Editorial: How to Break Local Governments’ Addiction to Land Sales Revenue
Another step has been taken toward the centralized collection and administration of fiscal revenue. Last Friday, four departments — the Ministry of Finance, the Ministry of Natural Resources, the State Taxation Administration and the People’s Bank of China — together issued an announcement called “CZ  No. 19” that transfers the right to levy the four forms of nontax government income — income from the assignment of the right to use state-owned land, special income from mineral resources, charges for sea area utilization and charges for the use of uninhabited islands — from natural resource authorities to tax departments. Among the four items, particular attention has been paid to income from the assignment of the right to use state-owned land, also known as “land transfer fees.” This reform of nontax income collection and administration system will improve the efficiency and normalization of collection, administration and fiscal transparency while also strengthening the central government’s oversight on land finance and local government debt. However, this announcement will still not be a “panacea” for local governments’ dependency on land for funding. To effect a radical solution, a series of reforms that ensure and respect local fiscal autonomy should be brought into further clarification of powers and expenditure liabilities, as well as restructuring of local governments’ fiscal basis with an emphasis on fiscal relations between governments below the provincial level. Ultimately, intergovernmental fiscal relations, which assure local governments of full autonomy and get rid of soft budget constraints, will be established.
There is some basis for certain parties to interpret this transfer of rights to tax departments as an attempt to strengthen centralization. In recent years, both the consolidation between national and local tax authorities and the incorporation of income from nonnatural resources into the collection and administration system are signs of the trend that collection and administration is being centralized. But it is somewhat lopsided to label these reforms as attempts to strengthen centralization or “move local governments’ cheese.” This is more of a misinterpretation of CZ  No. 19 as a “termination of land finance” or “farewell to land finance.” The document makes special mention that policies concerning the scope, objects, standards, exemptions, sharing, utilization and management of the four forms of nontax government income will continue to be executed in accordance with the existing regulations. Prior to the announcement, certain problems existed in the expropriation of land transfer fees by local natural resource departments, such as delayed handover to the national treasury as well as noncompliant collection and handover processes. With this transfer of rights to tax departments, certain disorderly phenomena within local governments including the reduced amount, exemption and illegal refund of land transfer fees will be constrained; problems such as local governments’ illegal “financial support” for urban construction investment platforms, expansion of implicit debts and reserving and speculating on land will be reduced; and the central government will gain a more comprehensive and accurate understanding of financial situations of local governments.
Over the past decade or so, income from land sales has become the mainstay of most cities’ fiscal revenue. This pattern, also known as “land finance,” cannot make ends meet, and thus a consensus has gradually formed on its unsustainability. Nevertheless, the real situation is contrary to the prediction: income from land sales has continued to grow, rising rapidly as a proportion of the GDP. In recent years, China’s top 50 cities have consistently received more revenue from land sales than from taxes. This indicates that local governments have become adept at using land finance while also highlighting the lack of alternative means, both of which are represented by obdurate path dependence. To cure this dependence, it is necessary to accelerate fiscal and taxation reform, straighten out the fiscal relations between governments, regulate tax revenue of all types and defuse fiscal and financial risks, while also maintaining the initiative of local governments in economic development and services for the people’s livelihood.
Steadfast efforts should be made to promote the division of financial powers and expenditure responsibilities. The fiscal relationships between the central government and provincial governments are relatively clear, but those among governments below the provincial level have long been ambiguous. In recent years, however, progress has been made in the relevant reform. In August 2016, the State Council issued the “Guiding Opinions of the State Council on Advancing the Reform of the Division of Financial Powers and Expenditure Responsibilities between Central and Local Governments.” Later, in January 2018, the General Office of the State Council published the “Plan for the Reform of the Division of Financial Powers and Expenditure Responsibilities between Central and Local Governments in the Field of Public Services.” The guiding principle of the reform is clear: to change the situation of “delegating administrative power while concentrating financial power.” Nevertheless, the regulations on expenditure responsibilities are too much like principles that are difficult to implement.
It is more urgent to accelerate fostering the local main tax categories and reconstructing the local fiscal revenue base. Obviously, facing a large revenue-expenditure gap, especially the absence of main taxes, local governments will probably seek nontax revenue dominated by land transfer fees that may give rise to arbitrary charges and rely too heavily on the financing platforms of urban development investment companies, thus increasing the risk of local debts. Notably, due to the great impact of the Covid-19 epidemic on economic development and tax revenue, the dependence of local governments on local finance has become more serious. In 2020, local general public budgets, mainly tax revenue, registered approximately 10 trillion yuan ($1.6 trillion), down 0.9%, while revenue from land sales included in government-managed funds increased by 15.9% to 8.41 trillion yuan. Judging from both the rise and fall, the situation is clear.
For fostering local tax categories, top priority should be given to real estate tax. The Ministry of Finance and other departments recently held a symposium on the pilot reform of real estate tax, and reform has accelerated sharply since then. Whether for systematically managing land financial dependence or enhancing local financial autonomy, the introduction of real estate tax is imperative.
In addition, more efforts should be made to advance the standardized development of local government debts. A few years ago, China issued the new “Budget Law” and “Several Opinions of the State Council on Strengthening the Administration of Local Government Debts (GF  No. 43),” which proposed the debt risk management strategy of “appropriately arranging the scales of new local government debts and strictly implementing the debt limit and budget management system for local governments.” Since then, the scales of standardized local debts have continued to expand, but are still not large enough today. In 2019, the land transfer fees of East China’s Jiangsu province reached nearly 900 billion yuan, the highest in the country, while its debt limit increased by only 200 billion yuan from the previous year. The standardized development of local government debts can lighten the burdens of local finance through financing. More importantly, compared with the top-down supervision of the administrative system, the market’s supervision of the government’s financial behavior enjoys unique advantages. In particular, the latter is more sensitive and objective as it has access to richer information.
Under certain circumstances, there is a contradiction between strengthening the supervision of the central government over local finance and maintaining the initiative of local governments. Since reform and opening up, China has made remarkable economic achievements, which can be partly attributed to the incentive mechanisms of local governments. Policymakers have also repeatedly stressed the need to continue to fully motivate both the central and local authorities. In the future, the fiscal relationship between governments should be clarified on the basis of externalities, information processing complexity and incentive compatibility. Only in this way can local governments’ land fiscal dependence be eradicated and the central-local government fiscal relationship be established with a clear division of powers and responsibilities, balanced assignment of financial resources and regional coordination.
Contact editor Michael Bellart (email@example.com)
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