Financing Road Construction and Maintenance After the Fuel Tax

ISBN 978-92-9092-874-4 (Print), 978-92-9092-875-1 (PDF) Publication Stock No. RPT125089

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Asian Development Bank. Financing road construction and maintenance after the fuel tax reform. Mandaluyong City, Philippines: Asian Development Bank, 2012.

1. Road construction. 2. Tax reform. 3. People’s Republic of China. I. Asian Development Bank.

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Printed on recycled paper Contents

Tables, Figures, and Boxes v

Foreword vii

Acknowledgments viii

Acronyms x

Executive Summary xi

1 Introduction 1 1.1 Background 1 1.2 Objectives 2

2 Road Programs in the People’s Republic of China 3 2.1 Program History 3 2.2 Current Status of Road System Development 3 2.3 Organizational Structure for Delivering Programs 7 2.4 Road Financing 8 2.5 Program Delivery—Road Planning, Construction, and Maintenance Administration 12 2.6 Existing Problems in Ordinary Road Development 15

3 The Fuel Tax Reform 19 3.1 Context for the Fuel Tax Reform 19 3.2 Main Points of Fuel Tax Reform 20 3.3 Case Study 22 3.4 Assessment of Fuel Tax Reform Implementation 25

4 Future Revenues and Needs 30 4.1 Road Development Strategy and Targets in the People’s Republic of China 30 4.2 Ordinary Road Construction and Maintenance Demand 31 4.3 Road Construction and Maintenance Funding Demand 34 4.4 Revenue Estimates Requirements 36 4.5 Funding Gap 43

5 Fuel Tax Reform Policy Issues 45 5.1 Introduction 45 5.2 Inadequate Funding 45 iii iv Contents

5.3 Lack of Provincial and Local Revenue Mechanisms for Roads 46 5.4 Declining Purchasing Power of Fuel Taxes 46 5.5 Program Administration and Performance 47 5.6 Reform Implementation Issues 48 5.7 Longer-Term Funding Considerations 48

6 Policy Options and Recommendations 50 6.1 Introduction 50 6.2 Division of Roles and Responsibilities 51 6.3 Funding Allocation 56 6.4 Adjusting Current Funding Sources 59 6.5 New Funding Options 62 6.6 Rationalizing Use of Debt Financing 68 6.7 Fund Management 70 6.8 Organizational Capacity 72

References 74 Tables, Figures, and Boxes

TABLES ES-1 Summary of 2010–2020 Ordinary and Rural Road Needs, Revenues, and Gap xiii 1 Road Length Classification in the PRC 4 2 Road System Development Responsibility Arrangement in the PRC 7 3 Comparison of Ordinary Road Development Status 18 5 Fuel Tax Revenue Allocation Formula 21 4 New Excise Tax Rate for Various Oil Products 21 6 Pre- and Post-Reform Road User Charges 26 7 National Development and Reform Commission Fuel Price Adjustments 27 8 Examples of Provincial Debt Levels 29 9 Long-Term System Road Length Targets vs. Current Road Lengths 30 10 Long-Term System Road Length Targets vs. Current Road Lengths under the Baseline Growth Scenario 31 11 Scale of Annual New Road Construction and Upgrades and/or Reconstruction, 2010–2020 32 12 Maintenance Road Length Share, 2010–2020 33 13 Maintenance Length of Each Classified Road by Category under Unconstrained Needs Scenario, 2010–2020 33 14 Maintenance Length of Each Classified Road by Category under Baseline Growth Scenario, 2010–2020 34 15 Estimated Ordinary Road Construction Funding Needs, 2010–2020 35 16 Average Cost of Ordinary Maintenance Engineering Work, 2009 36 17 Estimated Costs for Ordinary Maintenance Engineering Work under Unconstrained Needs Scenario, 2010–2030 37 18 Estimated Costs for Ordinary Maintenance Engineering Work under Baseline Growth Scenario, 2010–2020 38 19 Central Government Revenues for Ordinary Roads, 2010–2020 39 20 Estimated Fuel Tax Revenues, 2010–2020 40 21 Vehicle Purchase Tax (Fee) Revenue over 2000–2009 41 22 Estimated Vehicle Purchase Tax Revenue, 2010–2020 42 23 Road Construction Financing from Central Government Budget and Other Sources, 2002–2009 42 24 Estimated Funding Gap over 2010–2020 44 v vi Tables, Figures, and Boxes

25 Japanese Road Funding Responsibilities by Level of Government 54 26 Evaluation of Policy Options with Respect to Roles and Responsibilities 55 27 Evaluation of Funding Allocation Options 58 28 Evaluation of Tax Adjustment Options 61 29 Japan’s Highway Taxes and Uses 64 30 Evaluation of Funding Options 66 31 Evaluation of Potential Sources of Additional Road Funding 67

