Experience in Macro Control

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5 Experience in Macro Control

1. Observing Market Economy Rules and Improving Fiscal Control

2. Sticking to Scientific Approach to Development for Coordinated Socioeconomic Development

3. Carrying on Reform and Innovation to Create Institutional Conditions for Macro Control

China has experienced A profound transition from planned to market economy since 1949. Prior to reform and opening-up in 1978, China generally followed a planned economic system, and its fiscal operations were highly dependent on government mandatory planning. Fiscal policy had an enormous impact on the country’s socioeconomic development, but the policy instruments and their functions were limited by the planned economic system. The gradual transition to a market economy began in 1978 when the central government started to let market play a role and to apply fiscal policy tools for macro control. This proved fruitful. During the ten-plus years since 1993, China went through three sizeable economic fluctuations, from inflation and overheating to deflation and some cooling, and then back to overheating, with significant structural problems. To address these fluctuations, the government adjusted its fiscal policy accordingly, adopting moderately tight, then proactive and prudent fiscal measures. These adjustments have contributed considerably to a sustained, rapid, and sound economic development. While learning from international experience, the Chinese government has been able to make its policy decisions in light of the country’s actual conditions, and has accumulated valuable experience.

1. Observing Market Economy Rules and Improving Fiscal Control

Under a socialist market economy, the government has to respect the principles and rules of market economy and let market play a fundamental role in resource allocation; the role of the government in macro control is mainly to make up for market failure or inefficiency. This has been the practice since 1992, when China set the goal of establishing a socialist market economic system through reform. In the process of adjusting and transforming its fiscal policy, the government always changed innovatively its methods of macro control in strict accordance with the discretionary principle. As a result, the fiscal control system has been improving.

1.1 Transforming and Innovating Fiscal Control Measures

In the course of establishing and improving the socialist market economy, the government has kept on reforming its fiscal control system, which is transformed from direct to indirect control with multiple rather than single instruments.

1.1.1 From direct to indirect control

From 1978 to 1988, administrative measures were the main tool of macro control over business and production activities. In the late 1980s, the government began to utilize fiscal and monetary policies for indirect control. However, restricted by the administrative planned system at the time, such control effort failed to produce expected results. Fiscal control in its true sense did not appear until after 1992 when the government decided to establish a socialist market economy and enhance marketization. The three fiscal policy shifts since 1992 have enabled China to move from direct to indirect fiscal control.

To cool down the overheating economy in 1992 and 1993, China adopted a moderately tight fiscal policy, which continued until 1997. At first, some direct administrative measures were adopted, such as strict examination of new projects before approval and tight control on institutional consumption. Later, such direct administrative measures gradually gave way to indirect ones, such as cutting fiscal deficit and reforming fiscal and taxation system to curb the excessive growth of aggregate demand. By coordinating fiscal policy and other macro control policies, the government realized a successful “soft landing.” After the Asian financial crisis, China managed to sustain rapid economic growth from 1998–2004 by exercising a proactive fiscal policy. More emphasis was placed on indirect control measures including treasury bonds, taxation, subsidies, and income distribution. Administrative measures played only a supplementary role. In 2005, China gradually began to shift toward a neutral or prudent fiscal policy. Indirect measures have since replaced direct ones as the major instruments of macroeconomic control, although some administrative measures are still in use for cleaning up fixed asset investment projects.

1.1.2 Diversifying fiscal control instruments

The main fiscal policy tools include treasury bonds, expenditure, taxation, transfer payments, and fiscal subsidies. However, different policy packages featuring varied focuses and methods of policy implementation produce different effects. Fiscal control concerns multiple layers and aspects, such as enterprises, individuals, programs, and regions. Therefore, appropriately identifying the objects and scope of control and properly coordinating all policy tools are preconditions for effective implementation of fiscal control. Prior to 1993, China’s fiscal control was dominated by administrative measures with limited policy tool options, such as cutting expenditures and reducing projects. Through the three shifts in fiscal control since 1993, China has made substantial strides in diversifying fiscal instruments, with more emphasis placed on the integration of a variety of fiscal policy tools.

