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The following are the Conclusions and Recommendations of the OECD publication Challenges for China's Public Spending: Toward Greatere Effectiveness and Equity.
China’s evolution from a centrally-planned to a market-based economy has led to a major transformation of its public expenditure policies. Significant progress has been made in raising infrastructure spending to levels more in line with China’s development needs and objectives and in improving mechanisms for expenditure budgeting and planning. Nevertheless, the transformation of expenditure policies remains incomplete. This incomplete transformation is reflected in problems in the macroeconomic dimensions of expenditure policies, in the allocation of expenditure among alternative uses and government organs, and in the technical efficiency with which expenditure policies are formulated, implemented, and assessed.
This report has focused on the first two dimensions of expenditure policies - macroeconomic and allocative efficiency - and has highlighted several problem areas and the efforts authorities are making to address them. First, a substantial part of China’s public expenditure, more than one-third of total spending, is outside the formal budget and its planning and control mechanisms. This outside-the-budget spending is partly a vestige of the former central planning system and partly the result of strains that have arisen in the fiscal relations among levels of government. The result has been a severe weakening of accountability, coherence, control and transparency in expenditure policies. Some expenditures, notably those arising from contingent liabilities of the major banks and many of the larger SOEs (for which state backing is virtually unavoidable) are, at best, under only very limited control of the government. Transparency of expenditure policies is further undermined by the extensive resort to tax expenditures; and by the antiquated system for classifying expenditures, which is largely based on administrative distinctions and which makes it difficult to identify or monitor the amounts being spent on key functional areas such as education or science.
Second, while the rapid growth of public spending over the past decade in part represents a healthy correction of the decline of on-budget spending relative to GDP to sub-optimal levels in the mid-1990s, it also reflects some more problematic features. While some of the forces that have driven the rapid growth in official government spending may abate somewhat in the medium-term, there remain important uncertainties about off-budget spending by local governments and especially the growth of contingent liabilities. Moreover, China’s government may be spending less than needed to achieve its development goals in key areas, notably education, health, and science, while spending a relatively high amount on public administration. If anything, this imbalance has increased in recent years as spending on public administration has grown more rapidly than spending in the other areas.
Third, the degree to which China’s expenditure policies achieve their goals depends as much on the effectiveness with which they are formulated, planned and implemented as on how funds are allocated. China’s governments have made considerable progress in modernising budget systems and are making good use of international practices in seeking to improve the efficiency with which public goods and services are produced and delivered. But many of these efforts are in an early stage and are most developed at the central government level; they will need to be further developed and extended to lower levels.
Fourth, China’s public expenditure policies have been seriously impeded by the distortions in fiscal relations among levels of government. The higher degree of decentralisation of expenditure responsibilities relative to revenues has led to major financing gaps of sub-national governments that are greatest at their lowest levels. The fiscal transfer system has only very partially reduced the gap between expenditure responsibilities and revenues for the western provinces, has done little for the central provinces where the gaps are now greatest, and has increased the disparities between the interior and coastal provinces. The strains resulting from these gaps have been further aggravated by the imposition by the central government of unfunded mandates on sub-national governments, by the lack of clear standards for the division of revenues between higher and lower levels of government and by the limited formal accountability of local governments to their citizens. They have also been aggravated by the prevalence of "top-down" evaluation of local government officials based on local aggregate output growth and other criteria at best imperfectly related to the practical needs of the jurisdictions they are responsible for. These distortions, and the adverse incentives they have engendered, have been important factors limiting government spending on education and other social/development needs and have encouraged the resort to off-budget expenditures and other inefficiencies in China’s public expenditure policies. Recent reforms, notably those to reduce agricultural taxes and suppress unsanctioned fees and other charges, while beneficial in themselves, risk aggravating government financing gaps and the distortions resulting from them in the absence of a more comprehensive reform of China’s fiscal federalism arrangements.
These findings suggest the following guidelines for further reforms to improve the effectiveness of China’s public expenditure policies.
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Continue efforts to bring expenditures now off-budget onto the budget as part of broader efforts to subject all expenditures to more rigorous formulation, implementation and accountability. Accurate and comprehensive reporting of all government expenditures should be required of all government levels. Over time and as conditions permit it would be desirable to include estimates of tax expenditures and of contingent (and other off-budget) liabilities as part of published budget reports.
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Improve transparency by reforming accounting systems for expenditures along functional lines, using international standards as a guide, so that amounts spent on key social, development and strategic needs can be clearly determined and assessed.
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Improve the allocation of public expenditure by raising spending on education, health, science, and other social/development needs, as a share of overall spending and relative to GDP, to the extent necessary to achieve China’s development goals and objectives. In particular, public expenditure on education should be raised within the next several years to a level that is in line with the longer-standing official goal. Strong efforts should be made to constrain the growth of spending on public administration by improving efficiency and eliminating waste. Public administration spending could be reduced by simplifying the administrative system, for example by bypassing the prefecture level in fiscal administration, at least in certain provinces.
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Reform fiscal relations among central and sub-national governments to bring expenditure responsibilities at each level of government more into line with financial resources. This effort will entail some combination of changes in expenditure and/or revenue assignments along with reform of the fiscal transfer system, as well as establishment of enforceable norms for expenditure assignments and revenue distribution within provinces. Central government mandates that entail additional spending by sub-national governments should be explicitly accounted for in budget statements and wherever possible accompanied by transfers or other additional revenue. Among other specific reforms that might be considered are: the establishment of a graduated system of tax sharing under which poorer provinces would receive a higher portion of shared revenues than more wealthy provinces; and increases in transfers to poorer provinces (only) that are able to improve their tax collection.
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Improve accountability of sub-national governments by establishing more explicit criteria for performance in key areas such as education. These should include not only aggregate targets but also, for higher levels of government, indicators of uniformity of accomplishment across lower levels for which they are responsible. Recent initiatives from the central government to broaden criteria for evaluation of provincial and lower level government officials to include indicators of progress toward key social goals are a useful step in this direction. Consideration might also be given to allowing local governments some greater discretion over the rates and other provisions of certain taxes.
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