FIGURES 1 Technical Classification of Roads in the PRC, 2009 5 2 Administrative Classification of Roads in the PRC, 2009 6 3 Total Length of Expressways in the PRC, 1995–2009 6 4 Road Financing Source and Allocation Flowchart 8 5 Annual Gross Vehicle Purchase Tax Revenues, 2000–2009 9 6 Total Road Funding Sources, 2008 12 7 Classification of Ordinary Trunk Roads 16 8 Classification of Rural Roads (County and Township) 16 9 Traffic Congestion Examples 17 10 Examples of Poor Pavement Conditions 17 11 Oil Product Consumption Trends, 2000–2007 40 12 Government Budget Spending for Road Construction 43 13 Cumulative Change in Fuel Tax Purchasing Power Assuming 5% Annual Inflation Rate 47 14 Federal Highway Trust Fund Revenues by Share: Fiscal Year 2007 63 Foreword

n January 2009, the Government of the People’s Republic of China (PRC) introduced a fuel tax reform that sought to rationalize fuel prices, encourage energy efficiency, reduce emissions, and Imobilize funding for road maintenance and construction. The government subsequently requested the Asian Development Bank (ADB) to provide technical assistance for a small-scale project, Financing Road Construction and Maintenance after Fuel Tax Reform, to conduct an initial study on the impact of the fuel tax reform on road sector financing and management and to propose policy directions and financing strategies to support ordinary road construction and maintenance.

The technical assistance was financed by ADB and implemented by the Ministry of Transport (MOT). Under the guidance of MOT officials and ADB staff, consultants engaged by the Research Institute of Highways developed the framework for the study, carried out research, conducted stakeholder consultation workshops, and prepared the study report. An international workshop was held in Beijing in September 2010 to discuss road financing issues and policies, with participation of high-level PRC officials and experts from the United States, Germany, and Japan.

The study provides valuable insights into the status of road sector development in the PRC and the road financing issues that need to be addressed. It shows that there are likely to be significant shortfalls in funding for road construction and maintenance unless additional funding sources are introduced, and highlight the potential for linking future road financing contributions to other aspects of sector performance, such as road maintenance. Drawing on the analysis of PRC road program needs and expected revenues, as well as on international lessons in developed countries, various policy options are proposed for further study. This report will be of great interest to road sector policy makers, practitioners, and researchers in the PRC, and to other developing countries that face challenges in financing their road construction and maintenance.

Robert Wihtol Director General East Asia Department

vii Acknowledgments

The authors would like to acknowledge the assistance, guidance, and support of the following individuals and organizations in preparing this study:

1. Project Advisory Committee

Chairperson: Sun Guoqing Director General, Comprehensive Planning Department Ministry of Transport (MOT)

Vice Chairpersons: Cai Yuhe Deputy Director General Comprehensive Planning Department, MOT Ren Jinxiong Deputy Director General Comprehensive Planning Department, MOT Yu Shengying Deputy Director General Comprehensive Planning Department, MOT Yuji Ono Transport Specialist Transport Division, East Asia Department, ADB

Members: Liu Zhanshan Director, Comprehensive Planning Division Comprehensive Planning Department, MOT Kong Fanguo Director, Strategy Planning Division Comprehensive Planning Department, MOT Xia Hong Advisor, Comprehensive Planning Department, MOT

2. Project Experts Li Yaru Team Leader, Road Sector Financing Specialist Research Institute of Highways (RIOH) Craig Secrest Deputy Team Leader, Road Sector Financing Specialist High Street Consulting Company Gu Jinyan Road Sector Planning and Development Specialist, RIOH Su Min Fuel Tax Specialist, Research Institute for Fiscal Science Ministry of Finance viii Acknowledgments ix

3. Project Support Team Shu Mingxin Researcher, RIOH Zhang Yuling Research Assistant, RIOH Zhu Zhiqiang Research Assistant, RIOH Li Qian Engineer, RIOH Guo Min Research Assistant, RIOH Liu Yiyang Research Assistant, RIOH Jia Zhenyuan Research Assistant, RIOH Abigail Armamento Operations Officer, Transport Division, East Asia Department, ADB Gloria Gerilla-Teknomo Senior Transport Sector Officer, Transport Division East Asia Department, ADB Lei Kan Senior External Relations Officer, PRCM East Asia Department, ADB Ivette Labitoria Executive Assistant, Transport Division, East Asia Department, ADB

4. Peer Reviewers and Resource Persons Hideaki Iwasaki Principal Portfolio Management Specialist, ADB Shinichi Ishii Director of Engineering, Business Strategy Consulting Department Nomura Research Institute Ltd., Japan Steven Lewis-Workman Senior Transport Economist, ADB Deb Miller Secretary, Kansas Department of Transportation, US Dieter Neumann Partner, Olswang LLP, Germany

5. Project Management Tyrrell Duncan Director, Transport Division, East Asia Department, ADB Yuji Ono Transport Specialist, Transport Division, East Asia Department, ADB Xia Hong Advisor, Comprehensive Planning Department, MOT Acronyms

ADB Asian Development Bank CNY yuan COTR commercially operated toll road CPI consumer price index EU European Union FHTF Federal Highway Trust Fund FHWA Federal Highway Administration GDP gross domestic product GLRTR government loan repayment toll road GPS global positioning system LNG liquefied natural gas MOF Ministry of Finance MOT Ministry of Transport NCMS navigational channel maintenance subsidy NDRC National Development and Reform Commission NPC National People’s Congress OPCS oil product consumption subsidy OTR ordinary trunk road PCD provincial communications department PCU passenger car unit PRC People’s Republic of China RMCS road maintenance and construction subsidy RMF road maintenance fee RPFS road passenger and freight surcharges UK United Kingdom US United States VAT value added tax VMT vehicle miles traveled VPT vehicle purchase tax

x Executive Summary

Background

In December 2008, the State Council of the People’s Republic of China (PRC) issued the Notification of the Implementation of the Reform of the Oil Products Price and Taxation, which authorized the implementation of a fuel tax reform initiative beginning in January 2009. The reform reflects a major step toward achieving several important policy objectives in the PRC, including lowering oil consumption; reducing vehicle emissions; improving the efficiency, simplicity, and equity of road tax mechanisms; increasing central government influence over spending; and supporting transition to market-based pricing of oil products. Fully achieving these objectives, however, will be an evolutionary process that requires both refinements to the current reform effort and additional policy initiatives. The purpose of this report is to support this evolution by assessing the status of reform implementation, identifying associated issues and challenges facing the PRC, and providing options and recommendations to address them.

