SYMPOSIUM ON PUBLIC BUDGETING AND FINANCE REFORMS IN CHINA: PART I Editor: Kuotsai Tom Liou

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1 J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 23 (4), WINTER 2011 SYMPOSIUM ON PUBLIC BUDGETING AND FINANCE REFORMS IN CHINA: PART I Editor: Kuotsai Tom Liou Copyright 2011 by PrAcademics Press

2 J. OF PUBLIC BUDGETING, ACCOUNTING & FINANCIAL MANAGEMENT, 23 (4), WINTER 2011 PUBLIC BUDGETING AND FINANCE REFORMS IN CHINA: INTRODUCTION Kuotsai Tom Liou* ABSTRACT. Since the late 1970s, Chinese policymakers have implemented many policies to reform their country s administrative systems for the purpose of promoting economic development. In the area of public budgeting and finance, reform policies have been introduced to improve China s taxation system, budgeting system and intergovernmental fiscal relations. The implementation of these policies has resulted in many changes and improvement to China s society and has also created new challenges to China s future development. This symposium introduction provides a brief review of the development of reform policies and a summary of five articles that examine China s revenue system, public expenditure structure, budgeting control, incentive policy, and education finance. INTRODUCTION Since the late 1970s, China has emphasized many reform policies to improve China s economic performance and development. These reform policies have covered all major areas of government operation and have gradually changed the Chinese system from a totally government-controlled planning system to a market-oriented capitalist system (or a socialist system with Chinese characteristics). The reforms introduced include changes in major governance functions, policies, institutions that are related to public management (e.g., civil service reform, fighting corruption, e-government), public finance (e.g., taxation, public budgeting, public expenditure), institutional framework (e.g., regulatory management, enterprise * Kuotsai Tom Liou, Ph.D., is a Professor, School of Public Administration, University of Central Florida. His teaching and research interests include public management, local economic development, public budgeting and finance, and program evaluation. Copyright 2011 by PrAcademics Press

3 536 LIOU reform, intellectual property right), and sustainable development (e.g., environment, education) (OECD, 2005). These reforms are critical for China s reform goals of modernization and valuable for China s economic and social development. Among these reforms, policy and managerial changes in the areas of government revenue, expenditure and public budgeting are especially important because of their effects on economic development. On the revenue side, tax policies have been linked to economic development as policymakers like to use (or manipulate) various tax types and rates (e.g., sales, income, property taxes) as financial incentives and assistance to promote economic development in their communities. On the expenditure side, policymakers have also being interested in using public resources to invest in physical and social infrastructure (e.g., transportation, education) and services to produce demands for jobs and to stimulate economic growth. Finally, a public budgeting system provides policy tools, processes and institutions for government to perform control, management, and planning functions in the design and implementation of economic development policies. This symposium is designed to introduce major reforms and changes in China s public budgeting and finance during the reform years. This introduction paper first provides a review of important background issues related to China s reforms. The paper then provides brief summaries of major issues and findings of the five articles included in the symposium. The overall reform lessons and challenging issues are discussed in the conclusion section. SYMPOSIUM BACKGROUND China s economic system before the reform years was basically a central command planning system which designed national plans for the country s economic development. The system was characterized as having vertical information flows, centralized coordination and property, and limited and concentrated participation in economic decisions (Prybyla, 1982). Under this system, resources allocation decisions were made in response to commands from planners in the administrative hierarchy, rather than in response to prices from the market. The system led to allocation inefficiency because of such problems as misallocations of both investment goods and of inputs and outputs, restrictions on the use of material incentives and

