Chapter 6
China's Tax Revenue, Public Goods, and Economic Transition

Dashu Wang

INTRODUCTION
TAX REVENUE
PUBLIC GOODS
ECONOMIC TRANSITION
CONCLUSION
References

INTRODUCTION

The shift from a planned economy to a market economy poses some fundamental challenges for the fiscal authorities in transition economies. In 1994, China reformed its tax and fiscal system with the intention of halting the decline in budgetary revenue as a share of gross domestic product (GDP) and increasing the central government's share of total budgetary revenue by changing the way revenues were collected and divided between the central and local governments. A tax-sharing system between the central and local governments was introduced in the reform.

More specifically, the tax authorities established a value-added tax (VAT) system, unified the domestic income tax structure, improved the resource tax and urban maintenance and development tax, and introduced a land value increment tax. At the same time, in order to ensure the effective collection of the central government's portion of revenue, the central and subnational governmental tax collection bureaus were separated. The national tax collection bureau is in charge of the central government's revenue and the shared revenue, and the local bureaus are responsible for subnational governmental revenues.

There are four main features of the tax-sharing system. First, expenditures are assigned between the central and subnational governments. Areas such as national defense, diplomacy, and macroeconomic adjustment, are the responsibility of the central government. Subnational governments are in charge of local services and local economic development. Secondly, tax revenues are shared between the central and sub-national governments. According to this revenue-sharing system, the total tax revenue is shared between the central and local governments on the principle that the taxes

concerning national interest or macroeconomic adjustment belong to the central authorities, while those pertaining to local economic development are given to the subnational governments. The regular revenue of the central government is composed of the consumption tax, vehicle acquisition tax, customs duties, vessel tonnage tax, and the VAT collected by the Customs. The local revenue consists of city and township land-use tax, house property tax, urban real estate tax, farmland occupation tax, inheritance tax (not levied yet), fixed assets investment regulation orientation tax (suspended currently), land appreciation tax, vehicle and vessel usage tax, vehicle and vessel usage plate tax, deed tax, slaughter tax, banquet tax, agriculture tax, and animal husbandry tax. The revenue shared between the central and local governments includes domestic VAT, business tax, corporate tax, personal tax, resource tax, city maintenance tax and construction tax, stamp duties, fuel tax, and security exchange tax (not yet levied).

The third feature of the tax-sharing system is that of tax rebates from the central to the local governments. Actually, the tax rebate is a transfer payment, a lump-sum grant to maintain the revenue of the local governments at no less than the 1993 level. Moreover, revenue in 1993 is used as the base level, and if the revenue from VAT and consumption tax increases by 1 percent, the tax rebate (tax-related return grant) from the central government to the province would be increased by 0.3 percent.

Finally, there is the transitional transfer payment system. In order to regularize intergovernmental transfer payments, the central government has established a transitional transfer system based on a specific formula, by which the Treasury will give a grant to a province if a gap between the standard fiscal expenditure and standard revenue occurs.

Since 1994, China's tax revenues have rapidly grown. For example, excluding tariff and agricultural tax, revenues from tax in 2003 amounted to RMB2,045 billion, RMB345 billion more than in 2002, representing an increase of 20.3 percent. It should be noted that the incremental change between 2002 and 2003 (RMB345 billion) was larger than the tax revenues (RMB317 billion) for the whole of 1992.

It is beyond doubt that China has enjoyed rapid growth in tax revenues, but if attention is given to public goods provided by the government, the picture is not so promising. Indeed, the quantity and quality of public goods enjoyed by the Chinese people are far less than those enjoyed by their counterparts in other countries with similar tax burdens. That is to say, there is a huge gap between tax revenues and public goods. The purpose of this chapter is to analyze the reasons for this gap.

TAX REVENUE

The current tax structure and statutory rates in China are based on the efficiency of tax collections in the early 1990s. At that time, effective rates were low because there were many exemptions and concessions. In order to maintain the level of tax revenues, it is understandable that the tax authorities deliberately set high tax rates.