The Fuel Tax Reform

The fuel tax reform included three key elements: (i) it abolished a series of road maintenance fees (RMFs) that had been used at the provincial and local levels to fund road spending; (ii) it removed authorization for current and future tolls on class II roads; and (iii) it authorized significant motor fuel tax increases to replace the eliminated funding sources for ordinary and rural roads,1 and established an interim approach to allocating revenues that considers prior resource levels, increased investment demands, and debt repayment burdens of provincial and local governments.

Since its implementation, the reform appears to have made significant progress toward many of its objectives. The new fuel taxes have effectively centralized road funding; they provide a simpler, more efficient road taxing system and better economic incentives that promote efficiency; and road user charges are now better tied to system use. Additionally, some of the initial concerns on reform impacts have not come to fruition—the cost impact on low-efficiency vehicles and high-mileage users has been fairly minor, and because of other government policies, there has not been a significant increase in total fuel prices. As a result, several issues associated with the current implementation of the fuel tax reform have become apparent: t Inadequate Funding. While the intent of the reform was to fully replace the funding provincial and local governments received from the RMFs, it has not provided the revenue

1 Ordinary roads refer to national and provincial roads not tolled, and all rural roads. Rural roads include county, township, and village roads. xi xii Executive Summary

levels these entities expected to receive. As discussed below, the total road funding from all central government sources, including fuel tax receipts, national vehicle purchase tax (VPT) revenues, and general budget allocations, appears to fall far short of meeting even conservative estimates of the spending needs for ordinary and rural road construction and maintenance. t Lack of Provincial and Local Revenue Mechanisms for Roads. The fuel tax reform eliminated most dedicated provincial and local funding sources for ordinary and local roads, which were with annual central government funding allocations unlikely to grow as quickly. t Loss of Borrowing Capacity. With the removal of the RMFs and in light of the current budget law, which prohibits the use of central government fuel tax allocations to secure bank loans, local governments now lack the ability to deliver new projects through debt financing. The level and status of existing provincial and local debt associated with both borrowing against the RMFs and class II toll road revenues are also of considerable concern. t Need for New Funding Mechanisms. Unless the aim of the reform is to absolve provincial and local governments of responsibility for funding roads, new provincial and local road funding mechanisms will need to be established. t Declining Purchasing Power of Fuel Taxes. Because the fuel tax is imposed as a fixed amount per liter, the purchasing power of fuel tax revenues will erode over time due to inflation if it is not regularly adjusted. Based on recent inflation assumptions, the current motor fuel taxes established in 2009 have already lost 5% of their purchasing power and, by 2020, will have lost 40%. t Incomplete Implementation. The removal of tolls on class II roads has not yet been fully achieved in the PRC’s western provinces. t Traffic Diversion from Toll Roads. Gradual removal of tolls on class II roads appears to have resulted in significant but varying levels of traffic diversion from tolled expressways and class I roads to non-tolled class II roads. t Program Administration and Performance. Despite the centralization of road funding, the roles and responsibilities of different levels of government have to be revisited and redefined to accommodate the new program structure. Additionally, few mechanisms and policies have yet been put in place to ensure the limited national road resources are spent efficiently, effectively, and in accordance with national goals and priorities. t Longer-Term Funding Considerations. While the short-term prospects for the fuel tax are satisfactory, the expected longer-term transition to electric and high-efficiency vehicles will eventually reduce fuel consumption and limit the sustainability of the fuel tax as the primary mechanism for financing ordinary roads.

Ordinary and Rural Road Needs, Revenues, and Funding Shortfalls

The long-term target for total road system length in the PRC, including expressways, ordinary trunk roads, and rural roads, is about 5 million km (currently 3.79 million km), of which 4.85 million km are ordinary trunk roads and rural roads (currently 3.73 million km). While the PRC has pursued Executive Summary xiii rapid development of expressways and class I roads over the last 2 decades, the development of ordinary roads and rural roads has lagged behind. As a result, the PRC still faces critical investment needs as regards its ordinary and rural road systems: t Network Coverage Gaps. There are presently six prefecture cities, over 600 counties, selected border-crossing ports, major tourist areas, and important townships that lack direct connection to the national road system. t Road Capacity Improvement and Upgrade Needs. Thirty-five percent of the PRC’s ordinary trunk roads are classified class III and below, including over 50,000 km of class IV or substandard roads. About 30,000 km of ordinary roads, and over 500,000 km of rural roads, remain unpaved. The rural road system is about 96% class III roads and below.

System Improvement and Preservation Issues. Inadequate maintenance spending, weak road maintenance systems, and overloaded trucks have resulted in road condition deterioration. Also, these place many bridges throughout the PRC in dangerous condition.

