Progress in fiscal reform is key to transforming China

Then in October, the State Council issued rules to strengthen the management and supervision of local government debt. Meanwhile, both the Ministry of Finance and the State Administration of Taxation have rolled out a series of proposals to fine-tune the tax on resources.

The concerted effort to reform the country’s tax and fiscal system is in line with the Central Committee’s decision late last month passed by its fourth plenum, which noted that: “Legislation and reform policy decisions must go hand in hand, so that major reforms are backed by law and legislation proactively answers the real needs of a developing economy.”

To build a society governed by the rule of law, one major plank has to be the regulations that control how the government spends its money.

Tax and fiscal reforms are important because they directly affect the entire reform drive.

There are three major areas of concern in fiscal reform: budget management, the tax structure, and the fiscal relationship between the central and local governments. Among these, budget reform should be introduced first. We can expect progress on this front within the next two years.

The new Budget Law pledges to build a regulated, open budget system, while the State Council has also stressed that transparency will be a priority in the reform and implementation process.

The fourth plenum decision further pledged the disclosure of government information in areas such as the fiscal budget, the allocation of public resources and the approval of major projects. This is a clear and unequivocal goal.

What items should be open for our scrutiny? The balance sheet holds the key; a test of the government’s sincerity in practicing transparency is whether it will publish its annual financial report.

The economy is slowing after years of growth at breakneck speed. At this time, fiscal policies are particularly useful macroeconomic tools. Under the current budgeting system, however, the government often ends up amplifying the economy’s cyclical movements.

When the economy is heating up, for example, government revenues shoot up, resulting in a scramble at the end of the year to spend the extra money. At the same time, macroeconomic scrutiny is lax, which encourages enterprises to overinvest in good times. Conversely, in an economic downturn, governments at all levels are so eager to meet revenue targets that they end up overtaxing already ailing industries.

Over the past decades, policies that aimed to counter the effects of a fluctuating economy were largely cancelled out by the amplifying tendencies of the system.

The new budget law requires multiyear budgeting, which not only includes changing budget targets to estimates but also comes with guarantees on recurrent spending to ensure stability. This will help ease pressure on the government to respond to short-term fluctuations and counter the amplification tendencies.

Of course, it won’t be easy breaking local governments’ long-time habit of collecting revenues to meet targets. One way is to improve oversight of government behavior, as advocated in the fourth plenum decision – by legislators, the judiciary, society and public opinion.

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