Tax Rates

Most countries in the world do not collect an agricultural tax. It is interesting to note that many countries in fact levy a negative tax on agriculture—that is, they allocate special funds to subsidize farmers. However, China is an exception, together with a few other countries. The national average tax rate on agricultural products is 15.5 percent of the yield in a normal year, and the current average rate is 8.8 percent.

The major source of tax revenue in China is VAT, which makes up 40 percent of the total. The VAT standard rate in China is 17 percent. However, it should be noted that VAT in China is a production-based tax. Under this system, fixed assets are subject to taxes. Enterprises cannot claim tax deductions for purchases of fixed assets such as equipment and machinery. Because of the production base, the VAT rate of 17 percent in China is equivalent to 23 percent in other countries where VAT has a consumption base and tax paid for fixed assets is deductible. As a matter of fact, in most countries VAT rates are less than 20 percent (Table 6.1). China's VAT rate is one of the highest. Indeed, in the world there are

only eight countries with a VAT rate of more than 22 percent. China is one, and the others are all OECD (Organization for Economic Cooperation and Development) countries.

The corporate income tax rate in Singapore is 22 percent, but corporate income tax in China is charged at the rate of 33 percent. Another problem is that the allowable deductions for corporate tax are very limited. For example, only 800 yuan is deductible as wages for each employee per month. If an employee's monthly salary is 2,000 yuan, only 800 yuan is exempted from tax as expenses, and the employer has to pay tax on the remaining 1,200 yuan. Even worse, the employee has to pay personal income tax on the total 2,000 yuan. In this regard, there is double taxation.

As shown in Tables 6.2 and 6.3, China's highest rate for personal income tax is similar to those in the OECD countries. It is interesting to note that personal tax in China is calculated on monthly income. The limited exemptions create another problem. Taxable income is the monthly income after a lump-sum deduction of 800 yuan is made, and certain items (at present they include only basic pension insurance premiums, medical insurance premiums, unemployment insurance premiums, and reserve funds for housing) are treated as expenses, while other deductions are forbidden.

Tax Revenue and Tax Ratios

From Table 6.4, it can be seen that China's gross domestic product (GDP) ranks sixth in the world, and China's tax revenue maintains a similar position at ninth in the world. Tax is paid by the people, so when analyzing the tax burden, the population has to be taken into account. Superficially, tax revenue per capita is in inverse proportion to GDP per capita. Closer scrutiny, however, reveals that countries with a higher tax burden are those with

higher GDP per capita, such as the United States, Japan, and Sweden (Table 6.4). Tax revenue is positively related to economic development. The higher the income, the higher the overall tax ratio would be. If a country enjoys a high level of economic development and GDP, its tax base is large, and it is easy for the government to collect more revenue. Therefore, tax burdens in developed countries are higher than those in developing countries. Although China is a lower middle-income country, its fiscal revenue in 2000 was the largest in the developing world, and its fiscal revenue/GDP ratio was 15 percent (Table 6.5).

Taxes and Economies of Scale

In the 1970s and 1980s, some OECD and International Monetary Fund (IMF) economists conducted a regression analysis of tax burdens and came to the conclusion that there is no significant correlation between the tax ratio and per-capita GDP. After careful study,

however, it can be shown that this conclusion is a rash one. In fact, the countries that do not correspond to the norm are the United States, Japan, and Sweden. The United States and Japan are the most developed nations with large populations, and their tax/GDP ratios are very low by average OECD standards. On the other hand, Sweden, with a small population, has the highest tax/GDP ratio, and not surprisingly, it maintains a very high tax burden.