Two investment scenarios were developed as part of the study to illustrate the potential range of road spending requirements for 2011–2020: t Unconstrained Needs Scenario. This assumes the central government will significantly increase investment in road system improvements. This includes major investment in ordinary road construction and upgrade and/or reconstruction to achieve 100% of long-term national, provincial, and rural road development targets by 2020. t Baseline Growth Scenario. This assumes a more modest investment strategy, and achieves only 55% of long-term national development targets, 100% of provincial road targets, and 88% of length in kilometers. The cost of this scenario reflects a system expansion and upgrade strategy consistent with the road investment strategy that has been pursued in recent years.

Table ES-1 Summary of 2010–2020 Ordinary and Rural Road Needs, Revenues, and Gap (CNY billion) Item Construction Needs Maintenance Needs Total Needs Revenues Gap Unconstrained Needs Annual average 566 245 811 359 452 Total 6,228 2,690 8,918 3,950 4,968 Baseline Growth Annual average 347 229 576 359 217 Total 3,816 2,523 6,339 3,950 2,389

As summarized in Table ES-1, the PRC’s total ordinary and rural road construction and maintenance costs annually for 2010–2020 are estimated to average CNY811 billion ($124 billion)2 under the unconstrained needs scenario and CNY576 billion ($88 billion) under the baseline growth scenario.

2 The exchange rate used in the report is CNY6.53 = $1.00 (as of 18 April 2011). xiv Executive Summary

These needs compare with estimated annual central government road funding for the same period of CNY359 billion ($55 billion). Based on these figures, the anticipated annual road funding shortfall for 2010–2020 is CNY452 billion ($69 billion) for the unconstrained scenario and CNY217 billion ($33 billion) for the baseline scenario.

Conclusion and Policy Recommendations

The issues and challenges identified in the study include matters that are a direct result of the design and implementation of the fuel tax reform initiative—loss of direct local and provincial funding sources and a declining purchasing power—and other broader program considerations, such as inadequate funding and weak program administration. Given the overlap between the two issues, it is not surprising many of the potential policy solutions are crosscutting and need to build on one another. In particular, there is much interplay in the definition of roles and responsibilities, potential financial structures, financial capacity, goals and objectives, and program administration considerations.

To support the development of policy options that will contribute to a more sustainable road program in the PRC and ensure appropriate consideration of crosscutting issues, the consultant team, ADB, Ministry of Transport (MOT), Ministry of Finance (MOF), and National Development and Reform Commission (NDRC) collaborated to establish a set of principles to help limit the options for evaluation: t User-Pays Principle. Road investment should generally be funded through revenue mechanisms that charge users for the benefits they receive, except where they could not afford the fuel tax rate or other tax or fee levels needed to fully recover road construction and maintenance costs. t Regular and Long-Term Financing. Annual maintenance and operating costs should be covered from road user charges on a pay-as-you-go basis. Long-term investment costs may require long-term financing instruments, with the associated annual debt servicing costs funded through user charges. t Additional Funding Needs. While the gap analysis conducted was neither precise nor thorough, it clearly shows that a large gap exists and that mechanisms to provide additional funding for ordinary roads should be explored. t Existing Debt. The level of road-related provincial and local debt and the potential challenges governments face to repay this debt are not only a great concern but also a historical problem that should be explored and addressed through avenues outside of this study. t Maintenance Focus. Policy options should consider pragmatic approaches to both expand the road system and to ensure adequate resources are available to maintain and operate it. t Fuel Tax Increase. Increasing the motor fuel tax, whether through indexing, converting to an ad valorem tax, or other options, should be considered and explored as a leading option for addressing at least part of the ordinary road funding gap. Executive Summary xv

Based on the application of these principles, as well as on inputs from various PRC officials, research on relevant international best practices, and deliberations on the project, the following seven recommendations were prepared. These cover financial, policy, and administrative topics that are interrelated. t Division of Roles and Responsibilities. To provide the central government with greater means to direct investment on national priorities and improve accountability, it is recommended that it establish a target share for its contribution to road funding, inclusive of funding from the fuel tax and other central government sources. The central government funding share would then be matched by provincial and local government counterpart funds. This approach would have to be accompanied by the creation of a new provincial and/or local road funding mechanism. It would incentivize provincial and local governments to increase their spending on roads and avoid the perception of central government funding being “free money.” The central government should also consider establishing funding categories to require that a certain percentage of funding be spent on maintenance, safety, or other high priorities. t Funding Allocation. The approach for determining the allocation of funding is now a critical concern of provincial and local road agencies. While there may not be any one “right” method for allocations, approaches must strive to find a balance between national goals and needs, and considerations of fairness and equity. Despite some of its pitfalls, a formula-driven allocation approach may be the best way to address many of the road program challenges the PRC faces. A combination of program categories and formula-based allocations could be used to both direct a targeted level of funding and redirect appropriate levels of funding to underdeveloped regions. t New Funding Options. To raise additional revenues for roads, the PRC should either increase existing taxes or establish new revenue-raising mechanisms. Should the central government delegate funding responsibilities to other levels of government, new tax or fee mechanisms would need to be authorized for provincial and/or local government use. Based on the preliminary analysis conducted, raising the level of the current fuel tax may be the best option; motor fuels sales tax and carbon tax are also options. t Adjusting Current Funding Sources. The fuel tax reform established a fixed-rate excise tax on motor fuels. This has to be adjusted regularly to ensure revenues keep up with inflation and other factors such as rising real construction cost. While regularly adjusting tax rates based on needs will be ideal, it may not be politically viable. The next option is to index current fuel taxes and any future base rate increases to inflation. t Rationalizing Use of Debt Financing. Historically, the use of bank loans to finance ordinary road programs has largely occurred at the discretion of provincial and local governments. As a result of the fuel tax reform, provincial and local governments have lost the ability to obtain bank loans secured and repaid with road funding. While debt financing may support delivery of ordinary and rural road programs, it is premature to explore specific options for reestablishing road-related debt capacity until it is determined how jurisdictions will secure and service new debt. t Fund Management. The lack of a well-defined accounting mechanism for road funding, such as a road trust fund, leads to reduced clarity and greater uncertainty on whether all user charges will be allocated for road purposes, and what level of annual funding will be available. xvi Executive Summary

