Centriole Cynosure: Central –Local Interactions In post-1980 Chinese Fiscal Reforms

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  1. Rage

    Rage DFI TEAM Stars and Ambassadors

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    Alrite, Here's an article (essay, morelike) I penned some time ago on China's fiscal reforms post-1980, and central-local interactions thereof as part of my study on Chinese economics, posted exclusively here for your reading pleasure and feedback.

    Do not reproduce w/out permission. Article protected by the 'Rage-will-bash-your-head-in' Act.




    Centriole Cynosure: Central –Local Interactions In post-1980 Chinese Fiscal Reforms​



    The saga of post-1980’s Chinese fiscal reforms is an interesting one. Not only does it represent a pivotal point in Chinese economic and political history, it constitutes a novel approach in linear intra-state engagement for post-command economy countries and carries far-reaching implications for states confronted with that crucial dilemma of reconciling a centrist, command economy system with what is largely decentralized, free market-style economic liberalization. Prior to the fiscal reforms and the attendant ‘cadre evaluation system’, China was a unitary political state, with decisions- key economic as well as political, handed down from the centre (Tsai and Youqiang 71). The 1980’s fiscal reforms saw a revolution in this geospatial political and economic structure: with increasing power and decision-making capability transferred to the states. What brought about this change? What were its key features? Why was it so significant? What did the Centre, and the states, stand to gain? This paper aims to posit answers to such questions, and hypothesizes that: while the 1980’s fiscal reforms sought to delegate increasingly facultative and selective fiscal powers to the states, and represented some erosion in the centre’s ascendancy, control and directive prerogative, the concessions actually pandered to the Centre’s interests more than it did to the states’, and eventually sought to benefit the Centre’s agenda of economic reform and rapid economic development more than any presumptive anticipation of economic and political decentralization.

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    Last edited: Feb 6, 2010
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  3. Rage

    Rage DFI TEAM Stars and Ambassadors

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    To begin with, we must explore the reasons for the genesis of these reforms: the prelude to fiscal decentralization. Prior to the late 1970’s and 1980’s, China’s economic structure was unitary, centrist and rigidly hierarchic, with fiscal denouements and responsibilities handed down by the government at the centre to government at the local and provincial levels (Tsai and Youqiang 72). This entailed, as historical analyses of command economies have brought to bear, that while state-assigned responsibilities and state-sanctioned expenditures remained fixed, there was no incentive to economic development that could accrue to the states. Inevitably, this led to a stagnation in economic growth, as states were perceived merely as extensions or tools, rather than as agents of the centre. This is key, for without the incentive, states could not be expected to, and did not, act in ways that maximized economic growth at the local level, and therefore the national interest as it was perceived by post-Mao Beijing. They were content merely to execute centrally-delegated tasks and remit (often with some discrepancy) taxes collected within their jurisdictions. Consequently, economic growth stagnated, fiscal transfers to the centre witnessed no real growth and provincial governments remained lethargic to local economic development, preferring rather to operate within the status quo (Tsai and Youqiang 76).


    This changed however with the series of fiscal decentralization reforms that took place since the late 1970’s/80’s. The reforms can primarily be divided into two periods: those before the Tax-Assignment /Revenue Sharing agreement of 1994, and those after. During the early period, the central government seemingly gave away substantial fiscal benefits to provincial and local governments: to be particular, with the delegation of more numerous economic and political tasks came concomitant greater decision-making and discretionary/self-regulative ability. In addition, fiscal expenditure raising was delegated downward, so that the centre no longer had to shoulder the burden of local expenditure (Tsai and Youqiang 79). On the other hand, through the delegation of fiscal powers and the sharing of tax revenues, the center could provide local governments with necessary discretion to fulfill the delegated tasks of developing local economy, for which they would receive pecuniary rewards, namely increased fiscal revenues. Simultaneously, the centre retained control over fiscal variables such as tax rates and tax structure. It is also of note, that during the intervening period: 1977-1993, the Beijing government signed various fiscal contract systems (caizheng baogan) under a variety of fiscal regimes with its provinces (Saich 149, Tsai and Youqiang 82). These fiscal regimes were not admensuratedly uniform, for they specified, in respect to each province, the amount or ratio of fiscal revenues obligated to the centre. The rates were regressive, and therefore inherently offered incentives and benefits, the consequences of which were enormous for Chinese industry and development (Tsai and Youqiang 79).


