6 Prospect of Fiscal Policy

1. Meet New Challenges and Opportunities at a Citical Stage

2. Consolidate Fiscal Control Through Enhanced Fiscal Strength

3. Promote All-round, Coordinated, and Sustainable Development by Mobilizing Various Fiscal Policy Measures

4. Build a Harmonious Society by Bringing into Play the Role of Public Finance

5. Shore up Economic Restructuring and Promote Innovation in the Fiscal System

For china, the first two decades of this century will be an important stage, full of strategic opportunities, which should be firmly seized upon to make significant progress. During this period, the Chinese government will pool its resources to work toward a well-off society, in such a way that will allow the country to achieve a more developed economy, a more advanced social community, and a more flourishing culture for its wealthier population. The government will also strive to build up a society that has a democratic legal framework, equity and justice, integrity and fraternity, one that is brimming with vitality, where security and order prevail, and where humanity and nature coexist harmoniously. To achieve these grand goals, China will quicken its pace of industrialization, urbanization, and marketization. As it works to optimize structure, enhance efficiency, and lower costs, the government will continue to maintain a sustained, steady, and rapid economic growth, in an effort to achieve, by 2020, its goal of quadrupling the GDP of 2000. While constantly building on its national economic strength, the government will work hard to lay a solid foundation for raising people’s living standards, promoting the progress of social undertakings, and building a harmonious society. It is also important that China will put into place an improved socialist market economy and a more dynamic and open economic system and advance its strategic economic restructuring efforts, so as to markedly reduce gaps between industrial workers and farmers, urban and rural areas, and different regions. This will contribute to adequate employment and better social security. The government will also promote a transformation of the mode of economic growth, intensify environmental protection, and vigorously develop a recycling economy so as to achieve all-round, coordinated, and sustainable socioeconomic development. As departments of coordinating the country’s economic management, the fiscal authorities need to consider China’s overall economic and social situation in the context of globalization. To improve the public financial system, they should set their policies based on domestic and international economic conditions and the scientific approach to development. They should also try to be more flexible in using various fiscal policy tools and be effective in implementing fiscal policy. All these will enable the fiscal authorities to play a better role in building a well-off, harmonious socialist society.

1. Meet New Challenges and Opportunities at a Citical Stage

Both international and domestic economic developments show that China’s reform and development have reached a critical stage. There are both opportunities and challenges for its fiscal reform and development.

1.1 New Strategic Goals and Missions for Economic and Social Development

Between 2006 and 2010, the Chinese government will implement its Eleventh Five-Year Plan for National Economic and Social Development. During this period, China will face a broadly favorable environment both at home and abroad. However, there are many uncertain and unstable factors in the international environment. China’s economic and social reforms may also face some problems.

From an international perspective, the world economy, which has picked up speed in its recovery since the second half of 2003, is now entering a phase of steady growth. Economic globalization accelerates and science and technology improves everyday. The flow of production factors and industrial relocation revs up. Having become more integrated with the world economy, the Chinese economy is enjoying a favorable external environment for its growth in general.

However, factors hindering world peace and development are on the rise. One of them is the mounting imbalance of world economic development, in view of the fact that developed countries will continue for quite some time to maintain their advantages in economic development and science and technology. International competition is getting fiercer, resulting in the resurrection of trade protectionism in new manifestations. These will pose new challenges to China’s economic and social development.

Domestically, after over 20 years of reform and opening-up, the Chinese economy is growing rapidly. China’s overall national strength is rising constantly, and the socialist market economic system continues to improve. All these have paved the way for the country’s future economic development. Presently the Chinese economy is entering into a new round of steady growth, in which residents’ consumption pattern improves, industrial restructuring and urbanization accelerate, and national savings rates remain high. On top of that, infrastructure will continue to improve, and science, technology, and education will advance soundly in the context of political and economic stability. In addition, China will maintain its obvious advantages in labor resources.

Nonetheless, while making rapid social and economic progress, China is still confronted with some deep-rooted conflicts and problems. The mode of low efficiency and resource intensive economic growth has yet to be changed fundamentally. The economic structure still retains some problems, and its ability for innovation needs to be strengthened. Together with the imbalanced development between urban and rural areas and among different regions in China, the widening income gap between certain social groups and relatively high unemployment pressure will also persist. Furthermore, the development of social undertakings has yet to be expedited and the increasingly acute conflicts between social progress and economic development, and between resources and environment need to be addressed.

Having taken into full account these issues, the Chinese government has set the following main objectives for the Eleventh Five-Year Plan (2006–2010): maintaining stable macro economic operations, achieving an annual GDP growth of 7.5%, doubling the GDP of 2000 by 2010, creating jobs for 45 million urban residents and 45 million rural migrants, stabilizing price levels, and sustaining a basic balance in international payments. To attain these objectives, the government will strive to optimize and upgrade the industrial structure, substantially enhance resource efficiency, gradually balance rural and urban development, and work for a noticeable improvement in basic public services. The country’s capacity for sustainable development will thus be strengthened, and its market economic structure will be optimized. This will in turn further raise living standards, and score new achievements in building democratic and legal systems and developing advanced culture and ethics.

1.2 New Opportunities and Challenges for Fiscal Regulation

Fiscal management provides important resources, policy tools, and institutions for the development of a country. All the general objectives and strategic missions set out in the Eleventh Five-Year Plan are directly and indirectly related to fiscal reform and development. Specifically, MOF will shoulder a crucial responsibility in further improving the country’s fiscal policy, deepening its fiscal and tax reforms, improving the functions of public finance, and promoting all-round, coordinated, and sustainable economic and social growth. Viewed from the perspective of overall economic development and improvement of public finance, there will be both opportunities and challenges in the government’s effort to strengthen and improve its macro control in fiscal policy in future.

Let us consider the opportunities. First, China’s continuously improved socialist market economic system and its sustained, steady, and rapid national economic growth will provide room for the implementation of its fiscal policy. Second, the preliminary establishment of a public finance framework and the improved functioning of public finance offer an effective institutional guarantee for fiscal control. Third, the phenomenal growth of fiscal revenue, the increasing fiscal strength, and the notably enhanced regulatory role of the central budget since the initiation of fiscal and tax reforms in 1994 provide a solid foundation for more flexible utilization of fiscal tools. Fourth, China has accumulated rich experience for conducting discretionary fiscal control in light of macroeconomic developments in the process of opening-up and reform. In particular, over the past decade, timely shifts have been made in fiscal policy, from moderately tight, to proactive, and then to prudent. These shifts have helped China effectively iron out economic fluctuations.

