(writing practices) 1994 tax reform of China

 In the late 1970s, before the Chinese government underwent economic reform, the local government did not have incentives to increase tax revenue. The local government relied on the central government’s transfer in providing local services. 

To avoid the decrease in tax revenue, they adopted a divided budgetary system in 1977 (分灶吃飯的財政包干體系). The contract specified the amount of revenue that the local government needed to submit to the central government, but as for the rest of the tax revenue, the local government can allocate it freely. The central government was really cautious in promoting this change. They first adopted this system in several provinces, and then applied it to all provinces in 1980. It was believed by bureaucrats that this system could guarantee the financial income for the central government and increase the financial income for the local government. The local government was the main beneficiary of this new system since they received much more additional payoff and a larger share of tax revenues. It is believed by scholars that this change was a result of faction competition at the central level. Reformists and Conservatists were debating the path of the national policy, and they needed support from local party cadres. Reformists adopted this tax reform to provide benefits for local party cadres in exchange for their support. The tax reform in 1980 increased motivation for the local government to stimulate the local economy and refine their budget in a much more cost-effective way to enlarge the taxable foundation. In the 1980s, this institution worked perfectly. However, against bureaucrats’ initial expectation of this policy reform, national governments did not receive sufficient tax revenue. This is mainly due to two reasons: 1) increasing competition from private companies and 2) a reduction of productive rate. However, this institution reduces the number of tax revenues that the central government receives, and it limits its ability to allocate funds to poor provinces. The central government tried to negotiate with the rich provinces to fish out more tax revenues, but since the local government is the agent who collects taxes, they have ways to bypass regulation. For instance, they allocate some funds from tax revenue to extra budget revenue so they do not need to allocate this share with the central government. In 1998, the central government identified and penalized local governments for 20,000 different kinds of government charges and fees, including aid, favorable tax cuts, or tax breaks for industries or companies. These companies then pay the local agents with bribes or other luxury goods. These methods that the local governments used to protect their interests made the economy less efficient. The local protective policy restricted the free transmission of commercial products. Therefore, in the 1990s, the Chinese government sought to regain its power to collect taxes. However, the local government successfully deterred this policy change. It was not until 1994 that the Chinese central government finally enacted a new tax delegation system. They allocated items to the central government, local government, and shared taxes. This reform intended to increase local government's tax revenues and central government's tax revenues. The central government restricted the boundary of the extra-budgetary fee and established an annual growth rate for tax revenue; if the local government does not reach this goal, it will cost them their jobs. The reference base for the annual growth rate was the previous tax revenue. The obedience of local government to this new tax reform did not originate from motivation, but from political pressure and executive orders. Local government responded to this policy change by faking their statistics of income and expenditure in order to fulfill their required tax revenue goals. As a result, the nominal number of tax revenues increased, yet the tangible income that the central government can use was reduced. In order to collect more money, the central government then taxed more revenue from initially classified extra-budgetary items by changing the law or issuing executive orders. These changes increased the uncertainty and distrust among central and local government. Local governments sought new methods to bypass submitting taxes to central government. In the end, most of the government’s expenditure and income was not specified within the budget.