This uncertainty has generated concerns among provincial and local officials—whether they will receive sufficient resources to fulfill plans and meet the demand for improvements, maintenance, and debt repayment. It is recommended that the PRC adopt a special fund for central government road user charges to improve transparency and funding predictability. t Organizational Capacity. The current organizational structure and institutional capacities of the MOT, relevant sections of the MOF, and provincial and/or local road agencies, were established to support a highly decentralized, locally funded highway program. Depending on the directions the central government takes on some of the other policy issues, these structures and capacities may not be suitable or adequate to meet future roles and responsibilities, and may need to be refined. 1 Introduction

1.1 Background

Over the last 2 decades, the combination of the national government’s proactive financial policy and widespread use of toll-based debt financing has enabled rapid expansion of the road system in the People’s Republic of China (PRC). By the end of 2009, the total length of expressways reached 65,100 km; the ordinary national and provincial trunk road networks and rural roads were also significantly expanded and currently total 360,000 km for trunk road networks and 3,369,000 km for rural roads. With this growth in the road network, travel demand has also grown rapidly and is expected to continue increasing at a fast pace. Additional system expansion of most road classes will be needed, but continuing the current pace of investment will be an enormous challenge because of the limited financial resources currently available to pay for system expansion, and the growing system operation and maintenance needs.

In December 2008, the State Council of the PRC issued the Notification of the Implementation of the Reform of the Oil Products Price and Taxation, the fuel tax reform, which included three key elements effective January 2009. The reform (i) abolished six road charges, including road maintenance fee (RMF), passenger and freight surcharges, transport management fee, and waterway maintenance and management; (ii) removed authorization for future loan-financed toll road initiatives on class II roads known as government loan repayment toll roads (GLRTRs) and established a schedule for gradually annulling the existing tolls on class II roads; and (iii) established a series of motor fuel tax increases to replace the funding sources.

The PRC also made important policy changes to the existing vehicle purchase tax (VPT) that temporarily reduced tax revenues. In January 2009, the VPT rate was reduced from 10% to 5% for passenger cars with engine displacement of 1.6 liters and less to encourage car sales as part of the economic stimulus package while incentivizing energy savings and achieving emission reductions. The rate was then adjusted to 7.5% in early 2010 but was reverted to 10% in 2011 for all vehicles.

The fuel tax reform initiative represents an important evolution in the PRC’s approach to delivering its highway program. But the combination of abolishing existing fees and annulling GLRTRs, increasing construction costs and maintenance needs, and rapidly imposing and implementing the fuel tax reform leave several uncertainties on the sustainability of the PRC’s road programs. In particular, the removal of stable and direct revenue mechanisms has created doubts on how local governments will meet their road maintenance needs and how they can use debt financing for road construction. Research and policy reform are needed to address these uncertainties.

1 2 Financing Road Construction and Maintenance after the Fuel Tax Reform

1.2 Objectives

This study3 focuses on exploring several fundamental issues associated with both the implementation of the fuel tax reform initiative and the improvement of the sustainability of the PRC’s highway programs. It identifies and explores high-level policy issues, options, and future research needs associated with financing ordinary and rural road construction and maintenance, with the aim of improving the overall sustainability of ordinary road programs in the PRC. The analysis also includes an assessment of the impacts, successes, and challenges of the fuel tax reform and identifies areas where additional actions may be required to improve program sustainability and effectiveness. Details of relevant experiences from other countries are also included in the report, as well as policy recommendations. The report seeks to answer the following questions: t Roles and Responsibilities. What is the current division of responsibilities between the central government and provincial and/or local road agencies regarding system planning, program administration and oversight, project selection, project implementation, and maintenance for different classes of highway? How does this division of roles and responsibilities align with the new centralized funding structure and the desire to achieve more sustainable highway programs? t Fuel Tax Reform Status. What is the status of the fuel tax reform implementation? To what extent has the reform achieved the goals, objectives, and impacts? What challenges and issues have resulted from the reform that still need to be addressed? t Funding Needs. What is the range of future annual spending needs for ordinary and rural road construction and maintenance? What level of spending can be sustained through current revenues, and what is the resulting funding gap to achieve the goals and objectives? t Revenue Options. What revenue mechanisms (either new or an expansion of existing taxes) offer the greatest potential for providing viable options for financing road construction and maintenance spending at the national, provincial, and local levels? t Program Effectiveness and Sustainability. What are the current barriers to establishing more effective and sustainable highway programs in the PRC? What structural, policy, program, and administrative changes can improve program performance?

