Cover Story: China Plans Fiscal Overhaul to Fix Local Government Finance Crisis (AI Translation)

【周刊提前读】新一轮财税改革：如何激励地方着眼长远？

[para. 1] China's economy is gradually recovering from the pandemic. However, the fiscal system reform between the central and local governments is uncertain amidst interest in various sectors. Plans for a new round of fiscal and tax system reform were initiated at the end of 2023, with the aim to complete reforms by 2029. Researchers regard this set of reforms as significant, akin to the reforms in 2013 and possibly more impactful than the 1994 tax-sharing reforms which initially shifted fiscal revenue distribution.

[para. 2] The 1994 fiscal reform established a modern tax system, increasing the central government's fiscal revenue significantly but left local governments with a high share of expenditure responsibilities while having limited financial autonomy. Although central transfers have been expanding, many funds are earmarked for specific purposes, causing local governments to still face financial challenges, aggravated by a downturn in real estate affecting land sale revenues.

[para. 3] The new fiscal reform, as approved at the Third Plenary Session of the 20th Central Committee, proposes changes in budgeting, taxation, and transfer payments, aiming to increase local financial autonomy. Measures include expanding local tax bases, revising the consumption tax collection, enhancing the VAT credit refund policy, and optimizing tax sharing between central and local authorities. Importantly, the main challenge remains balancing the central-local fiscal relationship.

[para. 4] Experts agree on the need to reform these fiscal relationships, but the path forward remains unclear, with issues like local financial autonomy and shared tax distribution still undecided. A consensus on the complete framework for these reforms is yet to be reached.

[para. 5] The urgency for reform stems from the conflicts between local government revenues and expenditures, highlighted by the strain on local finances. Despite pandemic-related one-time expenditures, the root issue remains unclear fiscal responsibilities and misaligned financial resources between central and local governments, leading to local governments resorting to hidden borrowing to manage their finances.

[para. 6] The reform efforts since 1994 have not been sufficient in delineating the responsibilities between central and local governments. The reform initiated in 2016 aimed to clarify these roles through shared responsibilities but left ambiguity, particularly in areas like public services and risk event management.

[para. 7] Former Finance Minister Lou Jiwei emphasized the importance of completing the task of strengthening the central authority and reducing delegated responsibilities to local governments. The central government needs to assume a greater share of fiscal responsibilities.

[para. 8] China's fiscal expenditures reveal a significant focus on economic construction compared to other major countries, suggesting a need for optimizing this structure by reducing excessively high construction expenditures and improving the effectiveness and efficiency of government spending.

[para. 9] As a significant portion of China's population reaches retirement age, social security expenditures are rapidly rising, adding strain to government budgets. This reality calls into question how financial responsibilities should be distributed between the central and local governments.

[para. 10] Experts believe improving these relationships requires a clear division of powers, expenditures, and financial resources. The starting point should be assessing governmental tasks followed by the allocation of resources, with any gaps bridged by transfer payments but necessitating top-level design and coordination, not something finance departments can resolve alone.