Friday, Jul 28, 2017, 8:54 PM CST – China


Fiscal Reform


China’s ongoing process of fiscal reform aims to redefine relations between the government, the market and taxpayers. To achieve this, relations between legislative and administrative bodies have to be reformulated

"Once one has too many debts, one stops worrying about them.” This Chinese saying exhorts people not to worry about things that can’t be helped. In the past few years, this has been used by Chinese media to describe China’s heavily indebted local governments. The central government, however, clearly does not subscribe to this mantra.

At a Tsinghua University forum on April 24, 2015, Finance Minister Lou Jiwei warned that in the next five to 10 years China has no more than a 50 percent chance of avoiding the so-called “middle-income trap,” referring to a lack of the dynamism needed to transform a middle-income country into a truly developed one. His words immediately appeared in headlines and triggered considerable debate, including disputes about whether or not such a trap even exists. However, there is little controversy regarding the major risks Lou listed that, if not urgently addressed, could halt China’s growth. Partly because of the rapid increase in local governments’ debt since 2008, he noted, the country’s total debt burden reached 193 percent of current GDP, a rate higher than that recorded in the debt-ridden EU.

The imprudence of China’s local governments is thought to be based on the widespread and reasonable assumption that the central government has to come to the rescue with taxpayers’ money once local governments’ debts threaten the banking sector and, in turn, drag the whole economy into a financial crisis that could cause a global shockwave. However, if the central government condones this presumption, it would undoubtedly find itself stuck in another trap, the so-called “moral hazard” of incentivizing risk-taking because said risk-takers know their problems will ultimately become someone else’s burden. This is exactly why local governments borrowed more than they could repay in the first place.

Reshuffling the entire fiscal system has been placed high on the Party’s agenda for renewed reform. As in previous rounds, the latest reform plan involves redefining administrative responsibilities and the allocation of fiscal resources between and within different levels of government. Besides this, principles of how the government can collect and use public money will be reformulated.

The project is supposed to be based on and at the same time facilitate the establishment of a full-fledged legal framework for the fiscal system. This is regarded as the most fundamental departure from the practices in place since the decades prior to the last round of fiscal reform in 1993, during which changes in fiscal policy were largely a closed-door game within the administrative system. Legislative efforts to establish fiscal laws have gathered steam recently – there is an expectation of more new legislation in this area. The reform is not about small, technical fixes, but about restructuring the legal framework concerning the relationships between the central and local governments, as well as between the cabinet, taxpayers and legislators.

To achieve this policy shift, there are growing calls to set overriding principles for the legislation and implementation of fiscal laws, and combat the weak enforcement of existing principles.

Principles Prevail

Principles matter the most in the legislative process of establishing a code of fiscal law. The review of China’s Budget Law started in 2004, but was not completed until 2014. “The division on whether the purpose of the law is to ‘facilitate’ or ‘supervise’ the government’s use of public funds had been going on for 10 years,” said Yin Zhongqing, a member of the budget review office with the Financial and Economic Committee of National People’s Congress (NPC), China’s top legislative body. The latter finally prevailed in its drafting of the new law, putting government spending under legislative scrutiny for the first time. The old Budget Law, effective since 1995, treated budget spending as a tool of macroeconomic policy to be wielded at the discretion of economic planners. Changing this is now recognized as prudent for the law’s revision.

In March 2015, the government also revised China’s Legislation Law, which dictates how laws come into being and which groups hold legislative power. Changes in the principles concerning tax collection, the main source of government revenue, were regarded by society and legislators as the most significant amendment. For the first time, it is stated clearly that only legislators, not the government as a whole, can decide whether and how a tax should be levied. A dramatic interruption to the ratification process illustrates the difficult struggle behind this revision. On March 8, legislators gathering in Beijing for the annual NPC session found that the rate of taxation was missing from the list of tax issues subject to legal review in the new draft of the Legislation Law, while it was included in the earlier list. This was strongly opposed by the public and by many legislators. Four days later, the rate was once again included in what became the new Legislation Law.

Changes of principles on paper have led to practical changes on the ground. Local governments in China used to set up companies to borrow money, keeping these loans off the books. In this way, they not only circumvented the borrowing ban imposed by the old Budget Law, they also took advantage of weak oversight over public spending under the old law. Thanks to the new law, the Ministry of Finance announced a US$327 billion bond package that will be issued by local provincial governments by June 10. These funds will be used only to repay loans taken out prior to June 30, 2013, and those that will mature in 2015. The use of this money, and any new loans for any purpose, will be on the books and follow the transparency requirements enshrined in the new Budget Law. The legislation of laws on particular taxes, such as the property tax, will also be accelerated and conducted by the legislators of the NPC. Tax increases put in place on short notice, a common practice for years, were immediately questioned by media right before and after the Legislation Law was revised.

The Law of Laws

However, experts say more principles need to be defined. For example, should fees charged by local governments, like social insurance payments, be included in tax packages governed by laws? If so, should such fees be legally turned into taxes and brought to light, just as issuing bonds has revealed the hidden debts of local governments? Should the National Audit Office report to the legislative NPC instead of to China’s cabinet, the State Council, in order to guarantee the independence of auditors? What if an article of taxation law can be interpreted in different ways and, depending on which principle is followed, therefore lean in favor of either administrative agencies or taxpayers?

All these questions have to be answered, as Xu Shanda, director of think tank SEEC Institute of Finance and Economics and former vice director of the State Administration of Taxation, told NewsChina.