Between 1993 and 1997, the Chinese government adopted a moderately tight fiscal policy, while losing no time in promoting reforms in the fiscal and tax systems. Multiple fiscal control tools were combined to fuel economic growth and structural optimization. From 1998–2004, the tools for fiscal control became even more diversified during the implementation of the proactive fiscal policy. The government not only adopted instruments including bond-financed investments, special treasury bonds, interest discount, and transfer payments, but also adjusted related tax and income distribution policies. In addition, policies were also formulated to adjust revenue and expenditure, regulate demand and supply, fuel economic growth through boosted consumption and investment, and promote social stability through improved social security programs.

In view of the new issues emerging since 2005, the government shifted to a prudent fiscal policy. To control aggregate demand and supply, measures were taken to cut fiscal deficit and reduce the issuance of long-term construction treasury bonds. In terms of structural adjustment, the weak links in socioeconomic development were buttressed, and overheating in certain industries and regions was controlled. In institutional innovation, short- and medium-term strategies were combined with long-term ones. Reforms targeting income distribution and the tax system were propelled forward. All these are signs that the government has become increasingly skilled at integrating diverse fiscal policy tools for macro control.

1.1.3 Moving toward active macro control

The key to attaining expected targets is exercising fiscal control timely and properly. Premature control measures may lead to overreaction of economic entities, whereas belated measures may exacerbate certain issues; and too many, too urgent, or too few and too slow measures are not good for sustained growth either. Therefore fiscal control needs to be timely, appropriate, and proactive.

Before 1993, several rounds of macro control were conducted to deal with overall or partial economic overheating and dramatic fluctuations. For example, GDP grew 11.7% in 1978, 5.2% in 1981, 15.2% in 1984, 4.1% in 1989, and 14.2% in 1992. Due to various limitations, compulsory measures were often taken to make emergent adjustments when it was hard to sustain rapid economic growth. This led to dramatic economic fluctuations at high costs.

The three shifts in fiscal policy after 1993 were made in a timely, resolute, and appropriate manner. They effectively curbed inflation and deflation, warded off dramatic fluctuations, and enabled steady and rapid economic growth.

Fiscal control between 1998 and 2004 was a watershed event. In 1998, China’s foreign trade was severely hit, domestic prices plummeted, investment and consumption were weak, the GDP growth rate was likely to drop below 7%, and monetary policy turned futile. In such adverse circumstances, the government took the initiative to adopt an expansionary fiscal policy. In the following few years, its fiscal control measures and policy tools improved with the changing domestic and international economic environment, and notable results were achieved. In 2005, the government adopted a prudent fiscal approach. In fact, the preparation for this policy shift began in 2004 when the Ministry of Finance (MOF) took active steps to identify the proper timing and extent of the new macro-control policy. Following a progressive approach, the ministry requested competent departments to forecast and analyze the situation, solicit opinions, and conduct focused studies before issuing early warnings, coming up with proposals for policy adjustment, and taking resolute measures to tackle identified issues. Policy adjustments were moderate and no drastic changes took place. This is a reasonable way for dealing with potential risks.

1.2 Improving Fiscal Control by Taking a Discretionary Approach

The key to successful fiscal control lies in correct projection, accurate analysis, and discretionary choice. This means that fiscal policy must be adjusted in response to a varying environment and objects. The selection of an expansionary, contractionary, or neutral fiscal policy should be determined according to the macroeconomic environment, development strategies, and the specific targets of macro control.

1.2.1 Discretionary fiscal control is a necessity

In theory, fiscal control takes two approaches: discretionary or automatic stabilizing. In China, turnover tax and income tax are the two major tax categories, of which turnover tax accounts for a large proportion and the direct tax a small one. As a result, it is hard for fiscal policy to play the role as an automatic stabilizer, and discretionary fiscal policy tools should therefore be adopted proactively in light of economic developments. Discretionary policy is a necessity for fiscal control. The practice of the past decade also shows that discretionary fiscal policy plays a very important role in promoting sustained, sound economic development.

Since the early 1990s, China’s mechanisms of economic operations and management systems have undergone profound changes in the process of accelerated reform, opening-up, and institutional innovation. The government became increasingly aware of and skilled at making discretionary choices to optimize the fiscal policy framework. From 1993 to 1997, curbing inflation was the priority. After thorough analysis, the government adopted a series of contractionary policy measures, made a “soft landing,” and ushered in a period of high growth and low inflation.