4 BUDGETING AND FINANCE REFORMS IN CHINA: INTRODUCTION 537 destructions of the energy, innovation, and enthusiasm of workers, managers, and farmers (Perkins, 1988; Prybyla, 1982). The system s problems were considered as one of major factors causing China s poor economic performance before the reform years. 1 Besides economic inefficiency problems, China s central planning system also suffered many bureaucratic problems and dysfunctions which contributed to the poor economic performance before the reforms. The huge administrative system was run not by competitively recruited civil servants but by cadres recommended by Chinese Communist Party organizations. The cadres did not possess the knowledge and experience that are necessary to manage economic development. The administrative system was characterized by many bureaucratic problems such asnonresponsiveness, lack of innovation, inefficiency, and corruption (Burns, 1983; Harding, 1981). China s post-mao leaders recognized that an efficient administrative system is critical to China s economic performance and that China s old system was inadequate to support the national goals of reforms. Since the late 1970s, China has gradually implemented many policies to reform its administrative systems to promote the country s economic development. In the areas of public budgeting and finance, Chinese policymakers have introduced reforms to change state budgeting and financial operations from a centrally planned economic system to a market-based economic system. Before 1979, the state budget was basically the financial component of the national economic plan. The budget included not only revenues and expenditures of the central and local governments, but also revenues and expenditures of all state-owned enterprises (SOEs). During the early stage of reforms, Chinese policymakers emphasized the separation of economic enterprises from administrative agencies and implemented a series of reform measures to improve the management of SOEs (Liou, 1998). Later SOE reforms have increased separation of enterprise management from direct state control by providing adequate financing mechanisms and establishing an effective corporate governance system for SOEs. SOEs today have to pay taxes to the government based on their incomes and revenues and have to obtained interest-bearing loans from the commercial banking system. Early reforms of China s tax systems included policy measures to improve SOE operations and changes to establish a more market-

5 538 LIOU oriented tax system (Toh & Lin, 2005). In the early 1980s, the government required a statutory 55% enterprise tax rate for large scare SOEs and introduced changes to include three indirect taxes (the value-added tax and two turnover taxes of business tax and product tax) in Since 1986, the government has also introduced the contract responsibility system to assess the profits or taxes of the SOEs to improve the business performance. The government expanded with indirect taxation the coverage of VAT and introduced several minor taxes (e.g., stamp duty, a vehicle and boat tax). In 1994, the Chinese government implemented a comprehensive tax reform to systematically restructure China's revenue system (Bahl, 1998). The reform was designed to address problems that had emerged during the reform years, including the coexistence of two sales taxes (the VAT and the product/business tax), highly differentiated tax rates for sales taxation, and unequal income tax treatments for enterprises (Toh & Lin, 2005). The 1994 reform covered the country's tax structure, tax administration, centralprovincial fiscal relations, and provincial-local fiscal relations. Main contents of the reform included the move from turnover taxes to value-added taxes, the harmonization of enterprise income tax rates for different types of enterprises, and the reform of the fiscal relationship between central and local government. Specific changes and implications of China s tax reforms can be found in the article by Xu and Cui in this symposium. Closely related to the reform of China s revenue system, Chinese policymakers recognized the need to develop a modern budget system to support the operation of a market-based economy. Under the old centrally-planning economic system, all resource allocation decisions were decided in the national plan and the budget served basically as a secondary accounting device. This is very different from the experience of the public budgeting systems in Western countries with a market economy. In the market economy, the government budget is considered an important policy document of government, which serves as an important tool for reconciling policy objectives and implementing them in concrete terms (OECD, 2005). China s old budgeting system was fragmented and lacked effective administrative or legislative controls (Wedeman, 2000; Ma, 2009). On the administrative side, for example, the finance department