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  4. Rage

    Rage DFI TEAM Stars and Ambassadors

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    To understand the impact of these pre-1994 fiscal reforms, it behooves us to consider the role of incentives in the economic structure. As already elucidated before, the key ingredient missing in the fiscal interaction between state and centre prior to 1980 was a clear and tangible incentive system. Under the prevailing system, it was incumbent upon local governments to only fulfill centrally-delegated responsibilities, so as to avoid evincing punitive measures in terms of ex-post fiscal curtailment: either through a larger punitive revenue extraction or a shorter budget in the subsequent iteration (Saich 144). From a more personal perspective, for the cadres, it could also mean an abrupt cut-down of their career prospects, or an internal party disciplining that could have a myriad of ornery consequences. As opposed to this purely punitive mechanism, the 1980’s fiscal reforms sough to establish a clearly delineated and ameliorating incentive structure. Coupled with greater economic freedoms, this meant that states had greater stimulus and greater means to pursue economic development, and to do so progressively increasingly, so that they could retain a larger share of the revenues under the rationally regressive contract systems (Tsai and Youqiang 79). It also mitigated to some degree the temptation to shirk responsibilities of government that were without the centrally-defined set of local responsibilities, given that local governments now had a set of tangible rewards that stimulated them to act in order to maximize their interests.


    The result of this incentive structure on state-local interaction was manifold and magnanimous. By their very nature, agents are more proximate to local interaction than are their more distant counterparts, and as a result have a tendency to cheat on their principles by indulging in extra-contractual activities, to their gain and the principle’s detriment. This is particularly more so when agents are stressed for resources and find it necessary to resort to all sorts of such activities to make up the shortfall. By creating an incentive structure that maximized gain by maximizing revenue, the centre gave local governments the need to collect higher taxes, thereby reducing transaction costs of such local sub-rosa action. By retaining control over tax rates and tax structures, the government ensured that the only way that states could achieve this was by spurring economic activity, not by an injudicious use of the tax rate. This is significant to note, for it achieved two things: first, it ensured that the centre had control over the most ‘sensitive’ fiscal variable i.e. tax rates, and thereby that public discontent was reduced; and second, that the centre’s objective of rapid economic development was indigenously and autochtonously carried out (Saich 144, Tsai and Youqiang 76, Zhan 16). Even more importantly, it ensured that the process had a life of its own by divesting itself of its previous expenditure coordination and remuneration activities. By providing the states local taxation possibilities such as the EBR [Extra-Budgetary Revenue] within tolerable limits, the center provided them the necessary leeway to be able to negotiate their tasks (Zhan 23). Simultaneously, by tying local revenue to local expenditure, the central government ensured the effective hardening of budgetary constraints, and that states therefore, spent their monies more wisely.


    Another feature of the divestment of central responsibility for expenditure was the redistribution of risk sharing: no longer was the central government solely liable for risk eventualities, for local governments had to share a portion of the risks as well (Zhan 13). Of the various fiscal contracts signed between the central government and the provinces, many established a remission quota that was fixed or held static for a period of a few years, the surplus of which could be retained by the local governments either in full, or at significantly higher than normal retention rates (Tsai and Youqiang 79). The more significant feature of the fiscal contract system however, was that states, galvanized by the higher share of revenues accruing from higher collections, were more enthusiastic about local development. The centre could concentrate on macroeconomic variables and factors at the national level, rather than trying to micromanage regional expenditures and spur regional growth.