In 1998, new changes took place in China’s economic situation. Affected by the Asian financial crisis, effective demand was insufficient, which constrained economic growth. Under these circumstances, the government made a resolute decision to adopt a proactive fiscal policy instead of a moderately tight one. The new policy enabled China’s economy to successfully withstand the impact of the Asian financial crisis, promoted economic restructuring, and contributed to the sustainable, rapid growth.

Since 2004, China has stepped out of deflation and picked up its growth rate. However, issues such as excessive investments remain in some sectors and regions. Economic growth became increasingly constrained by the supply of resources, especially coal, electricity, petroleum, and transportation. Meanwhile, the grain price hike raised consumer prices, increasing the inflation pressure. In this context, the proactive fiscal policy would not control the excessive fixed asset investment. On the contrary, it could have exacerbated inflation by inducing a more severe imbalance between investment and consumption. The government also recognized that what had happened was not an all-round economic overheating, as there were still weak sectors and areas in socioeconomic development. In view of this, the government made another discretionary choice by shifting from proactive fiscal policy to prudent one.

1.2.2 Practices of discretionary fiscal policy

China’s discretionary fiscal policy carries characteristics of its own, and some of its practices in implementing the policy are noteworthy.

First, the implementation of discretionary fiscal policy is based on an accurate grasp of macroeconomic trends. The direction of fiscal control usually goes against the business cycle. The timing of macro control should be decided properly, and its extent should be managed flexibly. Compared with the previous approaches of macro control, the implementation of moderately tight (contractionary) fiscal policy, proactive (expansionary) policy, and prudent (neutral) policy is based on the thorough analysis of macroeconomic trends. The more accurate timing and extent, the better policy effectiveness.

Second, economic forecasts and analysis should be strengthened in order to support timely fiscal policy making. Scientific and discretionary macro control is based on prompt and accurate economic forecasts and analysis. Forecasts and analysis are an important basis for the government to assess the economic situation, and make informed decisions on macro control. If these are not prompt or accurate, the government will remain in the dark and hang back when it comes to policy decision. Premature or delayed macro control measures are likely to have a negative impact on economic operations.

Third, selection of policy instruments should take account of the characteristics of fiscal revenue and expenditure policies. Under the current fiscal and economic system, China’s fiscal expenditure policy plays a more direct role, and its effect is more obvious compared with the fiscal revenue policy. Despite an indirect role and slower effect, the fiscal revenue policy carries more weight in sustaining the vitality of the economy. In practice, the decision on how to combine the two policies can vary with the actual situation.

Fourth, fiscal policy should be coordinated with other macro control policies. A macroeconomic policy is formulated to adjust demand and manage supply. In this case, the decision on fiscal policy tools should be made on the basis of aggregate demand and supply. To rationally and effectively apply macroeconomic policy instruments in China, fiscal policy should be coordinated and combined with monetary policy, land policy, industrial policy, and others. Only thus can the synergy of different policies be exploited for the consolidated effect of macro control.

2. Sticking to Scientific Approach to Development for Coordinated Socioeconomic Development

Development consists mainly of economic development and social progress. Economic development is the premise and foundation of social progress. At the same time, social progress is the purpose of economic development, providing intellectual and integrated support for the former.

Coordinating economic development with social progress and establishing an all-round, harmonious, and sustainable social and economic development are the major goals of the Chinese government and at the core of the scientific approach to development. As a major tool for the government to achieve its various development goals, fiscal policy can also play an important role in macro control, enabling the government to perform its functions and duties. As a large developing country, China puts more emphasis on fiscal policy in promoting development. Public administration, macro control, and social development cannot proceed without fiscal support. The goals of increasing employment, maintaining stability, and advancing reforms will not be achieved unless a certain growth rate is ensured. Taking development as the top priority in running the government and building the nation, and promoting an all-round, harmonious, and sustainable social and economic development, are the major targets set by the Chinese government for macro control. This is also the treasured wisdom gained by the Chinese government in exercising macro control over the past decade.