6 BUDGETING AND FINANCE REFORMS IN CHINA: INTRODUCTION 539 tended to allocate budgetary funds in a lump sum to each department because of the lack of departmental budgets. Many departments also expanded their off-budgetary finance to spend offbudgetary funds without clear supervision. On the legislative side, the legislative review was ineffective because Chinese governments tended to maximize executive discretion when they submitted their budgets with aggregate totals of revenues and expenditures without clear information about specific policy activities and expenditure. In 1999, China implemented a budget reform which includes reform measures covering departmental budget, treasury management, and government procurement activities. In the departmental budget, for example, the reform requires that governmental budgets be compiled on a departmental basis based on standardized budgetary formats and procedure. Based on the reform, legislatures are in a better position to exercise their power to supervise government budget when government budgets are submitted early, with more detailed information specific to department levels and activities. Over the years, China has made improvements in all aspects of the budgeting cycle: formulation, approval, implementation and audit (OECD, 2005). Additional discussions about the background and effect of budgetary reform are provided in the article by Ma and You in this symposium. SYMPOSIUM ARTICLES AND ISSUES The brief review of financial reforms provides good background information for the introduction of symposium issues. The symposium consists of five articles that examine changes and challenges in China s revenue system, expenditure system, budgeting control, incentive policies, and education finance. These articles provide a comprehensive review of major reform issues in China s public finance and budgeting system and indicate major challenging issues affecting the country s future development. In the first article, Hua Xu and Huiyu Cui examined changes in China s revenue system and discussed key systemic issues and new challenges. They first provided a review of tax and fiscal reforms and their effects during the past three decades. They further explained the mechanisms of the revenue structure at both the local and the national levels of government. Xu and Cui identified new challenging issues in the areas of intergovernmental fiscal relations, fiscal

7 540 LIOU disparities of local governments among regions, central-local governments fiscal arrangements in major public service areas of education, health and pension, rising housing prices and the consideration of a new real property tax. They emphasized the importance of administrative capabilities and accountabilities in the implementation of future fiscal reforms. On the expenditure side, Qin Zhu and Xiaohu Wang reviewed structural developments of China s public expenditures and emphasized an increasing need for services in public education, health, social security and housing. They first provided theories to explain the need to adjust the spending structure and showed distributions of major public expenditure categories between 1978 and They then explained the need to focus on public series, such as public education, public health care, retirement and pension financing, and public housing. Zhu and Wang supported a proper structure of public expenditures in the four service areas by 2020 and discussed a possible path to this spending structure. On the budgeting side, Jun Ma and Li Yu studied the effect of recent budget reforms by emphasizing the issue of budgetary implementation and control. Ma and Yu first provided a review of the background of the 1999 budget reform and the importance of budgetary controls to enhance budgeting capacity and financial accountability. They collected data to show the control problem of delaying spending and accumulating unused funds after the 1999 budgetary reform. Ma and Yu further discussed some factors causing the control problems, including weaknesses in legislative process and controls, administrative fragmentation and separation, and budgeting capacity and cash management. They concluded with some lessons about China s budgeting reform and emphasized the importance of a well-designed budgetary control system for building budgeting capacity. Focusing on the issue of financial incentives, Kuotsai Tom Liou examined the development of China s incentive policies and their relationship with economic development. Liou reviewed different types and arguments of government-oriented incentive policies and explained the development of Chinese incentive policies to promote efficiency in their administrative system and preferential tax policies to attract foreign investment for economic development. The results of these policies are China s achievements in high rates of economic

8 BUDGETING AND FINANCE REFORMS IN CHINA: INTRODUCTION 541 growth, successful accumulation of foreign investments, and rapid development in coastal provinces and cities. But these policies have also resulted in some challenging issues, such as effectiveness and equity concerns, managerial accountability and transparency, and economic upgrade and balance. Finally, Wen Wang and Zhirong Jerry Zhao analyzed the effect of the rural taxation reform on the financing of compulsory education in rural China. Since 2000 the central government has installed a series of rural taxation reforms, which shifted the administrative responsibilities of rural compulsory education to the county level in 2001 and implemented a series of policies to make up for the loss of revenues to education. Wang and Zhao used a provincial-level dataset from 1998 to 2006 to examine whether and how the rural taxation reforms have affected the adequacy and equality of compulsory education finance in China. They found that the changes have contributed to reducing the overall inequality in total expenditures for compulsory education, but have not been effective in either closing the gap in the level of educational spending or alleviating the inequality in educational revenue and spending across provinces or between rural and urban areas. Wang and Zhao concluded their study by requiring corresponding reforms in intergovernmental fiscal relations to rebalance fiscal responsibilities and revenue authorities and to maintain proper accountability for local officials. CONCLUSION The purpose of this symposium is to present major reforms and developments in China s public budgeting and financial management. The articles included in the symposium have examined important changes and challenges in the areas of public revenue system, expenditure structure, education finance, incentive policies, and budget controls. The symposium findings provide evidences to support the success of China s economic reform in introducing important macro-economic policies to support economic development. The findings further showed major improvements in China s financial systems in establishing a modern taxation system and a government budgeting system to support the operation of a market-based economy. The achievements of China s economic

