By Xi Si (席斯) and Chang Xi (常溪)
Issue 580, July 30, 2012        
News, page 6
Translated by Tang Xiangyang
Original article: [Chinese]

Some Chinese local governments’ fiscal revenue decreased rapidly in the first half of the year with some provinces and cities having difficulty meeting their budget targets. The EO recently did a cover story citing local governments’ excessive reliance on land sales as the main problem. The EO has invited three observers to suggest possible solutions to this problem including Stephen Green (王志浩), head of research for the greater China branch of Standard Chartered; Guo Kai (郭凯), a researcher with People’s Bank of China and a former economist with the International Monetary Fund; and Ni Hongri (倪红日), a researcher with the development research center under the State Council. 

EO: How should local governments deal with the coming fiscal deficit?

Stephen Green: It will be clear in 2012 and 2013 that local government’s current financing model can't last. Infrastructure has too high a cost. There are at least three problems: First, not all expenditures are open to the public. If we have independent evaluation of urban expenditure planning, it will be more restricted and be more reasonable.

Second, the government has done too much. Private enterprises can take care of constructing highways and railways. They will finance most of their costs through reasonable toll systems. Currently the financing method of many infrastructure projects is unsustainable. Subways should be financed by those who use it rather than through taxes. The subway in Hong Kong combined property development and commercial development. It shows us subways can be financed by construction enterprises.

Another way is to allow those companies to issue local bonds for projects guaranteed to pay off. Local governments should focus on constructing decent schools and hospitals, and providing social welfare to those less privileged. Banks are issuing loans to those infrastructure projects because they expect local governments will pay off in the future.

Ni Hongri: The fiscal revenue in the second half of the year will depend on the economic situation. On the one hand, fiscal revenue should be increased by imposing stricter tax inspection. On the other hand, we have to reduce spending. The economic situation might gradually turn up in the fourth quarter.

Guo Kai: Currently, local governments can’t issue bonds and financing platforms are under pressure from regulators. With the growth rate of fiscal revenue lower than expected, local governments must reduce unnecessary spending, delay non-emergency spending and ensure spending on key projects.

China’s fiscal spending is quite flexible. Comparatively, government spending in foreign countries is mainly for social security and public services. It’s very difficult to readjust. However, China’s government spending contains investment and car buying, so there’s room to improve. They mustn’t make unreasonable fiscal revenue targets. It cannot be done in a year, but over a period of three or four years it can be changed.

EO: Why has the growth rate of fiscal revenue dropped so dramatically? Is it because of the global recession or there are other reasons?

Stephen Green: The slowing down of the Chinese economy is mainly a result of tightened monetary policy and the sluggish property industry. Tax revenue slows down as the economy slows. Revenue from land sales dropped by 40 percent compared to the same period last year. Since developers will delay payment, the real situation might be even worse. Currently, monetary policy is changing, so the economy will stabilize and even improve in the second half of the year. However, I don’t think local governments will get much relief.

Guo Kai: This year economic growth, business profits, the inflation rate, housing prices, and trade volume in the property market have all gone down. They are connected to fiscal revenue. The sluggish global economy is one of the reasons, but the major reason is still from within.  

EO: How do we deal with the relationship between fiscal revenue and land?

Guo Kai: Local fiscal revenue must have a sustainable and stable tax base. Revenue from land sales can be neither sustainable nor stable. It even provides an unreasonable stimulus. It’s not sustainable because land will be sold out sooner or later. It’s not stable because land sales are dependent on the market situation. The unreasonable stimulus exists because one of the beneficiaries of the increased land price is local government. The local government in the US is also sort of dependent on land. Its revenue is not from selling land though, but from collecting property taxes.

EO: The newly-revised draft of [the] Budget Law doesn’t allow local government to issue bonds. How do you see this? What would you say is the proper way to finance local governments?

Stephen Green: Issuing bonds is like plastering over a big wound. If we don’t deal with the wound, the plaster is useless. Local governments’ spending should be supervised and controlled. I hope the local NPC will actively supervise spending and periodically summon officials to explain where tax revenue has been used. The budget needs to be opened to the public since it’s paid by taxpayers. If the public isn’t informed, how can they trust the government? Without real transparency and supervision, I don’t see any difference between local government bonds and local financing platforms from banks (ie. loans).

Ni Hongri: To solve the problem at its root, we have to make it possible for local governments to issue bonds. It’s because of inadequate financing channels for infrastructure that local governments rely on land sales for fiscal revenue. It’s a problem with the current system.

Currently local governments are not allowed to finance because there is no good supervision system. There is budget supervision - mainly higher level government supervising lower level - but there is no public supervision. So on the one hand, we should have pubic supervision and on the other hand local governments should issue bonds at a controlled scale. If bonds exceed a reasonable scale, they could snowball into a national financial crisis.

To solve the problem at its root, we have to make it possible for local governments to issue bonds. It’s because of inadequate financing channels for infrastructure that local governments rely on land sales for fiscal revenue. It’s a problem with the current system. 

Currently local governments are not allowed to finance because there is no good supervision system. There is budget supervision - mainly higher level government supervises lower level - but there is no public supervision. So on the one hand, we should have pubic supervision and on the other hand local governments should issue bonds at a controlled scale. If bonds exceed a reasonable scale, they could snowball into a national financial crisis.