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Revenue Partitioning

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

Revenue type

Tax categories

Central revenue

Import duty; excise tax; central SOE income tax and remitted profits; income tax on banks and nonbank financial institutions; combined revenues (business tax; income tax; remitted profits; urban maintenance and construction tax) from railway system and headquarters of national banks and insurance companies; (responsibility for covering tax rebates for exporters)

Local revenue

Business tax; local enterprise income tax and remitted profits; personal income tax; urban land use tax; adjustment tax on fixed asset investment; tax on motor vehicles and ship licenses; stamp duty; slaughter tax; agriculture tax; deed tax; animal husbandry tax; special agricultural product tax; urban (nonresidential) property tax; tax on nonfarm use of farmland; estate tax; land value appreciation tax; proceeds from state-owned land use right transfers

Shared revenue

Value-added tax (75:25); resource tax (offshore marine resources for central government and most other resources for local governments); security transaction stamp duty

Major post-1994 changes (through 2005)

Local enterprise income tax and personal income tax were redefined as shared taxes with a 50% central share in 2002 and 60% in 2003; export tax rebates were turned into a shared responsibility in 2004 (75% central and 25% local; adjusted to 92.5% central and 7.5% local in 2005); agricultural tax was abolished in 2005

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 [1]

collecting local taxes only.[2] 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.[3] 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.[4] 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,[5] 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.[6] 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.[7]

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.[8] 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.[9] 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,[10] 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.[11] This further change marked the beginning of the rise of urban markets in land use rights.[12] 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.[13] 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

Land sale proceeds as percentage equivalent of local budget revenue, 1995-2010

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.[14] 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.[15] 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,[16] and (2) resale of the converted land on the primary market for urban land use rights.[17] 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

transfer, 1993-2005


Primary market sale



Secondary market sale

Secondary market renting

















































































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.[18] 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).

  • [1] The State Administration of Taxation (SAT) has four levels of office: national, provincial, (prefec- tural) city, and county (including county-rank city).
  • [2] The Local Administration of Taxation (LAT) is divided into three levels: provincial, (prefectural)city, and county (including county-rank city). The provincial-level tax authority is placed under thejoint supervision of the pertinent provincial government and the central government, with the formerbeing the locus of control and the latter mainly providing policy guidance. Lower levels of the local taxauthority are controlled by the provincial-level LAT in terms of personnel, budget, and administration,though such control is to be done in consultation and coordination with the pertinent lower-level governments. The three levels of the local tax authority are responsible for collecting the revenues from thetax bases designated for provincial, city, and county governments, and the revenues they collect enterthe treasuries of the corresponding levels of government ( 6 608/^138877/^138 997/^3 53323/^3 539 21/83 6103 5.html).
  • [3] In 1993 they made up 69% of all indirect taxes (also known as industrial and commercial taxes) (CTY 1994, 15).
  • [4] Before 1994 foreign-invested companies paid the unified industrial and commercial tax (gongshangtongyi shui) instead of the value-added tax. Also, dozens of products that had been subject to the product tax were redefined as products subject to the value-added tax. In 1986 a total of 260 types of products were subject to the product tax. By April i99i, the value-added tax was levied on i70 of theminstead. In 1994 only 25 types of products were subject to the excise tax that replaced the product tax.
  • [5] In 2016 the government announced plans, based on pilot programs in select sectors and locales, toreplace the business tax with the value-added tax, hence eliminating the most important tax belongingto local governments.
  • [6] During the decade after 1994, for example, over 90% of excise tax and over 70% of value-added taxcame from the industrial sector, whereas over 80% of business tax came from the tertiary sector, and thebulk of the remainder came from construction (CTY 2007, 488, 497).
  • [7] In 1993 the value-added tax and the product (excise) tax combined to make up 50% of the tax revenue of local governments (FYC1994, 353); in 1997 this share dropped to 21% (FYC1998, 357).
  • [8] After the socialist transformation in the 1950s, rural land was turned into a collective asset, whereasurban land, plus all uninhabited and unfarmed land outside the space of people s communes, becamestate owned. This reality was formally ratified in the 1982 constitution (Zou Yuchuan 1998).
  • [9] After agricultural decollectivization (1979-1983), rural households were required to pay a land contract fee (also known as cun tiliu or chengbao fei) to the village for the use rights of farmland. Beginning in 1979 foreign-invested entities were required to pay a fee (rent) for the land they used if their localpartners did not include in their equity shares the value of the land they had occupied. In 1987 a tax onnonfarm use of farmland was introduced, which was followed by a tax on urban land use by domesticindustrial and commercial entities in 1988. In 1990 the deed tax was resumed after being suspended during the Cultural Revolution. A land value appreciation tax was added in 1993. All these levies belongedto local governments. In addition, after the start of reforms unauthorized renting (which represented aform of illicit charge) of urban land between existing occupants and space-deficient organizations alsobecame increasingly prevalent despite repeated bans by the government (Zou Yuchuan 1998, 137-140).
  • [10] The State Land Administration was merged into the newly formed Ministry of Land and Resourcesin 1998.
  • [11] The law did not spell out the details of how to implement this allowance and left the matter to theState Council. In reality the subsequently adopted policies on transfers of land use rights restricteddirect sale of the use rights of rural collective land (divided among residential uses, farming, and nonfarming activities) for urban development. The only legal avenue for such conversion is to have thestate (represented by city and county governments) rezone the boundaries between urban and ruralareas, acquire the use rights of the affected rural land with compensation for existing owners/users, andresell the use rights to users for limited duration (e.g., seventy years for most residential developmentprojects). See the discussion below.
  • [12] In 1987 pilot programs were carried out in Shenzhen and a few other cities to sell the use rights ofstate-owned land with limited durations, which paved the way for the amendment in 1988.
  • [13] In 1994, for example, the proceeds from transfers of land use rights recorded by the State LandAdministration were equivalent to 176% of the funds in the “other” category in local extrabudgetrevenue, to which such proceeds, along with other miscellaneous funds, were supposed to be booked(FSPCC 1994. 76; SYCLR 199s, 98).
  • [14] Among the demands reiterated and emphasized in the directive is that local governments shouldmove from administrative allocation to market sale and from one-on-one negotiation to open competition (e.g., through bidding or auction) in the transfer of land use rights.
  • [15] The amendment also broke the lock of local (i.e., city and county) governments on land revenueby stipulating that a fee be levied on the revenue from the sale of use rights for land newly added tothe space demarcated for (economic) “construction” (jianshe yongdi), including rural land obtainedthrough requisition. The fee would then be divided between the central government and the overseeing(provincial) government according to a ratio of 30 to 70. In 2009 this fee was equivalent to 6.5% of thetotal amount of reported proceeds from the sale of land use rights (
  • [16] The law did not give township governments the authority to acquire land for urban development.They have therefore been facilitators rather than independent players in the urbanization drive. Butthey do have great influence and bargaining power in the process because much of the rural landacquired for urban development has been physically situated in the space under their purview.
  • [17] Primary land markets in China refer to the markets where local governments sell the use rights ofthe (urban) land they “own” de jure or have obtained through requisition. Secondary markets involveexchanges of land use rights between buyers and existing users, including those that have purchased therights from primary or secondary markets or have compensated the government for the land that hasbeen allocated to them administratively (free of charge).
  • [18] For a discussion of the roles played by these fundraising platforms in local public finance, see Walterand Howie 2012.
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