Home Political science Dancing with the devil : the political economy of privatization in China
In face of the growing problems associated with the fiscal contract system, the central government began to experiment with measures in the late 1980s for a restructuring of the fiscal relations with provincial governments. In December 1993 it issued a directive to replace the provincial fiscal contracts with a new arrangement for central-provincial fiscal relations. It was called fenshui zhi, or system of tax separation. Effective from January 1, 1994, all fiscal revenues were partitioned along the lines of tax categories. Specifically, revenues were divided into three categories: taxes belonging exclusively to the central government, taxes belonging exclusively to provincial governments,
Table 3.3 Revenue partitioning between central and provincial governments in 1994
Source: Contents of the table are based on descriptions in Jia Kang and Zhao Quanhou 2008.
and taxes shared by central and provincial governments according to fixed percentages. Table 3.3 summarizes the basic elements of this arrangement.
It should be noted that the 1994 restructuring was not a complete departure from the fiscal contract system. Under the new system, the central government nominally had a 100% share in the excise tax (converted from the product tax) and a 75% share in the value-added tax. Both taxes were created in 1984 as spin-off tax categories from the industrial and commercial tax (see note 5). To compensate for the “revenue loss” of local governments, the central government would annually repatriate to them a lump sum equal to the revenue they had collected through these taxes in 1993, plus a 0.3% equivalent of this lump sum for every 1% of the growth portion of these taxes. In 2002 the local enterprise income tax and the personal income tax were reclassified as shared revenue. Again, the sharing formula between the central government and local governments (initially 50:50 and then 60:40) would apply only to the growth portion of these taxes relative to the base year (2001) amounts retained locally, which the central government would repatriate to the pertinent local governments. Moreover, fiscal relations at sub-provincial levels were not covered by the new arrangement of revenue partitioning. By and large they continued to be governed by various fiscal contracts formed before 1994, albeit with adjustments reflecting the changes in central-provincial fiscal relations (Jia Kang and Zhao Quanhou 2008).
Despite these linkages and continuities, the 1994 restructuring did usher in many important changes with far-reaching implications. First, an immediate outcome of the new system was an increase of the central government’s share in budget revenue, largely owing to its commanding the lion’s share in the most important and stable tax—the value-added tax. As shown in table 3.1, the central share in budget revenue jumped to 52% in 1995 and remained at that level throughout the following decade and half. In the meantime, however, the share of the central government in direct budget spending trended down. Embodied in these movements is a growing ability of the central government to redistribute fiscal resources through various fiscal transfer programs, especially those to economically less developed provinces. Most of these transfers, though, had to be filtered by provincial governments, thus adding a new dimension in the bargaining relations between provincial and sub-provincial governments.
Second, to facilitate the implementation of the new tax system, the collection of taxes was divided into two separate authorities: the State Administration of Taxation (guoshui ju) and the Local Administration of Taxation (dishui ju). The former was directly controlled by the central government and would collect both central revenues and shared revenues and then download the local portions of the shared revenues back to pertinent provincial governments according to preset formulas.11 The latter was placed under the control of pertinent provincial governments and would be responsible for 
collecting local taxes only. This change significantly reduced the room for maneuvering by local governments to move budgetary revenues into extrabudgetary categories or nonbudgetary channels.
Third, although indirect taxes continued to be the most important source of budgetary revenue after the 1994 restructuring (as shown in figure 3.1), the fiscal property rights over them changed. Before 1994, the bulk of the indirect taxes came from three taxes: product tax, value-added tax, and business tax. Under the fiscal contract system they were mixed together with other taxes and fees in the larger pool of revenue that local governments collected and then shared with the central government. Accordingly, the property rights over them were not clearly defined. In 1994 the product tax was converted into the excise tax and the scope of the value-added tax was expanded. At the same time the central government locked in 100% and 75% of the growth portions of the excise tax and the value-added tax respectively. The business tax became the largest tax solely “owned” by local governments, accounting for 25%-зо% of government budget revenue during the decade after the restructuring. Unlike the excise tax and the value-added tax, which are mainly derived from industrial activities, the business tax is in the main levied on service activities. Given the central government’s dominant shares in the excise tax and the value-added tax, and with the decline of the relative significance of tax refunds in fiscal transfers, the 1994 restructuring phased in a process where the centrality of industrial activities in the revenue base of local governments experienced gradual erosion, which, as will be discussed below, had important implications for both public and private enterprises.
Fourth, one of the changes in the 1994 restructuring that initially did not capture much attention but had far-reaching implications for local public finance and local government policies toward public and nonpublic enterprises is that the proceeds from the transfer of land use rights were categorized as local revenue. Under the prereform system, land was publicly owned and allocated administratively according to the needs of central planning. Limited compensation was provided for converting rural collective land into state-owned land, so as to alleviate the negative consequences for rural collectives. But in the regular accounting of economic organizations, the value of land was not assessed or booked as part of their assets, nor was there any explicit charge for land use other than the agriculture tax in rural areas.
Explicit charges for land use emerged in the late 1970s and early 1980s. That was followed by a gradual relaxation of the restrictions on the transfer of land use rights. In 1986 the government enacted the Land Administration Law and created a new agency, the State Land Administration, to enforce the law. Among the changes the law introduced was allowing rural collectives to use, subjective to administrative approval, land as equity capital to form joint ownership enterprises with urban public enterprises. As a result of such self-arranged, lateral transfer of land use rights to a common resource pool, government acquisition ceased to be the only avenue for the transfer of rights, and administrative allocation began to be supplemented with other forms of such transfer.