As far as challenges are concerned, attention should first of all be paid to various new issues, which will crop up in carrying out the following strategic missions: implementing the scientific approach to development, building a harmonious, well-off socialist society, cracking “hard nuts” in reforms, promoting innovation, improving the socialist market economic system, and working toward a resource-efficient and environment-friendly society. Second, the potential risk factors in the world economy, together with some deep-seated institutional elements that restrict domestic socioeconomic development, will pose great challenges to the implementation of fiscal policy. Third, risks from all aspects of society are shifting toward the fiscal area. Fiscal risks, implicit ones in particular, are increasing. Fourth, building a good public financial system still remains an arduous mission. There is a need to improve both the tax system and the management system for non-tax incomes. It is also essential to continuously optimize the fiscal expenditure structure, and standardize the fiscal management system, especially that below the provincial level. All these challenges call for the fiscal authorities to speed up their self-improvement efforts.

1.3 Four Relationships that Need to be Properly Handled in Fiscal Control

In the face of the new changes and missions, the central government must carefully handle the four relationships, as described below, in order to optimize China’s fiscal policy, strengthen and improve its fiscal control.

First, the relationship between reform, development, and stability should be effectively managed. They are dialectically unified: reform is the driving force, development is the goal, and stability is the premise. Therefore, the relationship between them must be properly addressed in a way that will harmonize the magnitude of reform, the pace of development, and the stability of society. Thus, reform and development can be achieved while social stability is maintained, and social stability can also be promoted through reform and development. This is the key to building a prosperous, harmonious society. The central government needs to bring into full play the role of reform as a driver of economic growth since development can help address current major social conflicts and issues and maintain social stability, which will in turn cultivate a harmonious social environment for reform and development. Fiscal policy should not only iron out economic fluctuations to boost sustained, rapid economic growth, but also step up its support for all reform initiatives that are designed to improve the market economic system, safeguard, actualize, and promote the interests of the people, and maintain social harmony and stability.

Second, the relationship between fiscal control and the role of market mechanisms should be well handled. To improve fiscal policy and exercise fiscal control, the relationship between government function and market mechanisms must be correctly handled. A basic task of China’s economic reform is to accomplish a fundamental transformation from a central planned to a socialist market economy. In a market economy, the market is given its fullest play, while the government does not intervene, unless it really needs to do so. Market mechanisms play a fundamental role in resource allocation, while government macro control measures work merely as a guide or supplement. Therefore, fiscal control should contribute to the formation and improvement of the market economic system.

Third, the relationship between economic growth and fiscal sustainability must be dealt with rationally. Economic growth needs fiscal support, while fiscal support must take into account the capacity of the state’s total revenue. Over the past few years, fiscal policy has played a considerable role in bolstering steady economic development. However, it has also led to rising deficit and mounting debt. The Chinese government has been working hard to bring the country’s fiscal deficit and explicit liability under control. Effective measures have been taken to clear implicit and contingent liabilities. As a result, China’s liability risk has so far been kept within manageable levels. Over the next few years, while rendering active support for overall, coordinated, and sustainable economic growth, the fiscal budget should also seek improvement of its own sustainability. Effort will be made to prevent and defuse fiscal risks by setting up a government mechanism for liability monitoring and warning and keeping a reasonable size and maturity structure for various liabilities. It is also important to improve the social security system, bolster reform in the financial system, eliminate all kinds of implicit and contingent liabilities, and pay more attention to analyzing and resolving the contingent liabilities of local governments.

Fourth, the relationship between domestic development and opening up to the outside world also needs to be rationalized. As China deepens its reform and further opens to the outside world, its economy is becoming more and more integrated with the global economy. China’s WTO accession has enabled its economy to participate in international competition and cooperation at a higher level and a greater magnitude. Profound changes have taken place in the external environment for China’s economic development. However, it should be noted that economic globalization is a double-edged sword that brings about both more opportunities and challenges, requiring all governments in the world to be more efficient in economic management, especially in fiscal control. As an important force of safeguarding national economic safety, fiscal operations must prioritize the task of putting in place a sound mechanism for fending off all kinds of external risks and coping with external shocks. As a major tool of resource allocation, fiscal policy must be committed to creating an environment of fair and equitable competition both at home and abroad to better exploit domestic market and further expand international market. An international perspective must be taken in the design, formulation, and implementation of China’s fiscal policy. Only thus can it conform to international treaties, rules, and norms, and comply with the principles of market economy and the rules of globalization, creating a highly efficient and equitable environment for market players and providing them with accurate policy signals and timely forecasts of future developments.

2. Consolidate Fiscal Control Through Enhanced Fiscal Strength

Solid fiscal strength is an important indicator of a strong, stable, and safe country, and is also the platform for a government to effectively exercise macro control, overcome difficulties, and ward off risks. To build a well-off society, China needs to develop its economy and enhance its fiscal strength in a balanced manner, which will then contribute significantly to its social prosperity and stability.

2.1 Give Top Priority to Development in Governing and Rejuvenating the Nation, and Enlarge the Economic Scale

Economic scale determines revenue, and revenue in turn affects economic operations. An old Chinese proverb goes, “Accumulate wealth by correct means. Have more wealth makers than consumers. Wealth makers are keen, while wealth consumers are prudent. If this is the case, there will always be sufficient wealth.” Economy is the foundation of public finance and economic growth can create ample revenue. To make a bigger revenue pie, it is essential to sustain coordinated economic growth. Therefore, a bigger economic pie precedes a bigger revenue pie. In a socialist market economy, fiscal policy, as a major instrument for the government to perform macro control, must shore up economic development. This is true of all market economies. One important mission for fiscal control is to promote economic growth that in turn helps better the fiscal operations. However, supporting economic development through fiscal means does not mean reverting to the centrally planned economy under which the state directly invests in and manages specific companies and projects, nor does it mean resuming the old method of applying tax reduction and revenue sharing merely to SOEs. Rather it means managing and regulating the economy by deftly using economic levers and other indirect instruments in compliance with the rules of the market economy. Various policy instruments, including treasury bonds, taxation, financial credit, and subsidies, need to be employed to promote the role of fiscal and monetary policies in exercising macro control and create a fair, open, and relaxing fiscal environment. This will stimulate companies to seek business growth, fuel economic development, and transform the pattern of economic growth toward higher efficiency and steady progress. The functional role of fiscal policy should be brought into full play in conjunction with monetary policy and other macroeconomic policies in order to achieve steady and fast economic growth. It is estimated that China’s GDP will expand to about 30 trillion yuan in 2010 from 18.2 trillion yuan in 2005, and the per capita GDP will hit about 23,000 yuan in 2010 from 13,985 yuan in 2005 (Exhibit 6.1).

