"Unified Revenue and Spending"
The basic structure of the prereform public finance system was set up in the mid to late 1950s (Zuo Chuntai and Song Xinzhong 1988). Its main function was to facilitate centrally planned allocation of resources. To secure the necessary funding for the acceleration of industrialization in face of a weak domestic economic base and a lack of external sources of financing (especially after the withdrawal of Soviet aid in 1960), the central government imposed tight control over the extraction and utilization of fiscal revenue.
The anchor principle of centralized fiscal control in the Mao era was “unified revenue and spending” (tongshou tongzhi). What it meant is that lower- level governments were required to remit all their budgetary revenues to higher-level governments, which would then assess, authorize, and provide for the spending by lower-level governments. Public enterprises were also required to turn over all profits to their supervising authorities, which in turn would be responsible for financing the expenditures and covering the losses (if any) of their subordinate enterprises. In addition, all expenditures of nonadministrative and noneconomic units would be covered by a unified government budget.
In reality this principle was only strictly practiced in certain years of the Mao era—that is, 1950, 1961-1963, and 1968 (Jia Kang and Zhao Quanhou 2008). In the other years fiscal relations between different levels of government were governed by variant versions of the principle, which commonly made spending conditional on revenue and allowed for varying degrees of latitude in the use of fiscal resources by lower-level governments. With the exception of some brief periods of significant delegation of fiscal authority (e.g., during 1957-1958 and 1971-1973), however, the flexibility granted to lower-level governments was quite limited and the link between revenue growth and spending increase remained weak and unstable (Zuo Chuntai and Song Xinzhong 1988). The fiscal contract system adopted in the 1980s and early 1990s was aimed at relaxing these constraints through formalized contracts, instead of being a new institutional setup. Before getting to that issue, though, let me first highlight some other features of public finance in the Mao era.
Under the prereform system the bulk of government revenue came from two major sources: profits remitted by SOEs and a tax (known as gongshang shui, or industrial and commercial tax) on industrial and commercial transactions (with the exception of wholesale).1 Together, they accounted for 86% of the total budget revenue in 1978, whereas the remaining 14% was derived from several minor taxes (CSY 1983, 67X  SOEs were the main contributors to the treasury. In 1978 the profits remitted and the taxes paid by SOEs made up 51% and 36% of total budget revenue respectively (FSFYC, 25).
While the revenues from SOEs were subject to centralized fiscal control, the majority of SOEs were not directly administered by the central government. As noted by David Granick (1990), nonfarm economic organizations in China’s centrally planned economy were organized under a “regional property rights” regime, where public enterprises were stratified according to a pecking order of relative importance for resource allocation. The most important ones (e.g., large, capital goods producers) were “owned” by the central government or provincial governments, whereas the less important ones (e.g., small, consumer goods producers), including urban collective enterprises, were “owned” by authorities at the city, county, and subcounty levels. At the bottom of the pecking order were commune and brigade enterprises (shedui qiye) under people’s communes in rural areas.
When the degree of centralized fiscal control was moderated from the extreme of “unified revenue and spending,” the level of enterprise “ownership” was used as a major benchmark for the division of fiscal flows between higher- and lower-level governments. The projected amounts of profits and taxes to be generated by public enterprises “owned” by different levels of government and the projected expenditures and costs to be incurred by these enterprises, for example, were among the key considerations in the setting of the annual targets of fiscal revenue and spending allowance for the government of the locale where these enterprises were situated. Regardless of the administrative ranks of their “owners" though, all public enterprises physically located in a particular city or county remitted their profits and paid their taxes to the local public finance authority. The latter in turn handed over the collected revenue, in full or after deduction of preauthorized amount for retainment, to higher- level authorities according to the prevailing fiscal rules of the time.
In addition to budget revenue there was a second category of fiscal resources generated and used by the government. It was called “extrabudget” revenue or fund (Deng Yingtao et al. 1990). It consisted of fiscal surcharges by local governments, administrative fees collected by government agencies, proceeds received by nonadministrative units (shiye danwei) (e.g., research institutes, cultural establishments, and schools), and funds retained by SOEs and their supervising authorities. The last category was by far the largest component of extrabudget revenue. In 1978 it made up 73% of extrabudget revenue (FYC 2011, 472). It included the depreciation charges and residual (postremittance) profits (if any) of SOEs, plus the proceeds from SOEs formed outside regular government budgets. The use of extrabudget revenue was directed toward supplementing centrally planned activities and was subject to pertinent regulations of the fiscal authority, though there was generally more latitude on the part of the government agencies that controlled them. In 1978 the total extrabudget revenue was equivalent to about 31% of budget revenue (FYC2011, 472).
Through budget and extrabudget revenues the public finance authority on average extracted some one-third of the country’s GDP for fiscal reallocation throughout the Mao era (Jia Kang and Zhao Quanhou 2008). The system nevertheless had two major problems: weak incentives for revenue expansion and high transaction costs. Because of the weak link between revenue and spending and the lack of flexibility in local appropriation of fiscal resources, government authorities responsible for activities related to revenue generation were not strongly motivated to expand their revenue bases. The same was true for public enterprises, where much of the accounting surplus was extracted by the government, which also subsidized all the financial losses. On the other hand, centralized micromanagement of public finance at all levels of the government system led to lengthy processes of decision-making and gridlocks of information flow. Frequent (oftentimes annual) negotiations over fiscal flows between higher- and lower-level authorities also seriously constrained the administrative capacities of the parties involved.
-  The industrial and commercial tax was introduced in 1973 by combining several taxes created in the1950s. For details see Zuo Chuntai and Song Xinzhong 1988, 401.
-  These taxes were collective enterprise income tax, livestock sales tax, rural market transaction tax,agriculture tax, and import duty.
-  From 1954 to 1983 China had three levels of government: central, provincial, and city/county.Townships were added as a fourth level in 1984. Although without constitutionally designated status,prefectural cities under provincial governments have been treated as a separate level of fiscal authorityand have (since 1982) been charged with the task of administering clusters of ordinary cities (includingcounty-rank cities) and counties. Since 2002 reforms have been carried out in an increasing number ofprovinces to place cities and counties under the direct purview of provincial governments. A note onthe ranks of cities and the evolution of various special status cities is posted at the book site.