2.1 Placing More Emphasis on Coordinated Development between Urban and Rural Areas

For a long period, due to special historical factors and specific national conditions, China had formed a typical dual economic structure. As such, its fiscal policy had placed more emphasis on urban development. In recent years, however, with the development of the market economy and the establishment of the public finance system, the Chinese government started to pay more attention to the positive role of fiscal policy in resolving the problems concerning agriculture, rural areas, and farmers, and balancing urban and rural development, while continuing to develop urban areas.

2.1.1 Expanding inputs in rural areas

Expenditure on agriculture, rural areas, and farmers from the central budget amounted to 262.6 billion yuan in 2004, and rose by 13.3% to 297.5 billion yuan in 2005. In 2006, 339.7 billion yuan was set aside for the purpose, up 42.2 billion yuan or 14.2% over the previous year. The support for agriculture has thus been gradually enhanced through fiscal policy, improving rural production and living conditions, raising comprehensive agricultural productivity, heightening agricultural development potential, quickening rural economic development, and increasing incomes for farmers. Furthermore, the government has prioritized rural development in allocating its increased funds for education, culture, public health, and other social undertakings. A mechanism for steadily increasing fiscal support for agriculture has been put in place, enabling vast rural areas to benefit more from public finance.

2.1.2 Promoting tax-for-fee reform and adopting preferential policies

To address the irregular and excessive taxes and fees, their collection and management, as well as the resulting heavy burden on farmers, the rural tax-for-fee reform was piloted in 2000, and then implemented nationwide in 2003. The main thrusts of the reform were: eliminating fund-raising in rural education, allocating budgetary funds for rebuilding dilapidated primary and middle schoolhouses, abolishing the livestock slaughting tax and administrative charges collected by the township and village authorities, and suspending various mandatory fund contributions and fund raising activities imposed on farmers. The tax-for-fee reform has considerably alleviated the farmers’ burden, standardized the distribution system in rural areas, safeguarded farmers’ interests, and promoted rural economic development. In 2005, the Chinese government implemented the policy of “three reductions or exemptions, and three subsidies.” These included reducing or exempting agricultural taxes, the tax on special agricultural products (excluding tobacco), and the animal husbandry tax; directly subsidizing grain producers; and subsidizing farmers’ purchase of improved crop strains and large agricultural machinery and implements. The direct benefits to vast majority of farmers amounted to over 60 billion yuan. As a result, a standardized distribution system is being set up in the rural areas.

2.1.3 Ensuring compulsory education in rural areas

The compulsory education management system in rural areas was reformed when the rural tax-for-fee reform was conducted. Previously, township-level governments and local farmers jointly sponsored the rural schools. After the reform, the compulsory education system is run and managed by the county-level governments, and the salaries of primary and middle school teachers are paid by county-level fiscal authorities in full and on time in strict accordance with national regulations. At the same time, the central and provincial governments are stepping up their support for compulsory education in rural areas, increasing their input in poor counties through transfer payments, and allocating special funds to rebuild and renovate dilapidated primary and secondary school buildings in poor rural areas. On top of that, to promote the rural compulsory education system, the government piloted a policy in 2001 to provide poor students in rural primary and secondary schools with free textbooks, pay for their miscellaneous education-related fees, and give poor resident students a living subsidy. By the end of 2005, about 30 million poor students have benefited from the policy, and the number continues to rise.

2.2 Placing More Emphasis on Coordinated Regional Development

When reform and opening-up started, China implemented a number of fiscal and tax policy measures to encourage some areas to take the lead in development to boost the national economy. Nevertheless, due to historical and other reasons, the development gap between eastern, central, and western areas of China is widening, despite notable progress registered in the overall national economy. To tackle this problem, in line with the scientific approach to development, the Chinese government has paid more attention to the role of fiscal policy in coordinating the economic development of different regions over the past years. The central government has increased its expenditures on and extended more policy support to the western region in compliance with the strategy of developing the region. First, it increased the western region’s proportion in the development funds arranged by the central budget and introduced more loans on favorable terms from international financial institutions and foreign governments, which has strengthened the infrastructure development of the region. Second, it gradually increased the amount of general transfer payments to the western region. The central government has allocated some special funds as transfer payments to areas inhabited by ethnic minorities since 2000. At the same time, special subsidies from the central government were targeted more at sectors such as agriculture, social security, education, science and technology, health, birth control, culture, environmental protection, and cultural relics preservation in the region. Third, it increased expenditures on infrastructure construction and poverty alleviation in rural areas of western China, and encouraged investment in the region through various preferential tax policies. This has improved the region’s development and investment climate, and boosted its characteristic industries with advantages.