First, effort should be made to promote the transformation of the mode of economic growth. The fiscal authorities will start with system reform and policy refinement in order to abandon the mode of extensive growth for an intensive development mode. A sound fiscal system, in which the government’s fiscal strength is made to match its administrative assignment, must be established and improved. In line with the principle of equalizing basic public

services, a scientific and standard transfer payment system should be established to prevent local governments from undertaking redundant projects and so-called “projects for keeping face” or “image projects” that waste manpower and money. From the policy perspective, the lever role of fiscal and tax policies must be given full play, so as to shape up a factor-pricing mechanism that reflects the situation of market supply and demand, as well as the scarcity of different resources. A circular economy should be vigorously promoted, as it can help save energy, water, land, raw materials, and other resources, and contribute to a comprehensive utilization of resources. The aim is to encourage less consumption, recycle production “waste,” and put into place a mode of development featuring low input, low energy consumption, low pollution, and high output. To this end, it is necessary to consider the feasibility of levying new taxes on resource, fuel, property, and other items to facilitate the shift from extensive to intensive economic growth.

Second, active support and proper guidance should be extended to non-state-owned sectors of the economy. The fiscal authorities are committed to creating a policy environment for companies operating under diverse forms of ownership to compete on a level ground and enjoy fair and equal treatment in taxation. Great effort must be made to create a legal, policy-driven, and market-oriented environment of fair and equal competition, in which both state-owned and non-state-owned companies can go by the same rules of the game. This will in turn promote sustained, sound, and rapid development of the national economy. The development of tertiary industry should also be given vigorous support, so that, by 2010, the proportion of its value added in total GDP will be increased by three percentage points over 2005. Adhering to the policy of opening-up, MOF will continue its active efforts to nurture a sound investment climate and guide and encourage foreign-invested companies to explore new development opportunities in China.

Third, the corporate capacity for innovation has to be enhanced. Enterprises are the most basic players in a market economy, and their vitality is a major driver of economic development. Enhanced corporate capacity for development and innovation not only ensures adequate state revenue, but also provides a fundamental guarantee for making a big economic pie. Fiscal policy should emphasize the enhancement of corporate capacity for innovation and render strong support to their technological innovative efforts, including original innovation, integrated innovation, and reinnovation based on imported and absorbed technologies. It should also encourage enterprises to train employees, improve intellectual property rights protection, and promote technical consulting, technological transfer, and the commercialization of research findings. The government procurement policy can also be used to stimulate corporate technological renovation. Incentive schemes including fiscal and taxation measures will be adopted, raising the proportion of research and development (R&D) expenses in GDP by 0.5 to 0.7 percentage points in five years time, reaching 2% of GDP by the end of 2010.

2.2 Improve the Revenue Policy Framework to Enlarge Fiscal Revenue

China’s fiscal revenue has expanded rapidly over the past few years, considerably contributing to the development of social and economic undertakings. However, looking ahead, it remains an arduous task to enlarge the fiscal pie and realize steady revenue growth, which are of great strategic importance.

First, fiscal expenditure is under substantial pressure. There is still a long way to go before sustainable development, economic restructuring, and institutional reform can be accomplished in accordance with the concept of “Five Balances.” Urgent measures must be taken to address those weak links in economic and social development.

Second, in terms of revenue-generating capacity, even though there has been rapid growth in the past few years, there is still potential for greater growth, especially in non-tax revenue. Some due taxes have not been collected in time or in full. Collection and management must therefore be tightened in order to promote a steady revenue rise. To this end, the Chinese government will continue to adopt earnest and effective measures to build up its fiscal resources. It is predicted that China’s fiscal revenue will see an average annual growth of 11% in the coming five years. By 2010, the national fiscal revenue is expected to reach about six trillion yuan or 18% to 20% of GDP, laying solid groundwork for the effective implementation of fiscal policy (Exhibit 6.2).

2.2.1 Improve and standardize the revenue system

First, the major taxes will continue to play a dominant role. In line with the principle of “simplifying the taxation system, widening the tax base, lowering tax rates, and conducting stringent tax collection and management,” VAT and income tax should be further improved by highlighting their position as major taxes and increasing their contributions to the state revenue. A relatively relaxing and fair fiscal

and tax environment will be created, through further reform of the tax system, for market players to boost economic growth. This, together with an improved economic structure, will increase the fiscal revenue and consolidate the mechanism for maintaining long-term stable revenue growth.

The second attempt is to introduce new taxes befittingly. This includes turning some administrative charges into regular taxes when applicable, i.e. putting the fuel tax into practice in due time, promoting the steady reform of the property tax, and exploring the possibility of converting social insurance premium into social security tax, and studying the feasibility of levying inheritance and grant taxes in light of the requirements of socioeconomic development and the need to narrow the disparity in income distribution. These policy measures will give more impetus to the fast growth of fiscal revenue.

The third effort is to fully tap the potential of non-tax revenue. The management of administrative charges and government funds should continue to be standardized. At the same time, effective steps have to be taken to strengthen the collection and management of the user fees of state resources, state asset (capital) gains, franchise charges, and other governmental non-tax revenues. Efforts must be stepped up to push for further reform in the collection and management of non-tax revenue. Drawing on the international practices in managing non-tax revenues, the fiscal authorities will work in stages to collect all non-tax incomes, and bring them under budgetary control. This will promote a sustained, rapid increase of various government non-tax incomes, making it possible to have a big fiscal pie.

2.2.2 Increase the efficiency of tax collection and management

A big fiscal pie will not be guaranteed unless vigorous efforts are made to “accumulate wealth by effective means,” such as collecting taxes according to law, managing taxation in a more scientific and standardized way, and heightening the efficiency of tax collection and management.