As with the management of enterprises, a country also faces the issue of economies of scale. Indeed, a large part of national spending consists of fixed costs—for example, a central government would bear the cost of a defense system, a police system, a legal system, and so on. If a country has a large population, more people can share the fixed costs, and the average cost to run the government will be reduced. In other words, there are more people to contribute to the tax revenue, and it comes as no surprise that its tax/GDP ratio is small. Large nations usually enjoy a low tax/GDP ratio. In the United States, for example, it is beyond doubt that the amount of tax revenue is the highest in the world, but its tax/GDP ratio is the lowest among the OECD countries because of its large population. On the other hand, nations with the highest tax/GDP ratio are more often than not medium- or small-sized, because fewer people share the tax burden.

To illustrate this point, some geographically close countries with similar levels of economic development have been selected for study, and their tax ratios are presented in Table 6.6. It seems that tax ratios in larger nations, such as the United States, Australia, and India are less than those of their smaller neighbors, such as Canada, New Zealand, and Pakistan.

China's tax revenue ranks first among the developing countries and its tax/GDP ratio is relatively high, even approaching that of some developed countries. However, its population is also the highest in the world. If economies of scale are taken into account, China's tax/GDP ratio should be at a lower level.

Three Tax Burdens

In most countries, taxes are the only source for, and the clear indicator of, public revenue. In China, however, because there are several ways for the government to collect revenues, the ratio of tax to GDP alone cannot describe the tax burden effectively. Based on government statistics, An Tifu (2002) has calculated three ratios. The first is tax revenue to GDP, denoted by T_0, and is computed by taking the total tax payment as a percentage of GDP for a given year. The second is fiscal revenue to GDP, denoted by T₁.¹

The third ratio is government revenue to GDP, denoted by T₂. Government revenue includes not only the budgetary revenue (T₁), but also extra-budgetary revenues and off-budget funds, which include user charges for government-provided goods and services, administrative fees for government services, and other non-tax receipts collected by the central, provincial, and local governments (T_G). Many studies have concluded that the magnitude of extra-budgetary revenues is in the neighborhood of budgetary revenues. For example, according to Zhang and Zhang (2000), the extra budgetary revenue and fees collected by all governments accounted for 6 percent and 8 percent of GDP, respectively, and in some years, they were equal to T_0. Wong's (2001) estimation is that extra- budgetary and budgetary revenues in 1999 were equivalent to 12 percent and 14 percent of GDP, respectively. According to an IMF report (Ahmad et al., 2002), the ratio of local off-budget revenues to total local revenues remained around 40 percent in the 1990s. In 1996, budgetary resources accounted for 11.4 percent of GDP, while an audit conducted by government ministries found that extra-budgetary

¹ The fiscal revenue is budgetary revenue, including tax revenue (T0), and revenue generated by public assets such as incomes from government-owned enterprises, and revenue from the selling of public assets.

revenues amounted to nearly 6 percent of GDP, or more than 50 percent of budgetary resources.

Among the three ratios, T₂ reflects the financial burden of the overall economy. Therefore, T₂ is more comprehensive and more accurate than T₀ and T₁. It can be seen from Table 6.7 that T₂ has generally been greater than T₀ by about 10 percentage points. In 2003, for example, T₀ was 17.5 percent, T₁ was 19.5 percent, and T₂ was 27 percent. In fact, this estimation is conservative, and some economists have suggested that T₂ was greater than 30 percent. According to Gao Peiyong (2002), for example, T₂ in 2000 was 34.4 percent.

As cited by the Research Group of the Association of China's Taxation Studies (2003), Forbes measures tax burdens by indices (the higher the index, the heavier the burden). Its conclusion is that China, with an index of 154.5, is a heavily-taxed nation, ranking third among thirty countries, behind only France and Belgium.

According to the 2004 Index of Economic Freedom compiled by the Heritage Foundation, China, with a score of 3.5, is one of the most “unfree” countries, ranking 128th in the world. Its fiscal burden score is 4.4, which is heavy, and its government intervention score is 3.5, which is considered heavily interventionist.

PUBLIC GOODS

Tax revenue divided by the population gives per-capita tax revenue, and its corresponding concept is per-capita public goods, because tax is the revenue which enables the government to provide public goods. Public goods are different from private goods, and

the willingness to pay for public goods is generated by the vertical summation of the individual demand curves. If the quantity of public goods is fixed, the more the population, the less the average cost to produce the per-capita public goods. It is due to national economies of scale that more people can share the fixed amount of public goods.