To rejuvenate the old industrial bases in Northeast China, the provinces of Heilongjiang, Jilin, and Liaoning have been adopting since July 1, 2004 such tax incentive schemes as expanding the range of VAT deduction, and adjusting resource tax and corporate income tax. This has promoted SOE reform, and improved the socialist market economic system in the area. Besides revitalizing industrial bases through market-oriented measures, the government has also actively relieved enterprises of their obligations to operate social programs. Those insolvent enterprises were given priority in the

national plan on enterprise merger and bankruptcy.

In addition, special transfer payment funds for rural tax-for-fee reform, and newly increased comprehensive agricultural development funds arranged by the central budget, were allocated to provide more support to the main grain-producing bases in central and other regions. Priority was also given to the central region in the arrangement of general and salary adjustment transfer payments. To stimulate the eastern region to “make a big cake” both in the economy and fiscal revenue through accelerated economic development, effort was made to improve the management system for the tax-sharing scheme and restructure the mechanism of export tax rebates with a view to clearing the tax rebates in arrears.

2.3 Placing More Emphasis on Coordinated Socioeconomic Development

While the economy is accelerating, social developments in education, science and technology, and health are lagging behind. This problem is becoming increasingly acute. To reverse the situation, the government has pursued a balance, in fiscal control, between economic development and social progress in line with the scientific approach to development in recent years.

For this, increased expenditures have been allocated to enhance social security, science and technology, education and government services, enabling public finance to play a more prominent role in satisfying social demands. First, the budget for social security programs has increased considerably. Fiscal authorities at all levels have been enhancing their support since 1998, with the proportion of social security expenditure in the total fiscal expenditures increasing from 11.1% in 1997 to around 16% in 2005. Second, the development of education and science has been vigorously boosted. To rejuvenate China through science and education, fiscal authorities at all levels, especially MOF, have increased their investments in these areas. From 1998 to 2002, spending from the central budget on education increased one percentage point annually, with a total increase of 48.9 billion yuan. Meanwhile, the proportion of education rose from 4% in 1997 to 5.1% in 2002, while that for science went up from 4.6% in 1997 to 5.2% in 2002. Third, the expenditure for public security, procurator and judicial organs increased rapidly, with their proportion in all expenditure rising from 4.6% in 1997 to 5.4% in 2005.

2.4 Placing More Emphasis on Harmony between Humanity and Nature

As China’s fiscal situation improved, the government has been stepping up its support for environmental protection and ecological conservation, with the aim of harmonizing the relation between man and nature. The grain, seedling, and cash subsidies are disbursed directly by the central government toward natural forest protection, transforming farmland back to forest (or grassland), and desert prevention and control projects. The central government also provides subsidies for a certain period of time to the local governments which are affected in fiscal revenue for undertaking these projects. From 1998 to 2004, 78.44 billion yuan was allocated from the project funds raised through treasury bonds to treat water pollution, sewage, and garbage in major cities and the pollution in the Three Gorges Dam area, as well as to support localization of environmental protection equipment and comprehensive urban environmental improvement. At the same time, the central government allocated 72.3 billion yuan for protecting natural forests, returning farmland to forest (or grassland), and controlling the sources of the dust storms plaguing Beijing and Tianjin. The launching of these key projects has contributed considerably to the protection of China’s ecological environment and promoted economic and environmental sustainability.

In addition, relevant fiscal and tax policy measures are examined and adopted to control the expansion of those industries and enterprises that consume too many natural resources or pollute environment. At the same time, support is extended to the development of industries and enterprises that contribute to resource conservation and environmental protection. All these have accelerated the shift of China’s mode of economic growth from extensive development to intensive growth.

3. Carrying on Reform and Innovation to Create Institutional Conditions for Macro Control

The slow-paced institutional and systematic reform has become a bottleneck to the sound development of China’s economy. This is why the Chinese government has recognized the importance of shoring up economic reform and institutional innovation through fiscal policy, and handling correctly the relation between macro control and system reform. The ultimate goal is to establish a long-term, effective mechanism for self-sustained, sound development.