First, taxes must be collected and managed according to law. All tax laws, regulations, and policies must be strictly enforced. Tax reduction and exemption must be subject to strict authorization. Disguised tax reductions and exemptions, such as the policies of collecting taxes at first and paying them back to taxpayers later, must be firmly curbed and rectified. Fiscal revenue should be accumulated in accordance with the law. It is necessary to follow the concept that stringent and impartial law enforcement is a basic service to taxpayers, and also a support for economic development. This will assist the efforts to stop indiscriminate acts in the administration and enforcement of taxation laws, fully protect the legitimate interests of taxpayers, and collect and manage taxes according to law.

Second, tax management must be tightened. A scientific and rigorous management system must be put into place, through which unified standards and procedures will be followed in tax management, collectors’ duties and performance evaluation as well as rewarding and punishing measures will be clearly specified and made highly feasible. The new computer network-based system for tax collection and management needs further improvement, whereby taxpayers submit tax returns by themselves, while the tax authorities conduct focused investigation. An array of tax collecting and managing methods may be explored under a mode of centralized tax collection and management.

Third, tax collection needs to be further straightened out and standardized. Effort should be doubled to investigate and publish tax-related illegal cases. The authorities will crack down on the illegal practice of issuing and accepting fake VAT invoices. More severe punishment will be meted out to those who commit export tax rebate frauds, and other major tax-evading activities through falsified accounts. Special and focused campaigns will be launched on a regular basis to improve the order of taxation.

3. Promote All-round, Coordinated, and Sustainable Development by Mobilizing Various Fiscal Policy Measures

A scientific approach to development is essential to the goal of building a well-off, harmonious society. It is also a key objective for fiscal policy and fiscal control. Over the next few years, the government will stick to this approach by focusing its effort on some very important sectors that have immediate bearings on the balanced development of social and economic undertakings. Different policy measures, such as taxation, subsidies, and fiscal input, will be adopted to address the problems of agriculture, rural areas, and farmers, promote coordinated development among different regions, build a resource-efficient and environment-friendly society, and balance domestic development and opening-up. All these efforts are designed to advance social and economic development in an all-round, coordinated, and sustainable manner.

3.1 Address Problems of Agriculture, Rural Areas, and Farmers to Balance Rural and Urban Development

Agriculture underlies economic development and social stability. It is a strategic sector that can pacify popular sentiment and promote social progress. At the same time, agricultural production integrates natural reproduction with social reproduction, making it a disadvantaged sector with low profit margins. In the past few years, Chinese agriculture has achieved a historic shift from long-term scarcity in supply to general equilibrium, and then a surplus in years of bumper harvest. However, conflicts still remain, hindering agricultural growth, rural progress, and increase of farmers’ income. The evolution of world economy shows that in the beginning of industrialization, agriculture supports industry; and when industrialization reaches a certain level, industry begins to reward agriculture and urban areas lend support to rural areas. China is currently at the latter stage where industry subsidizes agricultural growth, and urban development propels rural growth. The government should, therefore, follow the trend by increasing its support for rural areas through a series of measures, such as reorienting fiscal policy. Between 2006 and 2010, China will relocate 45 million rural laborers, raise the urbanization rate by four percentage points from the current level of 43%, and increase the per capita net income of rural residents by some 5% per year (Exhibit 6.3).

First, in strict accordance with the principle of “taking less, increasing input, and deregulating more,” the government will further optimize the system for supporting agriculture to ensure a steady increase in agriculture-supporting funds. Second, following the complete abolishment of agricultural taxes, the government will vigorously promote comprehensive rural reforms that target the township governance, the administrative system of rural compulsory education, and the fiscal system at county and township levels, so as to ease the financial difficulties of county and township governments and stimulate rural development. Third, the coverage of public finance in rural areas will be expanded and input in rural

infrastructure will be increased. Moreover, the government will take steps to unify rural and urban markets in terms of labor, capital, and land resources, and establish systems for labor and employment, household registration, compulsory education, and social security that cover both rural and urban areas. Through industrialization, urbanization, and marketization, the vast number of farmers will gradually integrate into the overall development process, and the goal of balancing rural and urban development will be realized.

3.2 Bridge the Regional Gap and Propel Coordinated Development

Since its opening-up and reform, China has initiated a series of development strategies, including a coastal development strategy, a strategy to develop the western region, a strategy to rejuvenate old industrial bases in Northeast China, and a strategy to support the rise of Central China. These strategies are designed to promote interaction, complementary relationships, and common development. The general guideline for implementing these strategies is to bring into full play the role of market mechanisms and the comparative advantages of different regions, so that the government can effectively regulate the economy and supervise the market. In view of regional disparities in the economic growth pattern, resources, and developmental features, the fiscal authorities should adapt their strategies to different regions. Measures, such as restructuring fiscal expenditure and long-term construction treasury bonds investment and increasing transfer payments, will be used to narrow the inter-regional economic gap and promote coordinated regional development.

Fiscal support for the grand strategy of developing China’s western region will focus more on “protection and development,” namely, accelerating infrastructure construction, strengthening ecological and environmental protection, reinforcing agricultural and industrial restructuring, developing science, education, culture, and healthcare, improving living and production conditions, and ensuring the availability of basic public services in underdeveloped areas. In addition, through state support, local efforts, and regional coordination, more fiscal measures will be taken to encourage the western region to speed up reforms and build up its strength of independent development.

Fiscal support for rejuvenating old industrial bases in Northeast China will concentrate on “reform and reorientation,” with more effort to deepen reforms. Old industrial bases are regions where the planned economic system has been deeply entrenched, constituting the biggest obstacle for development. As a result, reform measures, such as lightening the burdens on enterprises and undertaking technological upgrading, are hard to make inroads, and may even result in inappropriate protection of outdated industries and delay the reform process. Therefore, fiscal policy measures for the area will focus more on corporate restructuring to eliminate outdated systems, and on strategic economic restructuring. Through industrial restructuring and reorganizing of large enterprises with unlimited responsibilities, the scale of SOEs in the economy will be reduced. At the same time, secondary industry will gradually give way to tertiary industry in city centers. Moreover, the property rights of these old bases should be clearly defined with a flexible mechanism put into place and their market competitiveness enhanced. This will create greater space for economic growth, allowing them to better adapt to the trends of economic globalization, and international industrial development.