It is very difficult, if not impossible, to calculate the quantity of public goods. In this chapter it is estimated by using an incremental method. Since 1994 when the new taxation system was introduced, tax revenue has increased by more than 20 percent annually, but public goods in China have not been expanded by the same amount. Instead, in some areas, the quantity of public goods has even shrunk. For example, the coverage of Medicare has narrowed, and more and more people have to pay their medical insurance premiums; the government has also stopped providing housing, and undergraduates have had to pay tuition fees. It is even believed that the government will stop free education for postgraduate students, and that a tuition fee will be charged.

Many governmental duties are levied on enterprises. For example, in some areas, corporations have to provide education for the children of their employees, and there are more than 11,000 primary and secondary schools as well as many kindergartens funded by corporations. There are also more than 6,000 hospitals which are funded by enterprises.

Another problem in the provision of public goods lies in the fact that there is a two-tier system of government which separates China into urban and rural areas, resulting in about 800 million rural people being treated as second class citizens and excluded from some—if not most—public goods enjoyed by their urban counterparts. For example, rural infrastructure is mostly built by the farmers themselves, with only some subsidies from the governments. Farmers also cannot access unemployment benefits and they are not covered by Medicare. The World Health Report of 2000 (World Bank, 2002) ranked China sixty-first out of 191 countries in overall quality of health, but one hundred and eighty-eighth in terms of fairness of financial contributions.

Lin et al. (2003) present a particularly telling case in the funding of the educational sector. In some areas, farmers have to pay for their children's education. The local governments are primarily responsible for the development of local education but the implementation of the state-mandated nine years of compulsory education are at the county and township levels. Moreover, most of the funds allocated for the education sector are often transferred to other uses. For example, in two typical counties in Gansu province, Hezheng and Jishishan, personnel costs absorbed 98 percent and 93 percent respectively of total recurrent expenditures in education in 1999. As a result, schools lack instructional materials, and the quality of teaching is adversely affected (World Bank, 2002). At the same time, the lack of funds at the local level leads to the costs being passed on to the students and their parents through various school fees. For example, in one county of Gansu, even though tuition fees amount to only 30 yuan a year in primary schools, students have to pay 75 yuan for textbooks. With annual incomes averaging only 853 yuan in Jishishan, this means that 3–4 percent of family incomes are spent on sending a child to primary school (assuming there are 3–4 members in the household). In terms of cash incomes, which are typically only 50–60 percent of total income, the cost rises to 6–8 percent, which leads to school dropouts and low enrollments (World Bank, 2002).

Although China has enjoyed rapid economic growth, its income differentials are widening. In 2000, there were 30 million people living below the poverty line, which was defined as an annual income of less than 625 yuan.

ECONOMIC TRANSITION

Thus, the government in China at all levels has collected huge quantities of tax revenue, but has not provided adequate public goods. There are many explanations for the gap between tax revenue and public goods, but the most important reason is the fact that China has been in a transitional period from a planned economy to a market economy. The economic transition involves some transition costs and reduces the ability of the governments to provide public goods.

Decentralization and Transfer Payments

Decentralization is one of the important features of China's economic transition from a planned economy to a market economy. As a result of decentralization, local governments began not only to enjoy more autonomy in local economic management, such as local enterprise development, but also to assume primary responsibility for the provision of local public goods and services (Lin et al., 2003)—that is, government expenditures were also decentralized.

Provincial and sub-provincial governments account for more than 70 percent of all budgetary expenditures and two-thirds of extra- and off-budgetary expenditures. Another way of putting it is that central expenditures account for only 30 percent of total public expenditures. This is low by international standards. The rest is distributed among the other four tiers, which include about 47,000 local government units. The largest portions are spent in about 2,500 counties, which are the most important level of local government in terms of expenditure, particularly with respect to the financing and delivery of public services to the local people. Along with townships, counties account for about one-third of total government spending and one-half of employees in the public service units (Lin et al., 2003).

