The Role of Provincial Policies in Fiscal Equalization Outcomes in China

In a decentralized economy with wide disparities in the availability of local fiscal resources, national equalization policies play a key role in determining the quality of public services and the degree of their accessibility to citizens residing in different parts of the country. In addition, in a hierarchically fashioned government structure, the effectiveness of national equalization policies greatly depends on the further degree of vertical decentralization and the equalization effort of intermediate-level governments. Since the 1994 fiscal reform, China has re-centralized revenue while at the same time further decentralizing expenditure responsibilities. A significant potential advantage of the re-centralization of revenues is that it provides the central government with better means to improve horizontal equity in the allocation of fiscal resources. However, despite the fact that the central government has stepped up its equalization efforts since 2000, it would appear that largely this potential has not been realized in practice. Increasing horizontal disparities in the allocation of fiscal resources is leading to inequitable fiscal outcomes at the sub-national level; in particular, there is a lack of access to basic public services by many residents in poor and rural local jurisdictions. This paper explores one of the possible reasons for this disequilibrium: the extent to which these undesirable equity outcomes can be traced to the policies of intermediate-level governments. In this paper, we use pooled data for central-provincial and provincial-local governments in 2000-2001, overall involving more than 4,000 sub-provincial governments, to assess China's sub-national fiscal equalization practices and outcomes. Our goal is to explain horizontal fiscal disparities between and within provinces, with a special focus on the role played by intermediate-level governments, particularly the provincial governments, in overall equalization outcomes in China. The significant policy implication of our findings is that if the goal of the central government is to improve equity in the distribution of fiscal resources throughout the entire national territory, it will not be enough to improve the design and size of central-provincial transfers. There will also be a need to re-structure and control the structure and practices of provincial fiscal systems.