Fiscal support for the coastal region of eastern China will continue to encourage institutional innovation, accelerate economic growth, and enhance its ability to stimulate and drive the economic development in central and western areas. The government will support the eastern region’s efforts to stay ahead in building up its capability for self innovation, optimizing economic structure, shifting the mode of economic growth, and improving the socialist market economic system. The eastern region should quicken the pace of developing a group of independent intellectual property rights, core technologies, and brand names, making it possible to enhance industrial quality and competitiveness. Priority will be given to developing advanced manufacturing, high-tech industry and the service sector, with special attention to refined processing and highend products. Effort will be made to upgrade the processing trade, actively promote the shift toward high-tech and service industries, and heighten the quality of the region’s export-oriented economy.

The government will increase its fiscal support through more transfer payments to underdeveloped areas, remote border areas, and minority regions. This includes measures to protect the local ecology, improve the infrastructure, develop preschool education, popularize compulsory education, strengthen higher education for minority groups and minority regions, set up communities of traditional minority cultures, and encourage more minority publications. In addition, support will also be extended to the development of ethnic industries, such as production of ethnic goods and pharmaceuticals. Priority will be given to alleviating poverty and promoting socioeconomic development in the extremely poor and sparsely populated minority regions.

3.3 Build a Resource-Efficient and Environment-Friendly Society to Achieve Harmony between Man and Nature

As China accelerates its pace of building a prosperous society and as its economic scale expands, more pressure will be put on the country’s resources and environment. Therefore, building a resource-efficient and environment-friendly society has become an important task in China’s strategy of seeking sustainable development. Central finance should take full advantage of such policy measures as budget, tax, charges, subsidies, and government procurement, to ensure resource sustainability through diversification, conservation, and protection in the course of resource exploration, production, utilization, and consumption. This will promote the implementation of its mid- and long-range strategic plans and policies for improving resource conditions. Under the joint effects of fiscal, tax, investment, financial, and industrial policies, resource efficiency will be constantly enhanced. During the 2006–2010 period, energy consumption per unit of GDP will be reduced by 20%, water consumption per unit of industrial value added will decrease by 30%, the coefficient of water efficiency in agricultural irrigation will rise by 0.05 points, the recycling rate of industrial solid waste will increase by 4.2 percentage points, and the total emission volume of major pollutants will decline by 10% (Exhibit 6.4).

First, energetic support will be given to prospecting, exploiting, and protecting resources, so as to effectively expand their supply. The government will invest more in R&D for resource exploitation, in order to diversify the pattern of resource supply. An accountability system will be introduced in mining companies to improve the environment and ecology in mining areas. The current system for

managing mining rights will also need to be revamped so that the “dual-track” system of paid and free acquisition of mining rights will be unified into one single system of paid acquisition.

Second, resource conservation in production will be vigorously promoted so as to raise resource efficiency. The government will increase its fiscal support for key technological breakthroughs in energy conservation and comprehensive energy utilization, and establish a system of technical guarantees for this purpose. Companies are encouraged through tax incentives to invest more in R&D for energy conservation, technical innovation, and comprehensive resource utilization.

Third, resource consumption needs to be properly geared to cultivate a resource-saving culture. The government may subsidize the purchase of energy-efficient products in line with international experience, and expand the tax base of consumption tax to encourage rational consumers and curb wasteful or luxurious consumption. On top of that, it will optimize the government procurement system to purchase more energy-efficient products.

Fourth, a strategic plan and policy system for energy saving will be formulated and improved. Developing a resource-efficient community is a long-term strategic task for the Chinese government, and also a basic national policy. Therefore, while working hard to increase revenue and curb expenditure, the government should take the initiative to formulate, on the basis of research, a strategic plan and a policy system for resource efficiency so as to establish a long-term resource-conservation mechanism.

3.4 Shore up Efforts to Coordinate Domestic Growth and Opening-up in the Face of Economic Globalization

As China carries on its reform and opening-up, the influence of economic globalization on its fiscal policy is becoming all the more salient. Questions, such as how to better use domestic and foreign markets and resources in the face of economic globalization and how to perfect the socialist market economy, have become important agendas for China’s fiscal reform and growth. China will increase the depth and width of its opening-up, work for a balance between domestic growth and opening-up, and promote the shift from quantity increase to quality rise in foreign trade through various policy measures such as tax and subsidies. By 2010, China’s total volume of trade in goods and services is expected to reach US$2.3 trillion and US$400 billion respectively.

First, tariff policies will be properly used to safeguard the normal order of international trade. While faithfully honoring its WTO commitments, China will make reasonable adjustments to its tariff policies and apply the exception clauses of WTO in order to protect its infant industries, in accordance with theories on effective protection and tariff structure. In connection with the restructuring of the national economy, the government will also optimize its tariff rates structure so as to establish a rational system of tariff escalation from upstream to downstream products, setting lower tariff rates on the import of raw materials and higher rates on the import of ready-made

goods. In light of the international practice, the government will study the system of compound duties comprising specific duty, seasonal duty, sliding duty, interim duty, etc., and gradually extend its coverage. This will help bring into full play the regulatory role of tariffs, while maintaining the current duty bases. In line with the WTO non-discrimination principle and safeguard clauses, the government will build and improve its response mechanism to cope with all types of trade conflicts, using such policy tools as anti-dumping tax, anti-subsidy tax, tariff, and export tax rebates. Second, China will improve its policies on export tax rebate and subsidies to promote the transition of its foreign trade mode. In order to shift the growth mode of foreign trade from quantitative one to qualitative, the government will optimize the mix of export goods, through such economic tools as duties and subsidies. It will improve the policies concerning export tax rebates in compliance with WTO rules. Indirect fiscal subsidies will be mobilized, as permitted by WTO, and policies on fiscal input in agriculture will be optimized to boost agricultural restructuring and growth. At the same time, more fiscal support will be extended to scientific and technological advancement with a view to stimulating corporate efforts toward technical innovation, ultimately enhancing the overall competitiveness of China’s national economy. Third, fiscal management will be strengthened to improve the policy and institutional environment. In line with the requirements of national treatment, the government will merge the two separate corporate income tax systems for domestic and foreign-invested companies, creating a policy environment conducive to fair competition. In addition, all national fiscal policy measures and administrative procedures will be published or announced publicly to enhance their transparency and legality.