3.1 Addressing Current Economic Problems and Promoting Economic Restructuring

In terms of fiscal control, the major tasks of the Chinese government have been to find solutions to outstanding problems at every stage of economic development to maintain a steady and fairly fast economic growth. At the same time, the government also strives to clear institutional barriers in economic operations so as to build and improve a sound economic system that favors long-term economic development.

3.1.1 Deepening SOE reform

The government has continuously pushed forward with strategic adjustments in the layout and structure of the state sector, and improved the mechanism for the entry and exit, as well as reasonable flow of state capital. The reform to introduce a share-holding system in SOEs needs to be accelerated so as to enable a sound corporate governance structure and a management mechanism regarding corporate legal person in light of the goal to establish a modern corporate system. The corporate operating mechanism should also be transformed correspondingly. Over the past few years, more than 40 billion yuan has been earmarked in the central budget to subsidize policy-based closure and bankruptcy of SOEs, and support SOEs in relieving themselves of their obligations for social programs. Relevant fiscal and tax policies have been adjusted to accelerate reform in the railways and postal service sectors, and the reorganization of the electricity, telecommunications, and civil aviation sectors. A sound fiscal and tax policy system has gradually been established to promote small- and medium-sized enterprises (SMEs).

3.1.2 Supporting the reform of financial system

A number of measures have been taken to support the reform of state-owned commercial banks. In 1998, 270 billion yuan of special treasury bonds were issued to recapitalize state-owned commercial banks and increase their capital adequacy ratios. Financial policies, such as increasing provisions for bad debts and expanding the scope of writing off bad debts, were introduced to enhance the market competitiveness and risk resilience of state-owned commercial banks. The state’s foreign exchange reserves have been used to support shareholding-oriented restructuring and public listing of these banks. At the same time, reform of state-owned insurance companies has been energetically promoted. Thus far, PICC Property & Casualty Company Limited, China Life Insurance Company Limited, Ping An Insurance Group, and others have been successfully listed abroad.

3.1.3 Shoring up the establishment and improvement of a social security system

At present, China has established a preliminary social security system which conforms to the socialist market economic system. The system comprises pension, unemployment insurance, basic medical insurance, and the basic living guarantee system for employees laid off from SOEs, as well as the system of minimum subsistence allowances for urban residents. The coverage of the system has been expanding, and its capability for providing aid enhancing. By the end of 2005, about 174.87 million people participated in the pension plan, 106.48 million in the unemployment scheme, and 137.83 million in the medical insurance plan. A total of 22.41 million people enjoyed minimum subsistence allowances for urban residents. A preliminary social security framework based on China’s current development level has been set up.

3.1.4 Promoting the reform of the income distribution system

The income distribution system has been reorganized and regulated, and its roles enhanced. Since 1999, there have been four salary increases for employees in government agencies and public institutions, and remote and harsh benefits have been introduced and improved while irregular allowances and subsidies have also been reviewed and rectified. Measures have been taken to increase the incomes of rural and urban residents, especially that of the lower-and middle-income groups.

3.2 Persisting in Fiscal Institutional Innovation for Effective Fiscal Control

Reform and innovation in the fiscal system is the basis for effective fiscal control. An improved system and standardized management are essential for increasing the efficiency of fiscal policy and strengthening fiscal control.

3.2.1 Improving fiscal revenue system and establishing a mechanism for steady revenue growth

On the basis of tax reform initiated in 1994, the Chinese government has been improving its tax system, pushing forward tax-for-fee reform, and preparing a commercial and industrial tax structure with multiple taxes. These are dominated by turnover tax and income tax, and can be adjusted at multiple stages and levels. These have effectively guaranteed the fast increase in fiscal revenue. Since January 1, 2002, most of the revenue from the corporate income tax and all individual income tax have been shared by central and local governments. Prior to that, corporate income tax revenue was distributed according to enterprise ownership structure. At the same time, the reform aiming to separate the management of revenue and expenditure has been vigorously pursued. The revenue and expenditure from the extra-budgetary funds have been managed separately and are being gradually included in budgetary management. The system for collecting and managing non-tax government revenue has been restructured, and a preliminary framework for the collection and management of non-tax government revenue has been set up. With the fine-tuning of the fiscal revenue management system, the mechanism for maintaining steady revenue growth has taken shape, and public finance is playing an increasingly important role in macro control. From 1994 to 2005, national fiscal revenue rose from 521.8 billion yuan to 3,162.8 billion yuan, with an average annual increase of 17.8%. Central and local fiscal revenues grew 17.1% and 18.6% respectively year-on-year.