3 The study was financed through an Asian Development Bank technical assistance project, TA 7456-PRC: Financing Road Construction and Maintenance after Fuel Tax Reform. Road Programs in the 2 People’s Republic of China

2.1 Program History

The road system in the PRC has generally expanded in conjunction with national economic development. Road development has been significantly affected by the PRC’s overall economic development level, as well as by the country’s road administration system, the division of road program responsibilities among various levels of government, and the national road financing policies. Highway development in the PRC has gone through three distinct phases:

1949–1957: Immediately following the founding of the PRC in 1949, a wide array of national economic development considerations needed to be addressed. The central and local governments shared responsibility for road development, with road funding coming from central and local budgets. The central government was responsible for developing trunk roads and the local governments were responsible for local roads. Most of the local roads were built and maintained by local people through the “work relief policy”. Restrained by limited financial capacity, the road system developed slowly, and almost all roads were built as lower-class facilities (i.e., class III and below). By 1957, the total length of the PRC’s road system was 250,000 km.

1958–1983: In 1958, all responsibility for funding and delivering road programs (except those related to national defense) was decentralized to local governments, which continued to build and maintain roads through the work relief policy. No central government funding was provided in this 5-year plan, thus roads were not part of the central government’s “planned production.” In 1960, local governments were given authority to establish RMFs to assist in funding road maintenance. The RMFs became a stable funding source for road maintenance. During this period, the total length of the road system reached 910,000 km, including 17,000 km of roads classified as class II and above.

1984 onwards: In response to a growing backlog of road expansion needs arising from fast-paced socioeconomic development, the National Road Network Planning and Transport Policy Study was conducted in the 1980s. The study initiated the PRC’s modern era of road building and identified the need for construction of a 10,900-km network of national highways. Since then, a number of important policy measures, development programs, and initiatives have been implemented, including the toll road policy, VPT, RMF rate increases, and oil product tax reform.

2.2 Current Status of Road System Development

Since the 1980s, major improvements in the road system have been achieved through a combination of VPT-based funding and toll road initiatives, and implementation of key road development programs, such as the National Road System Program, the National Trunk Road Skeleton System Program, and the Rural Road Development Program. 3 4 Financing Road Construction and Maintenance after the Fuel Tax Reform ––––––––––– Table 1 Table Road Length Classiﬁcation in the PRC (km ‘000) 40.2 38.9 37.3 36.0 20.1 19.567.2 18.9 67.2 18.4 57.1 17.7 58.0 14.6 88.0 14.0 88.0 13.0 87.3 12.8 87.1 12.4 86.0 12.0 54.6 54.1 53.1 51.8 51.6 50.6 158.5 155.3266.0 137.1 263.2519.5 133.4 255.2 512.3 133.0 239.6 514.4 129.8 233.0 506.5 127.9 227.9 494.0 125.0 223.4 479.4 121.6 216.2 472.9 120.6 213.0 471.2 117.1 197.3 463.7 114.8 192.5 406.7 112.0 190.0 398.0 110.4 182.6 383.7 110.5 177.9 379.8 175.1 373.1 366.4 804.6 951.6 1,048.3 1,174.1 338.0 354.8 371.1 382.3 362.0 186.7 195.0 209.2 228.9 237.7 246.3 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1,019.6 1,011.1 998.41,830.0 987.5 1,721.0 1,622.0 981.0 1,532.0 945.2 898.3 865.6 813.7 623.5 589.9 536.8 500.3 472.8 454.4 3,056.0 2,779.0 2,535.0 2,283.0 1,591.0 1,516.0 1,439.0 1,383.0 1,336.0 1,216.0 1,157.0 1,070.0 998.0 948.0 911.0 3,861.0 3,730.0 3,584.0 3,457.0 1,931.0 1,871.0 1,810.0 1,765.0 1,698.0 1,403.0 1,352.0 1,278.0 1,226.0 1,186.0 1,157.0 2 3 4 5 6 7 8 , 1995–2009. Development Statistics Bulletin , Transport Waterway Highway and ) 2 Accommodation Administrative Classification National Provincial County Township Village Technical Classification Technical ExpresswayClass IClass IIClass III 65.1Class IV 60.3Subtotal 59.5 53.9 300.7 54.2 379.0 285.2 45.3 2,252.0 2,004.6 374.2 276.4 50.1 1,791.0 41.0 363.9 1,574.8 262.7 45.3 34.3 354.7 921.0 246.0 38.0 344.0 881.0 231.7 29.7 335.3 842.3 211.9 33.5 25.1 324.8 818.0 197.1 30.0 19.4 315.1 800.7 182.1 27.5 308.6 750.3 152.7 16.3 276.7 718.4 140.0 25.2 11.6 269.1 662.0 125.2 20.1 1,11.6 257.9 635.7 8.7 17.8 230.8 619.3 97.0 4.7 216.2 606.8 15.2 84.9 207.2 14.6 3.4 11.8 2.1 9.6 Substandard Total lengthTotal Density 1 (km per 100 km Note: Note: Accommodation roads are access to private and public properties. Source: Road Programs in the People’s Republic of China 5

Road Network Expansion and Increased Road Density. By the end of 2009, the total length of the PRC’s road system reached nearly 3.9 million km, resulting in a national road density of 40.2 km per 100 square km (Table 1). The densities reached 100.9 km per 100 square km in the eastern region, 77.4 km in the central region, and 21.8 km in the western region. In areas such as Shanghai and the provinces of Henan and Shandong, the road density increased to over 100 km per 100 square km, on par with that of some developed countries.

