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  • H61;
  • H63;
  • H74

Fan and Lv (2012) have convincingly argued that China's public debt, including borrowings by local governments, is relatively small and manageable. They have also correctly pointed out that over the last 10 years, while debt owed by local governments has surged, the government's contingent liabilities, which take into account the need to use public funds to bail out state-owned banks with large nonperforming loans, have declined sharply. I have little disagreement with Fan and Lv's conclusions, and my comments, which cover four major issues, are meant to clarify some details.

My first comment relates to centralization versus decentralization. Fan and Lv argue that China has a centralized fiscal system (de jure) based on the facts that top local officials are appointed by the central authority, tax revenues largely accrue to the central government, and the central government monopolizes the right to issue debt to the public. However, some economists have argued that China has a decentralized system (de facto) based on the facts that local government expenditures are very large relative to the central government expenditure, formula-based equalization transfers are relatively small, revenues from land sales make up a large share of total local government revenues, and borrowing by local government “financing platforms” helps to fund infrastructure projects. Even if we accept that China has a centralized fiscal system, based on the case of Japan, which has a centralized fiscal system but is running one of the largest budget deficits in the world, I still have some doubts about whether centralization necessarily means fiscal prudence (small budget deficits and public debt) as argued by Fan and Lv.

There is also a debate over whether decentralization favors economic growth. On the pro side, fiscal decentralization promotes competition among local governments, and it acts as a major force of economic development in China. On the con side, fiscal decentralization fragments the national market, encourages local protectionism, induces duplicated investment, and, hence, negatively affects economic growth.

Second, I would put more emphasis on land prices and pension liabilities as major determinants of fiscal balances and, thus, the size of the public debt. A fall in land prices affects the fiscal position of local governments in the following two ways. On the one hand, it leads to a decline in their revenue, since proceeds from land sales are a major source of revenue for local governments. On the other hand, some local government financing platforms involved in property development (if not speculation) using funds borrowed from banks may have difficulty servicing those loans. Pension liabilities relating to urban workers under the previous pension regime, the so-called legacy costs, are estimated to range from 82% to 130% of 2008 gross domestic product (GDP), depending on assumptions made (World Bank and Development Research Center of the State Council of the People's Republic of China, 2012). Ultimately, this obligation will have to be paid down through fiscal resources and should be counted as part of the government's contingent liabilities.

Third, I think more attention should be paid to the future trends of revenues and expenditures when discussing fiscal sustainability. On the revenue side, growth in fiscal revenues is expected to slow down as the pace of China's economic growth declines due to demographic changes and to the diminishing advantage of backwardness as China approaches the stage of an advanced economy. On the expenditure side, there is a pressing need to further increase spending on education, health, social protection, and environmental protection. Part of these incremental expenditures could be met through a reallocation of spending away from infrastructure investment.

Finally, I agree with the view expressed by the World Bank and Development Research Center of the State Council of the People's Republic of China (2012) that enhancing fiscal sustainability in China calls for raising revenues by further reforms in the following six directions: (i) higher taxes or prices on energy, water, natural resources, and pollution; (ii) raising state-owned enterprise dividend payments to the general budget; (iii) further mobilizing personal income taxes, which make up only 1% of China's GDP compared with an average of about 6% in high-income countries; (iv) enhancing the taxation of motor vehicles and pricing of parking and congestion; (v) enhancing property taxes; and (vi) auctioning public resources such as bandwidth user rights, franchises for public utilities, and exploitation rights for natural resources. These measures should improve not only fiscal sustainability but also improve equity and efficiency for the Chinese economy as a whole.

References

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  2. References
  • Fan G. & Lv Y. (2012). Fiscal prudence and growth sustainability: An analysis of China's public debts. Asian Economic Policy Review, 7 (2), 202220.
  • The World Bank and Development Research Center of the State Council of the People's Republic of China (2012). China 2030: Building a Modern, Harmonious, and Creative High-Income Society. Washington, DC: The World Bank. Available from URL: http://wwwwds.worldbank.org/external/default/WDSContentServer8/88WDSP8/88IB8/820128/8028/828/0003561618_8201202280013038/Rendered/PDF/671790WP0P127500China020300complete.pdf