4. Build a Harmonious Society by Bringing into Play the Role of Public Finance

Public finance seeks to fulfill the general demands of the society. Under the market economy, public finance is a fiscal operation mechanism for the government to solve public problems, provide public goods, and serve the interests of the general public. Fiscal policy, as an important vehicle to implement public finance, needs to be people-centered. By providing a rich variety of goods and services, the policy works to raise people’s living standards, safeguard their fundamental interests, and enable them to benefit more from reform and growth. Therefore, efforts must be made to provide full employment, establish an effective social security network, regulate income redistribution, and promote social progress. All these will necessarily contribute to social and economic stability, help safeguard the people’s immediate interests, and thus become the foci and bases for future fiscal policy.

4.1 Implement a Proactive Employment Policy to Increase the Employment Rate

As the foundation of people’s livelihood, employment calls for more attention from the government in its planning for economic and social development. A proactive employment policy will continue to be adopted that emphasizes the joint efforts of the individuals, the market, and the government. The government will render more support to employment and re-employment initiatives and improve the entrepreneurial and employment environment. It is projected that between 2006 and 2010, the newly-employed population in urban areas will reach a total of 45 million, while the registered urban unemployment rate will be kept below 5%.

First, the government will encourage self-employment and re-employment in the service sector by cutting or exempting related taxes or charges, establishing a “Security Fund for Small Loans by Lay-offs,” and offering fiscal subsidies.

Second, by adjusting its fiscal expenditure structure, the government will expand its capital inputs in reemployment programs, which will be paid out mainly in the form of social security subsidies, job allowances, micro finance guarantee and discount interest, subsidies for re-employment training, job agency subsidies, as well as subsidies for community labor and social security work.

Third, the government will help create more job opportunities in non-profit organizations and provide instant employment assistance, so as to help the laid-offs from SOEs who find it hard to be reemployed because of old age.

Fourth, the government will actively support the development of small- and medium-sized enterprises (SMEs), by setting up a “Development Fund for SMEs.” Special effort will be made to accelerate the growth of SMEs in the service sector, such as community service, catering, trading, and distribution.

Fifth, the government will promote the reform of the higher education system, improve the student loan system to ensure compulsory education for the children of farmers and poor urban households, and moderately prolong the schooling period to ease employment pressure.

4.2 Improve the Social Security System and Establish an Effective Safety Network

As a safety net for steady economic and social development, the social security system is and will be one of the top-priority areas for China’s fiscal policy. Based on past experience, China will increase its support for social security by stepping up its efforts to put into place a social security system that is appropriate to the country’s level of development. By the end of 2010, the basic urban pension system will cover 223 million people, and the new rural cooperative medical care system will benefit over 80% of rural residents.

First, the administration structure of social security will be further standardized and rationalized. The administrative responsibility of governments at different levels will be clearly defined, such that central government is responsible for formulating laws, regulations, and important policies concerning social security while local governments organize and implement specific programs. And among different departments of governments, steps will be taken to ensure that departments of labor and social security make policies, tax authorities collect taxes, financial departments manage the budget, and social insurance agencies examine, approve, and deliver the benefits.

Second, the urban social security system will be optimized. The government will promote coordinated reform in the pension system, which comprises the basic contributions from the government, the supplementary contributions from the employers, and the contributions from individuals, and progressively solve the system’s transitional cost. All social insurance programs will be further coordinated, and a new program that replaces subsidies with bonuses, as well as a new budgetary system for social security, will be put into place. The minimum living allowances for urban residents will be specified more appropriately to ensure that all social security benefits are better classified and more closely linked with employment policies.

Third, active yet prudent steps will be taken to establish a rural social security system. While improving health conditions in rural areas, the government will carry on pilot reforms to set up a new rural cooperative medical care system, minimum living allowances for rural residents, and a rural pension system. Migrant workers will gradually be included in local social security networks where they are employed.

4.3 Optimize the Income Distribution Policy to Steadily Narrow the Income Gap

Presently, unfair income distribution and a widening income gap between certain social groups have exacerbated social problems. The central government will improve its policy tools to regulate income distribution and the distribution of national revenue. An “olive-shaped” social income structure, dominated by the middle-class, will be formed so as to gradually prevent polarized wealth distribution.

First, the wage system of public servants will be reformed and their income distribution order regulated. To this end, the wage composition of public servants will be simplified by pegging their salaries to their job duties and rankings, and an effective regular wage-increasing mechanism will be put into place. After sorting out the existing allowances and subsidies, the government will establish a standardized allowance-and-subsidy system to satisfy the practical needs of public servants. The income distribution system of government-supported non-profit institutions will also be correspondingly reformed. In accordance with the principle of conducting separate control on revenue and expenditure, the management of administrative charges will be standardized in order to eliminate an income gap resulting from such charges.

Second, the corporate income distribution system will be optimized by gradually introducing a distribution pattern based on both the workload and the production factors. Companies are encouraged to implement a mechanism of collective negotiation on wage levels so as to establish equal pay for equal work. Meanwhile, to safeguard employees’ rights and interests, a minimum hourly wage system will be put into place after appropriate research. At the same time, dynamic wage adjustments will be introduced and companies will be expected to enforce the minimum wage system. A franchised system will be instituted, and special charges will be imposed on income generated by franchised operations. Here, the government will gradually work out a policy mechanism to regulate excessively high income in some monopoly sectors.

Third, more inputs will be channeled into poverty alleviation programs, such as those for enhancing the quality of life of the poor, raising scientific and technological levels, and improving the living and production infrastructure in poor areas. All types of social funds will be mobilized to reduce poverty through development in rural areas, and mechanisms of compensation will be introduced to cope with agricultural disasters and market risks.

Fourth, the tax regulatory mechanism will be improved. While optimizing current measures governing individual income tax, the government will study the feasibility of levying such new taxes as real property tax, inheritance tax, donation tax, stock exchange income tax, and social security tax. The aim is to establish a relatively complete income regulatory system that is able to adjust income distribution at multiple levels including balance, increment, and transfer of personal income, and to narrow the income gap for the sake of social equity.

4.4 Increase Fiscal Support to Expedite the Progress of Social Undertakings

Coordinating social and economic development will be another focal point of fiscal policy in the next few years. Apart from supporting the reform of government-supported non-profit institutions, the government will also promote the progress of such social undertakings as education, science and technology, healthcare, and culture by creating a favorable policy environment for non-governmental organizations to engage in such social undertakings.

