Sep 02, 2013 05:09 PM

Defining the Powers of Central and Local Gov'ts

Ballooning local government debt is a major worry of the country's economic regulators. There are many reasons for the gigantic size of debts, but one important cause is that local governments have too much to do but too little in their coffers; the financial resources in their hands hardly matches their responsibilities.

From a legal perspective, there is a systematic flaw behind the mismatch: the division of labor between the central and local governments has never been spelled out by law. A number of administrative regulations were made in this regard, but they remain vague, unstable and sometimes just verbal decrees. And there have been times that new policies trumped existing regulations. The lack of a legal footing sowed the seeds of a series of institutional problems regarding this division; uncertainty regarding policy changes brews social risks.

Moreover, China's laws fail to distinguish what kind of public goods should be provided at the local level and what should be nationwide. The central government could easily move some spending items to local governments' budgets by saying they are within their power or are a central-local shared power. The result is local governments have to foot the bill for central policies. Local governments, on the other hand, tend to keep administrative approval power in their hands and try to kick spending-related power back to Beijing. 

To meet local governments' fiscal needs, the central government doles out transfer payments. Again it's not an item with a strong backing in the law. Most of the transferred payments are project specific, meaning they do not face legal scrutiny, lack payment certainty and can incur a high cost during information collection in the approval process. The approval of transfer payments is in hands of central government departments. It is much more costly for them to collect information about specific projects and to understand the needs of citizens in various regions before parceling out transfer payments properly.

At the root of this problem are key questions regarding whether China is ruled by its constitution, and whether clear borders between the power of local and central governments can be drawn. The power to set the division of central-local labor should be charted out by law, and move out of the administrative realm. If amending the constitution is too complicated for now, we can pass a local government autonomy law that clearly defines national, local and shared-responsibility public goods and who should provide them.

Meanwhile, the transfer payments should be institutionalized. In the United States, one-third of local government income comes from the federal government, but all details – ranging from responsible agencies, payment levels and allocation methods – are clearly written in Congressional Budget and Impoundment Control Act and the Budget and Accounting Act. This kind of legal framework is lacking in China. Therefore, to gain more fiscal resources from the central government, local governments in China cannot resort to law, but have to grease the palms of central departments.

Laws alone will not suffice. There must be complementary policies, such as changing the performance evaluation system of local government officials, to make the new law-based division work. In addition, reducing administrative layers is also important. Currently the lower the government levels, the more severe the lacking of fiscal power to perform their responsibilities. Last but not least, we should invite external scrutiny of the government budgeting and spending processes.

When we build a legal framework to clarify fiscal and spending power of local and central governments, there should also be accountability. Currently, there is no rigid restriction to force local governments to spend within their means, and there are risks of run-away local spending. The only string attached to them is pulled by officials from the upper administrative level. If we aim to reduce the direct control exerted from one level of government to those below it, there should also be an accountability system based on law. This would make local governments answerable not just to their superiors but also to residents in their jurisdiction and lenders in the financial market via credit ratings.

Once local governments acquire more independent power, they should at the same time actively assume the role of providing public goods to local residents and be accountable for their responsibilities. The guarantee from the central government regarding local government debt should be phased out and the moral hazard problem brought to an end.

Moving the division of power between central and local governments to a legal framework is not as simple as passing a new law. This requires a whole institutional set-up to make it function.

The author is an assistant professor of law at Shanghai Jiaotong University

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