The centralization of public revenue and decentralization of public expenditure necessitate a governmental transfer system. China's transfer payment scheme has been evolving along with the entire fiscal regime. The implementation of the transfer payment arrangement during the transitional period in 1996 marked the establishment of a formal and comprehensive program of governmental transfer payments. These transfers fall into four broad categories: fixed transfers, returned tax revenue, special purpose grants, and general purpose grants. The general purpose grants, in turn, include transitional transfers, transfers to ethnic minority regions, transfers to increase the salaries of public servants and to improve social security networks, and other grants, such as settlement subsidies. At present, about 40 percent of local governments’ fiscal revenues are from transfer payments from the central government (Jiang and Zhao, 2003).

There is a sharp imbalance between the assignment of expenditure responsibilities and the revenues available to finance these expenditures. China is unusual in expecting the local governments to finance their responsibilities from their own revenues. Although the volume of central transfers is large, accounting for 46 percent and 48 percent of local expenditures in 2001 and 2002 respectively, the current system of intergovernmental transfers is poorly designed to support the financing of social services, such as education and public health in the rural areas. To reduce the imbalance in local government finances, the central government has been increasing its equalization transfers. In 2002, the central government allocated RMB435 billion (about 19 percent of total government expenditures, or 4.2 percent of GDP) to equalization transfers. In addition, since 2001, the central government has been intervening to assist the local governments in covering the cost of salary increases (mandated by the central government) and social security. These interventions have been mainly targeted at inland provinces and account for more than half of transfers net of provincial tax rebates. Corrective interventions have also accompanied the rural “fee-tax-swap” reform which, while reducing the financial burden of farmers, has tended to deepen the financing gap of the local governments. In 2002, this intervention accounted for 6 percent of transfers net of the provincial tax rebate.

Transfer payments have been playing an important role in the local governments’ budgets. According to Jiang and Zhao (2003), for example, about 41.3 percent of local government revenues were transfers from the central government in 2001. However, most of the transfers were purely a redistribution of tax revenues between the central and local governments as a result of implementing the tax-sharing system. Only a very small proportion of the transfers are dedicated to improving regional disparities. The share of the “equalization transfer” in total transfer payments from the central to local governments was only 1.8 percent in 2000 (He, 2001). Thus, many studies find that the transfer system has failed to equalize per capita fiscal expenditure as well as per capita income as richer regions receive even more transfers than poor regions (Wong, 2002; Ma, 2003).

The central government collects the larger part of public revenues but it transfers over 60 percent of this to the provinces. The 1994 tax reform, which introduced the tax-sharing system, was supposed to re-centralize control over public revenues and permit the greater interregional redistribution of resources. Its impact, however, has been regressive since transfers from the central government to regions have been based on their ability to collect taxes. As suggested by Lin et al. (2003), the last fiscal reform has led to highly differentiated local disposable revenues across regions, thus resulting in highly heterogeneous levels of local public service provisions. In richer regions, mainly the coastal areas, local governments, especially those at the township and village level, are able to provide better public goods and services to localities since they not only enjoy higher tax revenues from the development of secondary and tertiary industry, but can also draw on high-priced state land sales and non-tax profit remittances.

On the other hand, in less developed areas which are mostly located inland, local revenues depend mainly on agricultural sources which are usually very limited. Without sufficient and dependable equalizing transfers from higher-level governments, local governments usually find themselves in difficulty when trying to strike a balance between

revenue and expenditure. The situation became increasingly serious after the 1994 fiscal reform. Provincial governments in less developed regions tended to exact larger shares of revenues from lower level governments, and at the same time assign more responsibilities to the latter. As the World Bank (2002) reported, there is a trend toward increasing shares of expenditures at the provincial level, and a declining share for the county and township levels combined during the period 1994 to 1999.