Following a constitutional amendment on the transferability of land use right in 1988 the Land Administration Law was revised to allow the renting and sale of the use rights of both state-owned and collective land. This further change marked the beginning of the rise of urban markets in land use rights. In view of the fiscal implications of sales of land use rights, in 1989 the central government demanded a 40% share in the revenue generated. But the actual amount it received was miniscule, largely because of resistance from the “owners” (local governments) and the difficulty of ascertaining the net gains after deduction of requisition-related costs (which local governments could inflate) (Zou Yuchuan 1998). The sharing percentage was scaled down to 5% in 1992 and dropped altogether in the 1994 restructuring.
It is interesting to note that, unlike the taxes designated as local revenue in 1994, the proceeds from transfers of land use rights were not classified as budget revenue because of the ad hoc nature of their occurrence and therefore did not face close fiscal monitoring by the central government. Some of the proceeds entered the extrabudgetary accounts oflocal governments, but a large portion was not even booked as such. The central government did require that the proceeds from the sale of rights be included in “special government- managed funds.” But it was not until after 1999 that a small fraction of them began to show up in the local fiscal statistics on these funds. In 2000, for example, only 17% of the land sale proceeds recorded by the Ministry of Land and Resources was reported as “special government-managed funds” in the local fiscal statistics compiled by the Ministry of Finance (SYCLR 2001, 247; FSPCC2001, 387). In 2005 the percentage edged up to 21% (SYCLR2006, 177;
The Evolving Structure of Public Finance 99
FIGURE 3.4 Land sale proceeds as percentage equivalent of local budget revenue, 1995-2010
Sources: FYC1996,1998,2011; SYCLR1995,1996,1997,1999, 2006, 2011.
FSPCC2006, 431). It was not until 2006 that the central government tightened monitoring and placed land sale proceeds under direct budgetary control.24 What prompted that decision was a substantial growth of such proceeds after the turn of the century,25 as can be seen from figure 3.4. There are several twists behind the pattern illustrated by the graph.
Following the 1988 amendment of the Land Administration Law, markets in land use rights began to emerge. By the end of 1992 a total of 56 billion yuan of land sale proceeds had been generated (Zou Yuchuan 1998, 164). But the pace of growth was not exceedingly fast, and administrative allocation (free of charge) remained the dominant mode of rights transfers, even after the 1994 restructuring. In 1994 the acreage of transfers of land use rights through administrative allocation was 1.85 times of that through sale. In 1999 the figure declined, but the ratio still stood at 1.2. According to the former head of the State Land Administration (Zou Yuchuan 1998), the main reason for this measured growth of the land sale market during the first decade of the law is that local governments could administratively allocate land use rights to companies that they “owned” and then rent out or sell through these companies the
The percentage rose to 25% in 2006, 57% in 2007, and 93% in 2008 respectively (SYCLR 2007, 298; 2008, 311; 2009, 272; FSPCC2007, 977; FSPCC2008, 266; FSPCC2009, 321).
The absolute amount of land sale proceeds reported was 39 billion yuan in 1995; it rose to 130 billion yuan in 2001 and further to 808 billion yuan in 2006 (SLRYC1996, 164; 1999, 136; SLRYC1996; SLRYC 2007, 178).
use rights on secondary markets, for gains they could keep to themselves completely. Even for the sale of land use rights, over 90% of the transactions were conducted through an opaque arrangement called “transfer by agreement” (xieyi zhuanrang) (SYCLR 2001, 6-7), which could be easily manipulated to facilitate side payments and kickbacks, rather than open bidding or auction.
To address these problems, a second amendment to the Land Administration Law was made in 1998, which was further reinforced by a directive issued by the State Council in 2001. Among the changes (which took effect in 1999) was that the scope of administrative allocation was sharply reduced and limited to certain uses, such as land uses by military and government establishments and infrastructural facilities. Also, the sale of rural land (collectively owned) for urban uses now had to go through a two-step process: (1) conversion of rural land into state-owned (urban) land under city or county governments, and (2) resale of the converted land on the primary market for urban land use rights. These two changes made it difficult to use administrative allocation to channel urban land use rights to the secondary market or to transfer land use rights directly from rural to urban users. As a result, the market in the use of primary land assumed elevated importance for addressing the revenue concerns of local governments, and rural land requisition by local governments became the central avenue for the expansion of urban space and the main source of supply for primary land markets. The sharp rise of land sale proceeds after 1999 (figure 3.4) reflects the impact of these changes.
Table 3.4 Acreages (1,000 hectares) of different types of land use right
Sources: SYCLR1995,1996,1997,1999, 2006.
There are also some noteworthy developments in parallel to the changing patterns of land sale proceeds. Table 3.4 shows that secondary markets of land use rights experienced significant increases in the late 1990s and around the turn of the century. That was a period when massive privatization of state- owned enterprises and township and village enterprises took place in urban and rural areas. Furthermore, the table shows that there was significant growth in the total area of land mortgaged by existing users as collateral for obtaining bank loans. Many of the organizations involved in such dealings were actually “fundraising platforms” (rongzi pingtai) set up by local governments to obtain lending for urban development beyond the limit of their budgetary funds and/or for servicing existing debts. Since until recently local governments in China were not allowed to issue public debt, such land-leveraged
borrowing became an important instrument to expand the fiscal resources of local governments. In addition, the growth of land sale revenue was accompanied by an upward trend in the importance of the taxes related to land use and urban development. These taxes were designated as local revenue in the 1994 restructuring. They include the land value appreciation tax, urban construction and maintenance tax, urban land use tax, urban (nonresidential) property tax, deed tax, and tax on nonfarm use of farmland. Together they accounted for 7% of the budget revenue of local governments in 1993. This share doubled to 14% in 1994 and further rose to 16% in 2005 (FSPCC1994, 76; FSPCC 199s, 57; FSPCC2006, 67).
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