Although the new Budget Law puts all four sources of fiscal funding at the government’s disposal – taxes, non-tax fees, returns from State-owned assets and social insurance funds – under the scrutiny of legislators and the public, some components of these four categories are still missing. For example, the law does not cover local State-owned enterprises. Moreover, it is very common for non-governmental public institutions, such as schools and industrial associations, to rent out State-owned buildings to restaurants and companies and keep the resulting profits off the books. Any gains from the operation of these assets remain out of the reach of the new Budget Law. “The principles of dealing with all fiscal revenues and spending, and disposal of all State-owned assets and public debts, must be clarified,” Shanghai University of Finance and Economics professor Jiang Hong told NewsChina.

Another issue underlying reform of the fiscal system is the restructuring of the hierarchy of power and obligations at all levels of government. This has been made the priority of China’s ongoing reform. As Finance Minister Lou Jiwei explained in his article in Party mouthpiece the People’s Daily on December 1, 2014 , “who does what” changes frequently, increasing negotiation costs and impacting on the reliability of public services. Worse still, central and local governments often do the other’s job. For example, Lou said, affairs involving national interests and the free flow of public resources – such as river pollution, ocean management and food safety – are delegated to fragmented local jurisdictions, while the central government intervenes in services that local governments know how to manage much better, such as building water supplies, constructing decent sewage systems in rural areas or establishing public kindergartens. In 2013, budgetary spending at the central level accounted for 14.6 percent of the country’s total, compared with the 46 percent average seen in OECD countries. The result, he concluded, is holding back the development of a unified market, equal justice and universal public services.

The consensus is that the only thing that can underwrite these principles and resolve all issues relating to fiscal affairs is the law, and the division is only between whether there should be a single separate law for this purpose, or whether new principles should be integrated into relevant existing or upcoming laws. Mainstream opinion seems to lean toward the former. Legal scholars and government officials have gathered at recent forums to discuss the possibility of drafting a new Basic Fiscal or Fiscal Law. As Peking University’s professor Liu Jianwen wrote in his article in the January 28 edition of the Chinese Academy of Social Sciences journal Chinese Social Sciences Today, all other laws on fiscal affairs will have to follow the principles of the new Basic Fiscal Law, which will define the relationship between the government, the legislature and taxpayers, thus guiding fiscal reform.


In the meantime, some basic principles that are already embedded in new laws have been watered down, impacting the authority of legislators.

Transparency is at the heart of the new Budget Law. It is stated in the new law that budgets have to be open to the public within 20 days after they are approved by legislators. However, which items should be opened is not specified clearly enough. This makes it difficult for the public to track public funding, noted Professor Jiang Hong. For example, spending is roughly classified either by purpose (agriculture, healthcare and public security), or by accounting standards (salaries, the purchasing of goods and services and operation expenses for fixed assets). It is not definite which categories will be publicly accessible and which will not.

This apparently could hamper the ability of fiscal policy to boost the economy. Since 2014, Chinese Premier Li Keqiang has repeatedly urged to awaken China’s pool of “sleeping money,” or funds that have already been allocated for designated projects but were left idle for years for various reasons. For example, a research team may have applied for more funds than it actually used, or money originally earmarked for an investment project ultimately couldn’t be used because market conditions had changed. Earlier this year, China’s National Audit Office announced that, in nine provinces and nine cities, 30 percent of funding for the fiscal year 2013 could no longer be used for its original purpose. However, without exposing more details of government budgets to the public, such wastage can still occur. Several campaigns have been launched over the years to find out how much sleeping money there is in China, and why it is being kept dormant.

Budget review office member Yin Zhongqing stressed that local legislators should assess budget accounts, including the budgets of construction projects, not only in terms of legal compliance, but also in terms of efficiency. He also recognized that local legislators need more training on how to utilize the new Budget Law. In almost every NPC annual session in the past few years, legislators have repeatedly complained about elusive budget reports. While urging fiscal officials to disclose more details with simpler explanations, the public has also begun to ask why legislators seem not to have made an effort to acquire the skills necessary to do their jobs.

Another lingering and more fundamental problem for legislators is that they have devolved too much power to administrators. For example, Professor Jiang Hong noted, any spending should be open to review by legislators, however, in practice, changes are often made without review. By striking their own duties, he claimed, legislators have not only undermined the core principle of transparency embedded in the law, but also their own authority.

Lawmakers’ authority over their most important task – writing and enacting legislation – also needs to be strengthened. The administrative branch of government has long dominated the drafting and even definition of laws. The resolution on the rule of law passed in the Party’s October plenary session recognized that this imbalance has led to competition for power, as well as the neglect of some government agencies’ responsibilities, and vowed to change this. There are strong calls from academics and the public for the NPC or its standing committee to take responsibility for drafting the proposed Basic Fiscal Law and other laws on specific fiscal issues, such as tax legislation.

China University of Political Science and Law professor Li Shuguang explained to NewsChina that, on one hand, administrative agencies still hold firsthand, real-time and crucial information, while legislators, who may lack professional experience in a particular area, may not even know what data they should be asking for. On the other hand, civil servants, mostly technical bureaucrats, do not have the training in legal issues and the reciprocal principle of rights and obligations that most legislators specialize in. Moreover, Li added, third-party think tanks and private information providers are still too weak to be of much help.

The most realistic choice, Li believes, is to improve cooperation between legislative and administrative bodies. What legislators can (and must) do now to gain more heft, he stressed, is to keep pushing information disclosure. This is particularly important for application of the proposed Basic Fiscal Law and other related legislation, because, as Li puts it, “fiscal affairs are all about details.” For example, with regard to administrative spending, the NPC should work out a timetable on how much and what kind of information can be made available to the public, and explain why some information must remain undisclosed. Professor Li and other academics we spoke to agreed that listening to the public and experts also helps relieve the pressure on government agencies.

The drafting, ratification and implementation of new laws will be a test for China’s massive fiscal reform package, however, this program can only be guided by the law. 


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