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The following text summarises chapter 3 from the OECD publication Challenges for China's Public Spending: Toward Greatere Effectiveness and Equity.
Sub-national governments at the provincial, prefecture, country, township, and village levels carry out the bulk of public expenditures. They bear the main responsibility for education, health, social welfare, and infrastructure. Revenues are also highly decentralised but less so than expenditures. Moreover, while responsible for carrying out most spending, sub-national governments have almost no control over local tax rates nor over what can be taxed. They are also subject to extensive central government direction of their spending and have increasingly been burdened by unfunded mandates, such as paying for restructuring of local state-owned enterprises and supporting their laid-off workers.
This gap between expenditure responsibilities and revenues has necessitated a large-scale system of transfers, from the central government to provinces and within provinces from higher to lower government levels. Transfers have increased considerably in size over time, and central government transfers now account for 53% of its total on-budget expenditure. Nearly half of provinces depend on central government transfers for one-third or more of their total fiscal resources. The transfer system has become highly complex, with more than a dozen components for central government transfers alone. They are determined by a range of criteria, including the amount of taxes raised by provinces, and are at best partially related to actual needs.
The overall result is that large numbers of sub-national governments face severe gaps between spending requirements and their fiscal resources. Many county and township governments barely have enough funds to pay their workers, let along adequately fund education, health or other key needs. The gaps appear to be greatest in the poorer interior provinces and for (mainly rural) counties and townships within provinces. In fact, because the central government’s Western Development Programme has somewhat reduced the gaps in western provinces, it is now the central provinces that appear to have the greatest problems.
The gap between spending needs and resources is a key factor behind the large disparities in spending on education, health, and other social needs between poorer provinces in the interior and the wealthier coastal provinces and between urban and rural areas. It has also been an important factor behind the relatively low level of overall government spending on education and health. The strains engendered by the financing gaps have also encouraged the accumulation of substantial illegal government debt at sub-national levels and the resort to off-budget spending.
Disparities across provinces in selected categories measured by the Gini and Theil indices (1)
1. A higher figure indicates greater inequality.
Source: OECD calculations
However lack of money from the central government is not the only factor behind these problems. There are serious distortions in the distribution of revenues and transfers within provinces, which have nearly complete discretion in this area. Some provinces are fairly efficient in distributing those funds in accordance with needs but in others funds are held back for their own purposes and not enough is given to their lower levels.
Spending disparities at the county level are even larger than at the provincial level. A decomposition of the Theil index of inequality for per capita spending shows that 63% of the disparities observed across counties are attributable to within-province differences, with between-province disparities accounting for the remaining 37% in 2002. While expenditure disparities have remained about constant during 2000-02, the contribution of within-province disparities has decreased. This may suggest a more rigorous implementation of redistributive policies at the sub-provincial level. The largest within-province expenditure disparities are observed in the poorest western and the richest eastern provinces, while in central and north-eastern provinces expenditures are more equal in per capita terms.
Disparities in county level per capita expenditure by province
Theil index of inequality (1), 2002
1. A higher figure indicates greater inequality.
Source: OECD calculations from the All China Data database.
There are also large inefficiencies in sub-national government administration, such as overstaffing and, in some cases, excessive layers. Also, because of the way they are evaluated by their superiors, local government officials allocate money to high-visibility projects rather than to ‘softer’ areas such as education and health where the returns are less visible but may be significantly greater in the long run.
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