and western China where local governments face more fiscal pressure, the effect of decentralization is more significant. Also, in the acid rain and SO2pollution control area, more stringent laws and controls effectively regulate the action of local governments and reduce the negative effect of decentralization. In order to take the way of sustainable development and value the environment as well as economic growth, we should change the incentives of local governments and attach more importance on residents’welfare and environmental quality when evaluate their performances. For reducing the negative effect of interregional competition, fiscal system should be reformed to balance the financial capacity among different regions.