In general, decentralization has not benefited the poor. Public spending is biased against the rural areas, which in 1997, for instance, was only about 5 percent of rural GDP, while public spending for the whole country was 11.6 percent of total GDP. The per capita income of rural households in China is only two-fifths that of urban households; yet the former pay more in taxes than they receive in transfers, while the latter receive net transfers.

Public Servants

Governments are usually responsible for public goods but in China, the governments are overstaffed and divided into many overlapping levels. Most countries in the world have a three-tiered (federal, state, and local) government system, but China has a five-tiered (central, province, city, county, and xiang) arrangement. Currently, from the center to the provinces, to cities and to counties, there are five bureaucratic systems: the Party Committee, the Party Discipline Committee, the Government, Parliament, and the People's Political Consultative Conference. Another feature peculiar to the Chinese bureaucratic system is the fact that every central ministry has subordinate units at each level of administration.

Because public goods are provided by local governments, the local bureaucracy is expanding. Notwithstanding the central government's downsizing efforts, the size of township bureaucracies continued to expand after the mid-1990s. Before 1980, a township government had, on average, twenty to thirty staff. It now has more than 200. On average, the ratio of farmers to local cadres is as large as 40: 1. In 1995 alone, about one million new staff were added to the state payroll and this figure does not include new recruits paid with local resources (Yep, 2002).

According to an investigation conducted by Sun and Zhao (2002) in Anhui and Huan provinces, there were on average, 200 government staff in each xiang. For example, in a xiang with a population of 3,000 there are more than 100 government staff on the payroll. If the employees in schools, hospitals, the legal service, management offices, cultural offices, irrigation offices, and animal hospitals are added, roughly ten people support one public servant financially. The budgetary as well as extra-budgetary revenue of this xiang government is less than RMB1.5 million, but its expenditure is more than RMB2.5 million, resulting in a debt of RMB1 million every year.

Currently, the Chinese governments are the most labor-intensive in the world, and there are too many public servants. Some historical ratios of government officials or public servants paid by the Treasury to ordinary people are presented in Table 6.8.

Public Investment Goods

According to Niskanen (1971), a bureaucrat's objective is to maximize the use of the budget. A fundamental problem here is that in so doing it may be inefficient. Indeed, many governments pursue economic development strategies aimed at promoting growth. Unfortunately, many studies have found that government spending is ineffective in helping economic growth.

In most countries, governments collect tax revenues and return them to the public mainly by providing public goods. However, the Chinese government returns them by providing two goods: public goods, and public investment goods. Huge quantities of tax revenues enable the Chinese government to invest and stimulate rapid economic growth. This in turn provides a favorable environment for China's transition from a planned economy to a market economy. From 1998 to 2002, the long-term construction bonds issued by the Treasury totaled RMB660 billion, and induced investments funded by bank loans and other sources to the value of RMB3,280 billion. According to one calculation, these investments increased economic growth by 1.5–2 percentage points every year, and cumulatively created 7.5 million jobs.

Unfortunately, public investment has been inefficient because of government failure, and the loss from the investment is at the expense of taxpayers. It is possible also that the increase in public investment reduces private investment—that is, there is a crowding-out effect. In fact, what the government can do is to remedy market defects, but it cannot replace the market mechanism.

Apart from its side effects, public investment leads to an overreliance on the planning mechanism at the expense of the market mechanism. If the government invests too much and the short-term policy of government investments becomes long-term, the market mechanism cannot function well, and this is contradictory to the objective of establishing a market economy.

Because public investment has been inefficient, huge quantities of funds have been wasted as a result. By the end of 2002, the Chinese government had invested in 10,000 projects, funded by Treasury bonds valued at RMB4,100 billion. According to Wu (2003), in the process of construction, a project can change hands several times between

contractors, resulting in as much as 60 percent of the funds being wasted even before the project reaches a builder. The efficiency of government investments is lower than that of private investments, and only 30 percent of the projects are efficient, that is, 70 percent are unprofitable. Liu's (2003) analysis found that projects funded by Treasury bonds are inefficient, and that projects with positive returns, zero returns, and negative returns accounted for one-third of the total respectively.