Upgrades and Improvements to the Existing Network. By the end of 2009, the total length of the PRC’s classified road network reached roughly 3.056 million km (80% of the PRC’s total road system), 400,000 km of which are class II roads and above (11% of the total road system).4 Nationwide, 70% of all national and provincial trunk roads are now classified class II and above (Figures 1 and 2). This percentage increases to 80% in 13 provinces and 4 municipalities, and to over 90% in the provinces of Jiangsu and Shandong and in the municipality of Shanghai.

Figure 1 Technical Classiﬁcation of Roads in the PRC, 2009a (%)

1.70 1.50 Expressway 20.80 7.80 Class I 9.80 Class II

Class III

Class IV

Substandard

58.30

a The technical classifications of roads are according to the PRC’s Technical Standard of Highway Engineering and Design Specification for Highway Alignment. Expressways have 4–8 lanes, an average annual daily traffic (AADT) of more than 55,000, and design speed of 80–120 kph. Class I roads are 4–6 lane highways with 15,000–55,000 AADT and design speed of 60–100 kph. Class II roads are 2–lane roads with AADT of 5000–15,000 and design speed of 60–80 kph. Class III roads are 2–lane roads with 2,000–6,000 AADT and design speed of 30–40 kph. Class IV roads are 1–2 lane roads with an AADT of 400–2000 and design speed of 20 kph (AADT in pcu). Source: Highway and Waterway Transport Development Statistics Bulletin, 2009.

4 Highway classification refers to those highways that meet both technical indicators and current highway engineering standards. 6 Financing Road Construction and Maintenance after the Fuel Tax Reform

Figure 2 Administrative Classiﬁcation of Roads in the PRC, 2009 (%)

4.11 6.89 National

13.46 Provincial

County 47.40 Township

Accommodation

Village 26.41

1.74

Source: Highway and Waterway Transport Development Statistics Bulletin, 2009.

Figure 3 Total Length of Expressways in the PRC, 1995–2009

70,000

60,000

(km) 50,000

40,000

30,000

20,000 Expressway Length 10,000

0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Year

Source: Highway and Waterway Transport Development Statistics Bulletin, 1995–2009. Road Programs in the People’s Republic of China 7

Expressway Development. The PRC also has made significant progress expanding the expressway system (Figure 3). In the Eleventh Five-Year Plan (2006–2010), a national expressway skeleton system of 35,000 km, comprising five north–south routes and seven east–west routes, was completed.5

Improvement of Rural Road Conditions. Rural roads account for 90% of the total road length in the PRC and are critical for providing basic services to the public. Over the years, a number of rural road development programs have been launched by the MOT to provide increased funding support, particularly for the PRC’s western regions and other economically underdeveloped rural areas. By the end of 2009, all townships and 99.5% of the administrative villages in the PRC’s eastern region have road access (nearly all of which are paved); in the midland region, all townships and 97.2% of the administrative villages also have road access.

2.3 Organizational Structure for Delivering Programs

In accordance with the Highway Law and the Highway Administration Ordinance, road administration in the PRC is highly decentralized. The responsibility for construction of different road categories is summarized in Table 2.

Table 2 Road System Development Responsibility Arrangement in the PRC Road Classiﬁcation Administration Activities Assignment of Responsibilities National roads Planning Performed by the Ministry of Transport (MOT) in conjunction with relevant central government departments and in consultation with provincial governments; plans are submitted to the State Council for approval. Construction, maintenance, and Performed by provincial communications departments (PCDs). management Provincial roads Planning Performed by PCDs jointly with provincial government departments in consultation with lower-level local government entities; plans are submitted to provincial governments for approval and filed with MOT. Construction, maintenance, and Performed by PCDs. management County roads Planning Performed by the prefecture-level government; plans are submitted to provincial governments for approval. Construction, maintenance, and Performed by county-level governments. management Township roads Planning Performed by county-level road authorities; plans are submitted to county governments for approval. Construction, maintenance, and Performed by township governments. management

Source: ADB consultants.

5 The five north–south and seven east–west routes form a skeleton system connecting the capital city of Beijing, each of the provincial capital cities, municipalities directly under the central government, special economic zones, major transport hubs, and ports opening to the outside world. 8 Financing Road Construction and Maintenance after the Fuel Tax Reform

2.4 Road Financing

Prior to implementation of the fuel tax reform, financing for ordinary and rural road construction and maintenance was provided through a combination of funding mechanisms implemented by the central government, provincial and/or local governments, and other entities. Since the reform, some funding sources have been eliminated, while others remain in place. The following is an overview of past and current road funding approaches in the PRC. A diagram summarizing the funding sources is provided in Figure 4.

Figure 4 Road Financing Source and Allocation Flowcharta

Budgetary Central Government VPT

Expressway

Toll Road Debt Domestic Loan Financing

OTR Bank Loan

RPFS Local Self Financing Public Account Provincial/Local Level Private Sector

Rural Road RMF Enterprise Toll Charges

Foreign Capital

RMF = road maintenance fee, RPFS = road passenger and freight surcharges, VPT = vehicle purchase tax. a Use of foreign capital is limited to funding expressways and ordinary trunk roads (OTRs). Source: ADB consultants. Road Programs in the People’s Republic of China 9

2.4.1 Central Government Funding Sources

Vehicle Purchase Tax. In 1985, the central government created a 10% surcharge on vehicle purchases (automobiles, motorcycles, electric vehicles, trailers, and farm use vehicles) to provide a stable funding source for development of national roads, with revenues from the tax dedicated to a special account kept by the MOT. In 2001, this surcharge was renamed vehicle purchase tax, and revenues were redirected to the Ministry of Finance (MOF) and used to fund road program proposals submitted by provincial and/or local transport agencies subject to review and approval by relevant authorities.