3.2.2 Advancing fiscal expenditure system reform to improve fiscal fund utilization efficiency

First, departmental budget reform has been promoted continuously. This mainly involves practicing “one budgetary report for one department”; compiling a departmental budget pursuant to basic and project expenditure; continuing to separate the management of revenue and expenditure and gradually adopting a unified budget; formulating reasonable and standardized procedures for budget compilation; promoting reform in preparing performance-based budgets and shifting the focus of fiscal management from distribution to management. In the past five years since these reform measures were introduced, a new fiscal budget compilation and management system, which complies with the public finance system, has been set up.

Second, the treasury management system has been revamped as an important part of the reform of China’s budget management system. The goal is to establish a modern treasury system that is based on a single treasury account, and centralized treasury collection and payment. Specifically, through this reform, a single treasury account should be set up and managed by the fiscal authorities in a standardized way. All fiscal funds should be included and managed by a single treasury account system. The methods and procedures of the collection and payment of fiscal funds should be standardized. Fiscal revenue should be transferred directly to a single treasury account or a special fiscal account according to the stipulated methods of collection. Fiscal expenditure should be directed either to the target departments or to projects, through the single treasury account system, according to the stipulated methods of payment. The fiscal treasury management information system and the dynamic monitoring system have been established to control the whole process of disbursing fiscal funds, so that these funds are utilized safely and efficiently.

Third, reform of the government procurement management system has been promoted. The traditional free, scattered, and ineffective procurement methods have been changed, an operating mechanism and a legal guarantee system introduced and improved. Procurement is now standardized and unified, and carried out in accordance with the law. Laws and regulations have been improved to enable government procurement to play an active role in exercising fiscal expenditure management and macro control. The scope and range of government procurement have been expanded. Progress has been made in separating management from operations. The management has been further standardized. As a result, over 10% of the procurement funds have been saved each year. Data show that government procurement had enabled a cost reduction of about 100 billion yuan between 2001 and 2005.

Fourth, the system of fiscal transfer payments has been constantly improved. In 1994, as a part of the fiscal management system reform designed to introduce a tax-sharing mechanism, the amount and form of transfer payments between central and local governments were adjusted. While retaining the fixed sum subsidies and special subsidies from the central government, and turnovers from local governments, a system of tax revenue transfer from central to local governments has been established in response to the expanded scope and increased amount of the central government’s fixed revenue.

Since 1995, transfer payments in the transitional period have been implemented. Concepts of standard fiscal revenue and expenditure have been introduced. The standard expenditure amounts of local governments are examined and determined by taking into account factors affecting fiscal expenditure. A local government that can meet its needs for standard expenditure will not receive any transfer payments from central government. Otherwise, a factor analysis of its fiscal revenue will be carried out. There are two possibilities:

  • If the local government’s fiscal revenue is below the average level of the whole country, the gap will be filled by an increase in its revenue.
  • If the government still cannot satisfy its expenditure demand, even though its revenue reaches the average level of the country, or after it has achieved a revenue increase, the gap will be taken as the basis for calculating transfer payments. The central government will allocate subsidies according to the total amount of newly increased transfer payment funds, and the actual financial gaps of local governments.

In 2000, in order to perfect the methods of transfer payment distribution, and address the special difficulties faced by ethnic minorities, the central government set up a special transfer payment system for areas inhabited by ethnic minorities. Since 2002, the transitional transfer payment introduced in 1995 has been restructured as a general transfer payment.

The transfer payment allocation has been gradually standardized and extended to lower-level governments. More items are now distributed through formula-based transfer payments. A standard inter-governmental transfer payment system has been established. In 2005, over one trillion yuan-worth of tax revenue returns and various subsidies were granted by the central government to local governments.

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Experience in Macro Control

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