Other Transition Costs

During the transitional period from a planned economy to a market economy, China has encountered many transition costs, and governments have had to provide funding for them. For example, the reform of the price system has meant an increase in the prices of agricultural products, and the government has had to subsidize people in order to maintain social stability. Between 1991 and 1996, the central and local government budgets provided subsidies for grain, cotton, and edible oil, valued at RMB187 billion, for people in the urban areas, and farmers also benefited indirectly from this (Hou, 2001).

During the economic transition, some state-owned enterprises (SOEs) had to be closed down because they were unprofitable, resulting in large numbers of employees being laid-off. Governments at all levels then spent money to reemploy these redundant workers. In 2004, China introduced a new series of tax incentives to encourage reemployment of workers dismissed from the SOEs during corporate restructuring. The authorities encouraged those laid-off to set up their own businesses by offering three-year exemptions from taxes for expenses related to their business, such as urban construction and education costs. The government also raised the thresholds for levying business tax and VAT for such individuals. For companies and factories which helped to create jobs for the unemployed, the government offered tax favors, including cuts on business taxes and corporate income taxes based on the number of people they employed.

The authorities realized that government departments and agencies were too large and public servants were too numerous, so that in 1998, China tried to simplify the administrative structure and reduce staff. To settle 16,000 redundant personnel, the central government had to spend more than RMB5 billion, or an average of, 312,500 yuan per person (Wang, 2002).

China has recently increased its spending on social security. It guarantees the basic living allowance of the unemployed and the pensions of those retired, which are paid in full and on time. The government also subsidizes some urban people who have an income of less than a certain amount. In 2001, Treasury spending in these areas was RMB51 billion, and in 2002 it reached RMB59 billion, six times more than that in 1998 (Liu, 2003).

In 2002, the authorities decided to implement a rural taxation reform in twenty provinces, accompanied by a central transfer of RMB25 billion and provincial transfers of about the same amount. The nature of the reform can be summarized as a “fee-tax-swap,” which removes all local informal fees but increases the rates of formal agricultural taxes, and aims to prevent arbitrary charges by local governments and the “quasi- governmental” community organizations (Lin et al., 2003).

CONCLUSION

Since the tax and fiscal reform in 1994, China has collected a huge amount of tax revenue. Now its tax revenue ranks ninth in the world, but first among the developing countries. As a developing country with the largest population in the world, its tax to GDP ratio (T₀ ratio) is high. If non-tax receipts are taken into account, its ratio of government revenue to GDP (T₂ ratio) is very high compared with the rest of the developing world.

Huge quantities of tax revenue as financial resources have enabled the Chinese authorities to implement economic transition. For example, public investment has led to rapid economic growth, and the guarantee of jobs and higher salaries to government employees has been successful in reducing their resistance to reforms. All this has provided a favorable environment for economic transition.

However, it should be noted that the transition costs in China are large, and the overstaffed governments are inefficient. That is why the governments have enjoyed such high levels of public revenue but have failed to provide adequate public goods to the people. Indeed, the quantity and quality of public goods provided by the central and local governments are far lower than those provided in the advanced countries.

Although the current tax-sharing system has given the local governments incentives to foster local economic development, its positive impacts are limited in the relatively well-endowed coastal regions. At the same time, low revenue capacity and insufficient transfer payments have largely incapacitated the local governments in the less developed and agriculture-based regions to provide decent public services to the local population.

China has now successfully established the framework of a market economy but it should be noted that the market mechanism is not fully operative in the area of resource allocation. Indeed, the governments at all levels have intervened heavily in the economy, resulting in some government failures. It seems reasonable to suggest that China should limit the extent of government intervention, cut the size of government staff, and reduce public investment, to enable them to cut taxes and provide more public goods for the Chinese people.

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