First, more investments will be injected into education. The increase of educational expenses in the central budget will exceed that of the current revenue. And the proportion of educational expenditure in the GDP will be gradually raised. From 2006 to 2010, compulsory education in rural areas will be fully paid by public finance, and the cost incurred will be shared by central and local governments at an agreed ratio and based on specific projects. This system will be introduced to different regions in different years, but should be realized in two years and optimized in three years, with the aim of increasing the per capita schooling period from 8.5 years in 2005 to 9 years by 2010.

Second, support will be given to optimize the system of science and technology development and relevant operation mechanism. More effort will be made to promote technological innovation in such key areas as information science, life science, new materials, new energy, aviation and aerospace, environmental protection, and the comprehensive utilization of resources. Original basic research projects and programs for tackling key high-tech problems will be granted considerable support. More fiscal input will be made to ensure that expenditure on science and technology grows at a faster pace than the current revenue, raising step by step the proportion of science and technology expenditure in GDP.

Third, more input will be made to improve the public health system, so as to establish a disease information network, a disease prevention and control system, and a medical relief and treatment system. It is necessary to intensify research on serious infectious diseases, raise the quality of public health service, and enhance the capacity to handle public health emergencies.

Fourth, considerable support should be given to the development of public welfare culture, as well as traditional, national, and mainstream cultures, so as to nurture the birth and growth of advanced cultural forms. In addition, attention must be paid to protecting the unique characteristics and heritage of local cultures, with top priority given to outstanding national cultural forms, especially those on the brink of extinction.

5. Shore up Economic Restructuring and Promote Innovation in the Fiscal System

The fiscal authorities have been playing a very important role in China’s market-oriented economic reform. With continuous decentralization, they have opted out of the old system and borne a huge portion of reform costs by initiating a large number of tax incentives and fiscal subsidies. Having played an exceptional part in ensuring the smooth progress of China’s reform and opening-up, the fiscal authorities have also gradually reformed their production- and development-centered mode of fiscal operation and management under the planned economy, and established an initial public finance framework, in light of the development of the market economy. Currently, China’s social and economic development has entered a crucial phase, where the fiscal authorities are confronted with even more arduous restructuring tasks. On the one hand, they need to intensify their support for economic restructuring and actively bear the necessary costs incurred by reforms; on the other, they have to reform themselves at a faster pace, seek institutional innovation, and establish and improve a public finance system that fits well with a market economy.

5.1 Support the Efforts to Improve the Socialist Market Economic System

Generally speaking, the current system of SOEs does not comply with the requirements of a socialist market economy, hindering the enhancement of the quality of economic growth and overall national strength, and also discounting the regulatory efficiency of fiscal and monetary policies. In time, SOE reform and financial reform will become the central link in economic restructuring and an important subject that needs to taken into account in fiscal policy decision making.

Active support should be given to the SOE reform. First, the strategic restructuring of the state economy needs to be accelerated to enhance its competitiveness, and a flexible yet rational flow of state capital will be promoted. Continuous financial support will be provided to facilitate SOE bankruptcy and reorganization. Second, effort will be redoubled to push forward the shareholding reform of SOEs, with the aim of building a modern corporate system, making the shareholding system a major form of public ownership. At the same time, profit distribution has to be regulated between the state and SOEs, based on the market principle of “distributing dividends and profits by shares and investment.” On top of that, more effort will be made to relieve SOEs of their obligation to operate social programs in order to increase their competitiveness. Third, the regime and mode of state asset management should be optimized so that a sound budgetary system for state capital operations will be established, which will facilitate SOE restructuring and the transfer of property rights, prevent the loss of state assets, and enhance the competitiveness of the state economy.

Financial reform should be expedited. Reform of the financial system is an important task that has a bearing on the country’s overall reform and development. It is also a key project in the building of a modern market economic system in China. The fiscal authorities will continue to extend their full support to financial reform and the development of the financial market. Banks’ non-performing assets will be cleared up through multiple ways and means, and their capital will be further replenished. Continuous effort will be made to reform state-owned commercial banks by introducing the shareholding system, and push ahead with the reform of policy banks, thus transforming financial institutions into modern enterprises with “sufficient capital, strict internal control, safe operation, sound business, and good economic returns.” Furthermore, vigorous support will be given to pushing financial reform and improving financial services in rural areas, so that an effective financing system will be established for millions of farmers. A favorable environment should be created to facilitate steady and sound development of the capital market. The fiscal authorities will be actively involved in establishing a sound mechanism to promote the organic integration and coordinated development of monetary, capital, and insurance markets. This will safeguard the overall stability of financial operations and financial markets, and prevent system risks.

Reform of the investment system will be granted more substantial support. According to the principle that “whoever invests makes decisions, gains benefits, and bears risks,” companies will be given more power in investment decision, and an incentive and restraint mechanism that combines responsibility, power, and interests should be put into place to protect investors’ rights and interests. An investment approval system will be introduced as soon as possible to reduce the transaction costs of micro investors and invigorate the market. The coverage of government investment should be rationally defined according to the rules of the market economy. The government should stop investing in areas of general competition and confine itself instead to the provision of public goods and services. The monitoring mechanism of government investment in public areas should be improved, under which major public investment projects are subject to strict inspection and accountability check. This also means tighter oversight in the financial and auditing affairs.

5.2 Improve the Fiscal Management System by Linking Fiscal Power with Respective Administrative Responsibility

Under the general objective of establishing and improving the framework of public finance, pilot reforms have been launched over the last few years in some areas of the country. To improve the fiscal management system, these reforms introduced measures to bring county budgets under the direct control of provincial governments, and have town and township budgets controlled by counties. The system of fiscal transfer payments is also being standardized and improved step by step. However, the current fiscal management system has not played an effective role in balancing fiscal strength between governments, either at the same level or at different levels, resulting in a low level of public services. Therefore, central government will step up fiscal reform, improve the fiscal management system to match a local government’s fiscal power proportionately with its administrative responsibility, and further standardize fiscal relations between governments at different levels.

First, the responsibilities of governments at various levels for expenditure should be further defined on the basis of such factors as the benefiting scope of expenditure. The central government should be responsible for expenditure on national public goods and services, as well as the adjustment of income distribution, whilst local governments should be responsible for expenditure on local public goods and services. As for trans-regional public goods and services, responsibility should be defined clearly, and shared proportionately between central and local governments.