    The result was a manifold increase in both provincial and central revenues. “In 1980, when the fiscal decentralization reforms first started, the central share of national budgetary revenue was 24.5 percent. In 1984, the percentage increased to a high point of 40.5 percent. etween 1980 and 1992 when the fiscal contract system was experimented and implemented, the average growth rate of central budgetary revenue was 10 percent (as opposed to the -2 percent between 1953 and 1977)” and even correcting for inflation, at a rate of 3% (Zhan 12,13). Even though, as it may be argued, that the formulation of fixed remittances under the revenue sharing agreement constituted a major victory on the part of the provinces in their negotiations with the centre, the concession was actually a strategic one, designed to simultaneously optimize the principle’s interest, while optimizing the agent incentive structure. Such were the remission quotas concluded, that they stipulated a minimum of budgetary revenue equal to the revenue remitted to the centre last year, often with upward adjustments (Tsai and Youqiang 81). Furthermore, they were negotiated individually and isolatedly, to minimize the otherwise considerable bargaining power the states would wield, and crucially to the centre’s advantage (Saich 152). The quotas assured that at the very least, the centre’s share would not fall below the status quo of remittance as of last year, and usually ended up expanding the fiscal revenues sizably, while at the same time maintaining the incentive structure for the agents. The failsafe mechanism included was that the centre could exploit its unique and privileged position in the unitary constitution to make amendments to fiscal contracts for its benefit. Consequently, “the center often readjusted the provincial sharing rates of budgetary revenue in its own favor, reclassified certain taxes as central government revenues, and appropriated some of the most profitable enterprises in industries such as automobiles, petrochemicals, non-ferrous metals and shipping, by incorporating them into centrally owned enterprises” (Zhan 13). The failsafe mechanism was significant in its own right, in that it assuaged the concerns of the leadership in Beijing- particularly of economic conservatives- over issues of the erosion of its control over the states, by ensuring a recrudescence to the pre-1980’s fiscal mechanism, atleast on the income side, was wholly possible. The institutionalization of the system of “forced loans”, that entitled Beijing to borrow money from the provinces in the event of a crisis without the obligation ever to repay, and the centralized distribution of provincial quotas for national bonds also pandered out to the centre’s favor (Tsai and Youqiang).


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  5. Rage

    Rage DFI TEAM Stars and Ambassadors

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    As much as the fiscal reforms of the 1980’s provided a fillip to economic growth, ensured that the state’s agenda of economic development was rapidly and effectively carried out by its agents, and increased budgetary fiscal revenues- both central and local, it also had negative connotations that were antipodal to the centre’s interests. For instance, that the local governments would engage in activities that often imposed opportunity costs in the form of negative externalities on adjacent and other provinces is not surprising. Such externalities included environmental degradation, as provinces, in their zeal to encourage economic growth and maximize their fiscal returns, often failed to or purposively ignored the protection of environment in most areas (Saich 152). In addition, in order to attract business, while heavy tax-breaks and sops may have benefitted one area, their indiscriminate and injudicious use often resulted in a loss of national revenue for the country as a whole. Undesirable trade wars and blockades of markets between provinces were witnessed as well (Saich 154). To the center’s continued chagrin, the provinces also, atleast in the initial years, tended to encourage high-profit yielding, high-tax, lucrative, yet relatively low-investment, low-cost industries, but industries that had a negative impact on societal function and morality as well: such as the tobacco and liquor industries (Zhan 15, 22). Faced with an eroding moral authority in the post-Mao era, the centre could not tolerate any more activities that could, or had the potential to, erode its morality even further (Saich 142). The dynamic between the centre’s desire to assert and perpetuate its own version of morality, and local leaders’ desire to add pecuniary value to their performance given limited time-horizons and clearly delineated central tasks, was an interesting one to witness, and ultimately played out in the center’s favour, through central intervention in modifying the remittance structures in respect of these industries. Furthermore, despite the fiscal reforms and the incentive structure designed to mitigate this phenomenon, local leaders still at times saw their payoffs as deriving not solely from the centre. Many local officials pursued good relations with enterprises, often realized through extra-budgetary (and extra-legal) ‘incentives’, because it provided a more prosperous and viable career path to the erstwhile alternative of advancement through Beijing (Tsai and Youqiang 83). Given local agents as the sole representative of the principle in far-flung areas of the country, and the only means through which information of local industry was acquired, central government had for a long time to “rely on local reports to access the information regarding local tax revenue and expenditure and to obtain its share of the revenue” (Zhan 11). Even despite the incentive structure, local government officials had obvious other tangible incentives, in the form of kickbacks and bribes by local industry, to distort statistics and aggrandize themselves more easily.


