Central Transfer and Fiscal Capacity in China: Evidence from the Tax-Sharing System

摘要

In 1994, the Chinese government introduced a new fiscal system. Using the provincial panel data during the following period 1995-2010, we find robust evidence that central transfer (measured as the ratio of net central transfer to budgetary expenditure for each province) has a significant, negative effect on the fiscal capacity of a province (the sum of budgetary and extra-budgetary incomes as a percentage of GDP). Therefore, when the central government favors the poor provinces in central transfers (the common pool problem), the rich provinces expand their extra-budgetary income more to avoid predation by the central government, which helps increase the fiscal capacity and thus the market-preserving behavior of the rich provinces. Our result helps explain China's success, which has strong policy implications for other transitional economies.