Second, the central and local governments’ authority in managing fiscal revenue should be adjusted and regulated, in compliance with the principle that fiscal power should be proportionately linked to administrative responsibility. Taxes collected for protecting national interests and for implementing macro control fall into the categories of central taxes, taxes directly related to economic development are taxes shared between central and local governments, and taxes suitable for local collection and management are local taxes. Further research is needed to clearly define the authority of central and local governments in tax management, so as to affirm the legislative power of central government in regard to its centralized management of central taxes, shared taxes and those major local taxes that have a significant impact on the macro economy. This will help safeguard overall national interests, unify the taxation system, guarantee the implementation of taxation policies, and protect taxpayers’ rights and interests. Meanwhile, a study will be conducted on how to properly enlarge the extent of intergovernmental income distribution in light of actual conditions, so as to provide a stable and reliable financial basis for governments at all levels to perform their functions and duties.

Third, fiscal transfer payments and other systems should be improved. The standards for different regions in income and expenditure need to be examined and determined according to the principle of distributing basic public services more evenly. The size of transfer payments will be determined using a factor method instead of a base method, so that the size of special transfer payments can be controlled, while the proportion of general transfer payments can be raised. Thus the structure of transfer payments will be optimized. Incentive and restraint mechanisms will be improved, and the introduction of a monitoring and evaluation system will be studied.

Fourth, the fiscal management system below the provincial level should be improved. The responsibility of governments below the provincial level for fiscal expenditure should be clearly defined to ensure a more rational distribution of their fiscal revenues. The fiscal management pattern of provinces exercising direct control over counties will be explored actively in order to streamline management procedures. At the same time, more effort will be made to reform the fiscal system of towns and townships, by introducing the pattern under which the town and township budget is managed by counties but used by towns and townships. The method of subjecting the fiscal revenue and expenditure of towns and townships to management by county financial departments will be studied in great detail.

5.3 Reform the Tax System for an Optimized Structure

The opportunity that arises from a rapid and stable increase in China’s fiscal revenue should be seized to promote the reform of the tax system for an optimized structure, making it possible to start an internal mechanism which allows for a self-sustained, stable increase in fiscal revenue.

First, the VAT system should be improved to achieve a shift in its composition. Based on the experience of Northeast China in changing the VAT system on a trial basis, detailed measures should be refined before being adopted across the country, to promote corporate technological advances and enhance their capabilities for self-initiated innovation.

Second, reform should be accelerated to consolidate the existing separate income tax systems for domestic and foreign-invested enterprises. Nominal tax rates should be lowered appropriately to boost industrial structural upgrading and seek higher resource efficiency. Moreover, tax systems and policies should be unified, and all taxes should be collected in strict accordance with the law, minimizing the difference between nominal tax rates and taxes actually paid. A level playing field should be provided for all domestic and foreign enterprises that operate under different types of ownership.

Third, the new individual income tax system, which is both comprehensive and well classified, should be gradually implemented. Consistent or regular incomes such as salary, production and business incomes, service income, and income from property leasing should be classified as taxable comprehensive income, to which progressive tax rates should apply. Other types of income generated from property transfer, royalty fees, interest, capital gains, and dividends should be taxed separately on the basis of proportionate tax rates. The tax base should be further regulated and widened, and loopholes in taxation plugged. The progressive grades of income tax rates, and tax burden should be rationally adjusted, and the highest marginal tax rate appropriately lowered. Criteria for cost reduction and the preferential policy of tax reduction or exemption should be rationalized, and a two-way system, requiring employers and individual employees to submit separate tax returns, should be established.

Fourth, the property (real estate) tax will be studied for possible collection. At present, far more taxes are being levied on real estate transaction than those collected on real estate ownership, which is not conducive to the healthy development of the real estate industry. Therefore, it is necessary to introduce a property tax. Urban real estate tax, house property tax, and urban land-use tax should be consolidated when conditions permit. The tax rate should be determined on the basis of the present real estate tax and the charges applicable to different stages of real estate development. A unified property tax will then be introduced to guide spending on housing property and regulate the wealth gap between residents.

Fifth, a fuel tax should be levied as early as possible. In view of the short supply of energy and resources, as well as serious energy wastage in development, utilization, and consumption, prior preparation must be made before imposing this new tax to promote the economical use of petroleum.

5.4 Deepen the Reform of the Budget Management System

Improving the public finance system and managing finance in accordance with the law require a standardized budget management system. The government should forge ahead in the reform of the budget management system in light of the needs of public finance. This will ensure more standardized, secure, and efficient use of fiscal capital and provide a solid institutional basis for the formulation and implementation of fiscal policy.

First, the departmental-budget system has to be further improved. Procedures need to be standardized and particulars specified to enhance the budget’s fairness and transparency. Further reform will be needed to conduct separate control on revenue and expenditure, allow more departments to prepare their own budgets, and improve budget ration standards and the project budget management model. In addition, an overhaul is needed of the classification system of government revenue and expenditure to reflect more holistically and directly budgetary arrangements for all governmental functions. At the same time, a state capital budgetary system should be explored and established in due course.

Second, a performance appraisal system will be introduced for budgetary spending. Based on experience gained from pilot reforms, uniform and standardized methods will soon be adopted for performance appraisals. Meanwhile, appraisal parameters will be defined, and a basic database for appraising a performance-based budget system and budgetary efficiency will be established. The GFMIS (Government Finance Management Information System) will soon be put into place to promote standardized budget management.

Third, reform of the centralized collection and payment system by treasury will be strengthened. All budgetary units under governments at all levels will be included in this reform. The system of a single treasury account will be better regulated and feasible methods will be explored to improve centralized collection and payment. The management of treasury’s collection and payment needs to be strengthened by simplifying procedures, improving realtime monitoring of treasury status, and tightening the oversight of the whole budget-executing process. Measures will be formulated to manage cash in treasury, and raise treasury’s capital-operating efficiency.

Fourth, the government procurement system will be further reformed in order to cut down fiscal spending. More effort will be made to separate administration from operation in executing government procurement. Public tendering and competitive bidding can help expand the scope and scale of government procurement, standardize procurement procedures and mode, and optimize the management of budget preparation for this purpose.