    The major difference between the pre-1994 fiscal reforms and the Tax Reform of 1994 was that, while the former divested the centre of its local fiscal expenditure responsibilities, and to a great degree, relinquished power over local revenue collection and modes of industrialization, the latter helped the centre to regain its control over local fiscal revenue and power in several important ways. It increased the central share of budgetary revenue and designated as central-specific or central-local shared most large, easily collectable taxes such as VAT or consumption tax (Tsui and Youqiang 84). This had the immediate effect of increasing the central share of budgetary revenue: “In 1993, the year before the tax reform, the central share of budgetary revenue was only 22 percent. n 1994, the central share jumped to 55.7 percent, and the amount of central budgetary revenue tripled” (Zhan 14). As opposed to the fiscal contract system of the 1980’s, the 1994 Tax Reform permitted the centre the financial leeway to perform tasks it deemed fit at the macroeconomic level without having to rely on local financing for its expenditure. In order to mitigate the transaction costs of the agent-principal relationship, the central government also set up two designates of tax bureaus at the provincial and local levels to separate the collection of central and local taxes. Erstwhile, under the 1980’s fiscal reforms, all taxes - central, local and shared - were collected by taxation bureaus manned by local cadres and then remitted to the centre in accordance with revenue-sharing contracts (Tsui and Youqiang 85). The problems of this system were obvious, as collection, calculation, remittance and statistics could easily be manipulated in local favor. The 1994 Tax Reform sought to expunge such deviant behavior by operating national tax bureaus simultaneously in concurrence with local tax bureaus, but independent of them. Thus, the centre, rather than the state, was now responsible for refunding the local share of shared tax revenues, in a way evincing a return to the pre-1980 fiscal expenditure system (Tsui and Youqiang 85). The centre could also decide on the time and date of the refund, obviating the responsibility of immediate recompense, and could also proscribe restrictions on its use (Tsui and Youqiang 86). All this served to increase the centre’s control over and dominance of local money.


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  6. Rage

    Rage DFI TEAM Stars and Ambassadors

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    There were several benefits and disadvantages to the 1994 tax reform, with the benefits largely accruing to the centre and the costs largely accruing to the state. On the one hand, as is already seen, central share and control over tax revenue increased. On the other hand, states were forced to explore new avenues of revenue to make up for the shortfall from central expropriation (Zhan 27). The centre clearly had an agenda: by redesignating larger taxes to central or prorate, it intended to force, or rather coerce the states into developing economic sectors that were neglected under the fiscal contract system: in particular the service sector from where business tax, resource tax and real estate taxes- the most sizable taxes that remained under the purview of the states - were extracted (Tsui and Youqiang 84). Indirectly, the centre achieved its goal of developing “transportation, communication, information, tourism, culture, entertainment, and other service industries”, as states sought to exploit these new avenues via incentives and privatization (Zhan 25). Nevertheless, the new system had detrimental consequences as well. Local governments were left with taxes that were often vapid and difficult to collect. They resorted to extracting as much EBR as possible within the limit tolerated by the central government. “As a result, local EBR swelled unstoppably after the new tax-sharing system was enacted in 1994. Despite the occasional central attempts to curb the increasing trend, local EBR more than doubled in the years between 1993 and 2001” (Zhan 26). The aggressive pursuit of extra-budgetary fiscal revenues and the raising of taxes as result of local financing difficulties had undoubted mitigating consequences on local business and growth.