9 542 LIOU reforms have been very impressive in terms of scale, speed, and outcome measurements. Despite positive lessons from China s reforms, the symposium studies have also indicated some challenging problems resulting from or relating to economic development and reforms. The challenging issues include, for example, intergovernmental fiscal relations, financial disparities among local governments in different regions, lack of or efficiency of a sound monitoring and evaluation system, need for the transparency in fiscal allocations and investments, rising income gaps between urban and rural areas and between the rich and the poor, and importance of the rule of law and other mechanisms to combat corruptions (Hsu, 2004; Liou, 2009). These problems clearly show the importance in strengthening capacities of China s micro-financial management. Future reforms in financial management capacities and other areas are important for China s further development to meet new challenges of economic restructuring, unemployment and inflation, slow growth, export decline, and increased social welfare spending that are related to the global financial crisis and China s new and upgraded economic goals. NOTES 1. Many objective and subjective factors were related to China s poor economic performance before the reform years. The objective factors included, for example, China s huge absolute size and population increase, the shrinkage of farmland, the problem of energy shortage and the weight of traditional feudalism. The subjective factors consisted of policy errors and system problems. Policy errors refer to the politically induced economic policy cycle-the struggles between the two lines (i.e., rightists vs. leftists, revisionists vs. dogmatists). System problems are related to the nature of China s central administrative command planning system. For more information see, for example, Liou (1998, pp ). REFERENCE Bahl, R. W. (1998). Taxation Reform in China. Ann Arbor, MI: University of Michigan Press.

10 BUDGETING AND FINANCE REFORMS IN CHINA: INTRODUCTION 543 Burns, J. P. (1983). Reforming China s Bureaucracy, Asian Survey, 29(7): Harding, H. (1981). Organizing China: The Problem of Bureaucracy, Stanford, CA: Stanford University. Hsu, S. P. (2004). Deconstructing Decentralization in China: Fiscal Incentive versus Local Autonomy in Policy Implementation. Journal of Contemporary China, 13 (40): Liou, K. T. (2009). Local Economic Development in China and the United States: Strategies and Issues. Public Administration Review, 69 (Supplement Issue 1): S29-S37. Liou, K. T. (1998). Managing Economic Reforms in Post-Mao China. Westport, CT: Praeger Ma, J. (2009). The Dilemma of Developing Financial Accountability without Election A Study of China s Recent Budget Reforms. The Australian Journal of Public Administration, 68 (Supplement Issue 1): S62 S72. Organization for Economic Co-operation and Development (2005). Governance in China. Paris, France: Author. Perkins, D. H. (1988, June). Reforming China s Economic System. Journal of Economic Literature, 26: Prybyla, J. S. (1982). Economic Problems of Communism: A Case Study of China. Asian Survey, 22(12): Toh, M-H. & Lin, Q. (2005). An Evaluation of the 1994 Tax Reform in China Using a General Equilibrium Model. China Economic Review, 16: Wedeman, A. (2000). Budgets, Extra Budgets, and Small Treasures: Illegal Monies and Local Autonomy in China. Journal of Contemporary China, 9 (25):