Fiscal Decentralization in China: History, Impact, Challenges and Next Steps

Chunli Shen

Jing Jin

and

Heng-fu Zou

Fiscal decentralization has been a fundamental aspect of China’s transition to a market economy, and the country has made substantial effort to break down its highly centralized fiscal management system with various forms of fiscal contracting systems (1978-1993) and later a tax sharing system (1994-present). This paper is aimed to provide a comprehensive review of China’s experience in fiscal decentralization, explore the impact of fiscal decentralization on economic growth and public expenditures, and to identify political as well as economic issues arising after the 1994 tax sharing reform. As the government is shifting the development policy towards building a harmonious society, the current fiscal system requires immediate policy attention for its opaque and inappropriate expenditure assignment, particularly at the sub-provincial levels, the vertical fiscal gap and widening fiscal disparities, the complex and malfunctioning intergovernmental transfer system, the neglected sub-provincial fiscal arrangements, and the weakness in the vertical accountability of local governments to the Center as well as the horizontal accountability of local administrations to local needs and preferences.