    In order to measure and monitor, as well as evaluate the performance of local officials under the new fiscal regimes concomitant of the reforms, the ‘cadre evaluation system’ (ganbu gangwei zerenchi) was introduced in 1993. The criteria for performance were simple and broad-based, and included: “political integrity (de), competence (neng), diligence (qin) and achievements (ji), with an emphasis on actual work achievements” (Zhan 18). These criteria were universally applicable- to all levels of the political hierarchy - and accorded rewards or punishments on the basis of multiple, successive years of excellence or incompetence. Evaluations were annual and specific to economic tangibles such as industrial output, taxes, remittance, township and village-enterprise production, etc., as well as social variables such as family planning and the maintenance of law and order (Whitling 103). The ‘cadre evaluation system’ quantified targets and delineated performance criteria, but also stipulated the rewards and punishments through cadre responsibility commissions (zeren zhuang). As much as 15% of subordinate compensation would be withheld if assigned tasks were not carried out, and conversely generous bonuses were awarded in the attainment of difficult targets (Zhan 26). The system served to regulate cadre behavior by adopting a clear-cut, tangible and enforceable carrot-and-stick approach. Officials that did poorly would lose out to their peers- both in terms of remuneration and career advancement, while those that did well were rewarded with concurrent equivalent or other higher positions. Methods such as rotation of cadres between different geographical areas, spot investigations and the threat of expulsion or the reward of lagniappes were employed to keep cadres in check, and ensure that centrally-delegated responsibilities were fulfilled (Whitling 109). In the interaction between state and centre, the cadre evaluation system enabled the centre to regulate the performance of its agents, avoid, be alerted to and placate, or even forfend, public disharmony through the ‘petitions system’ under a political regime where public officials were not directly accountable to their citizens, and ensure the fulfillment of both macro and micro-economic decisions without the need for direct and more extensive intervention. Nevertheless, the system also entailed shortcomings in allowing cadres to shirk work through inadequate provision of public goods that were not included, or not equally emphasized on, in the performance evaluation criteria- such as education and health care (Whitling 116-117).


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  7. Rage

    Rage DFI TEAM Stars and Ambassadors

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    The fiscal reforms of the 1980’s saw the central government relinquish a greater degree of fiscal control in favor of local governments, in order to fulfill national goals of economic development and rapid industrialization. However, in terms of the relative shares of budgetary revenue, the evacuation of responsibilities and the achievement of interests and objectives, the larger benefit under the new regime accrued to the centre. The reforms however, did also evince a substantial improvement in the relative positions of states- primarily with respect to their incentives and freedoms under the pre-1980’s fiscal structure. While the 1994 tax Reform sought to impose a greater degree of central control over local taxation and revenue collection in comparison to its antecedent, it helped the centre to achieve its objectives of local fiscal and monetary tightening and service sector development, while simultaneously forcing local governments to explore new sources of revenue and forcing them to be more efficient. The effective execution and performance of these objectives under the various fiscal regimes was facilitated by the cadre evaluation system, and the punitive and reparative measures it entailed in ensuring cadre responsibility.


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  8. amoy

    amoy Senior Member Senior Member

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  9. Rage

    Rage DFI TEAM Stars and Ambassadors

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    Indeed. The fourfold criteria of 'de, neng, qin, ji' were crucial components in the erstwhile 'cadre evaluation system', before it was replaced by the more elaborate, and somewhat more indigent, system of six procedures: "democratic nomination", "democratic assessment", "public opinion poll", "analysis of actual achievements", "interview" and "comprehensive evaluation", in 2007.

    That can be amended. 'fact, it already is.
     

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