An Impressionistic View ofLocal Government Finances in China

Local Government Organization and Finance: China 163

andfiring ofpublic service unit employees are determined by the units themselves.

Currently,the degree ofautonomy and flexibility in the exercise of executive powers by local governments is high in most jurisdictions,because the party committees ofhigher-level governments often delegate significant authority to local party leaders.However,the degree ofautonomy and flexibility is very unstable and inconsistent across time and across jurisdictions, because this delegation is not formally defined and is at the discretion ofthe party leaders ofthe higher-level government.

An Impressionistic View ofLocal Government Finances in China

The current system oflocal government organization and finance in China has some positive features.Local governments assume a predominant role in the delivery ofpublic services.In this role,they are guided primarily by national mandates,yet they have significant opportunity to adapt and innovate to meet local circumstances.They have done a phenomenal job in alleviating poverty. They have also been successful in improving infrastructural deficiencies. Good-quality infrastructure is,afterall,seen as an important inducement to investors to pump capital into their jurisdictions.New investment enables local governments to enlarge their tax bases and local leadership to assume greater political clout.These benefits provide strong incentives for local governments to focus on local economic development policies.They also stimulate a great spirit ofcompetition to uplift local economies.

The local governments in China,nevertheless,suffer from a number of shortcomings.These include lack ofclarity in their roles,weak fiscal autonomy,poorly structured system offiscal transfers,lack ofincentives for responsive and accountable delivery ofpublic services,and perverse incentives to focus on private goods,at the expense ofessential social services.

China follows a layer cake,or top-down,model ofaccountability for various levels ofgovernment.In this model,policy determination is mostly at the center,and responsibility for service delivery is at the county level and below.The intermediate tiers/orders simply ensure compliance with higherlevel mandates.The efficient working ofsuch a system requires significant clarity in roles,responsibilities,and accountabilities.However,clarity in roles is currently lacking to allow greater flexibility for local-level governments.This works to the detriment ofresponsive and accountable local governance.

164 Baoyun Qiao and Anwar Shah

The revenue autonomy oflocal governments is fairly constrained.Tax policy is centralized and local governments have no discretion in defining the base and setting rates for local taxes.They have some flexibility only in user charges.This situation creates incentives for over-reliance on fees and user charges to raise additional financing,and thus restricts access ofthe poor and needy,especially the rural poor,to basic social services such as health services.

Local governments receive two-thirds oftheir revenues from central transfers that pass through provincial and prefecture governments.These transfers are poorly structured.Their one-size-fits-all design does not recognize the differential needs ofurban versus rural areas and size and geographical coverage ofvarious jurisdictions.There is no explicit standard ofequalization,and there are too many ad hoc specific-purpose transfers focused on micromanagement by higher levels ofgovernment but with no incentive and accountability for results (Shah and Chen 2006).

Some specific-purpose transfers provide perverse incentives and encourage local governments to act as employment-creation agencies or simply direct providers ofservices rather than purchasers,but not necessarily providers oflocal public services.In spite oflarge infrastructure deficiencies, local borrowing is restrained,which encourages off-the-books borrowing by local governments.The absence ofa legal framework for fiscal responsibility, fiscal discipline,and fiscal insolvency means that off-the-books behavior will go undetected until a major crisis erupts.

Both local public finance and local economic development concerns lead local governments to assume larger roles in providing private goods directly through local state-owned enterprises (SOEs) and promoting private business development,to the detriment oftheir primary role in providing local public services especially to the rural poor.Local economic development enhances the national political clout oflocal leaders. Local ownership ofSOEs encourages government to exercise informal power in the private sector,thereby opening doors for opportunistic behavior.The SOEs also help soften budget constraints and weaken local fiscal discipline.

Although local governments should be primarily accountable to local residents,in China their accountability is primarily to the higher levels of government and the local leadership ofthe Communist Party.To strengthen accountability to local residents,China is experimenting with direct elections ofthe executive body oftownship governments in selected jurisdictions.