Revenue from the VPT is mainly used for national and provincial trunk road construction, but is also used to support other activities, such as the water resource development fund, vehicle replacement and upgrades, and others. Annual revenues from the VPT have grown steadily in recent years, increasing from CNY21.6 billion ($331 million) in 2000 to CNY116.4 billion ($17.8 billion) in 2009, of which about 90% was used for highway-related purposes (Figure 5). Revenues from the VPT account for about 12% of central government funding for roads each year, and 3% of total road spending for ordinary national and provincial trunk road construction. Although limited in scale, the VPT provides a stable funding source for the central government, and has played an important role in supporting road development.

Due to the rapid increase in vehicle ownership in the PRC, revenues from the VPT have also grown rapidly. In 2009, year-on-year growth in motor vehicle sales reached 45.5%, causing VPT revenues to increase by 17.5% over the previous year. The temporary government action to reduce the VPT rate for more efficient vehicles reduced VPT revenue growth. However, the VPT rate has since been restored, and rapid growth in VPT revenue can be expected.

Figure 5 Annual Gross Vehicle Purchase Tax Revenues, 2000–2009a

140 116.4 120 98.9 100 87.7

80 68.7 58.2 53.5 60 47.5 CNY Billion 36.4 40 25.5 21.6 20

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

a The data on VPT revenue for 2000–2009 is from www.mof.gov.cn 10 Financing Road Construction and Maintenance after the Fuel Tax Reform

General Budgetary Revenue. The percentage share of funding provided for road construction through the PRC’s general budgetary revenue has been very small. State bond revenue is included in general budgetary revenue. Since 1998, some of this revenue has been put into road construction, with use of special fund proceeds determined by the National Development and Reform Commission (NDRC). Under this process, the actual funding is appropriated from the MOF to finance highway construction projects. The central government issues local bonds on behalf of local governments, which then construct roads and assume the liability for repaying the principal and interest.

2.4.2 Provincial and Local Government Funding Sources

In addition to receiving funding from central government sources, provincial and/or local governments have historically funded a substantial portion of total national road maintenance and construction spending through a variety of sources and mechanisms, including road user fees collected by local transport departments, local government self-financing, enterprises and institutional entities, domestic bank loans, and foreign capital.

Provincial and/or Local Government Self-Financing. Forms of provincial and/or local government self-financing have included bank loans secured by provincial and local governments, funds from public accounts, revenues from passenger and freight surcharges now canceled, and private investment: t Bank Loans. Road agencies must have at least 35% of the total project capital requirement before they get the approval to construct a project, and pay the remaining project cost through debt financing. However, the 35% requirement can be met through bank loans. t Local Public Account (general budgetary revenues). Based on available resources, local governments take a portion of locally raised funds from their budgets to support road construction and maintenance. t Passenger and Freight Surcharges (eliminated by the fuel tax reform). Before 2009, local governments could impose road passenger and freight surcharges approved by the applicable provincial governments or autonomous regions and municipalities directly under the central government. The surcharges were imposed on bus passengers and shippers and collected by local transport authorities at different levels. Revenues from the surcharges were used to pay for road construction and development of passenger and freight terminals. The national average fee was CNY0.015 ($0.002) per passenger-km for passengers and CNY0.025 ($0.004) per ton-km for freight. t Private Investment. The private sector can participate in road construction through a variety of means, including direct investment in toll roads, toll road operation rights transfers, and others.

Enterprises and Institutional Entities. Funding from enterprises and institutions, including RMF proceeds and surplus income from toll roads, has been used mainly to pay for road maintenance. These sources include the following: t Road Maintenance Fund Fee (eliminated by fuel tax reform). The RMF was established in 1960 by the State Council to charge vehicle owners a monthly fee based on a vehicle’s rated weight or passenger capacity. Provincial governments established the fee rates and provincial communications departments collected the fees. Rates varied by province. In 2009, the last year of the RMF, rate levels ranged from CNY180 ($27.6) to CNY240 ($36.8) per ton Road Programs in the People’s Republic of China 11

per month. According to the PRC’s Highway Law and the Rules for Administration of the Use of the RMF, at least 80% of RMF revenues shall be dedicated for maintenance purposes. Anecdotal evidence, however, suggests that in recent years, provincial and local governments have diverted a large share of RMF proceeds to fund road construction. t Toll Charges (partially eliminated by the fuel tax reform). In 1984, the PRC established a toll road and bridge policy that authorized provincial and local governments to construct toll roads and finance them with toll-backed debt. Under the policy, jurisdictions could toll roads through two kinds of investment facilities—government loan repayment toll roads (GLRTRs) and commercially operated toll roads (COTRs)—which are governed by different rules on toll collection periods, administration, and taxation. GLRTRs refer to roads that are built with loans or joint financing arrangements, financed in part through toll-backed debt and managed by the applicable public institution for a given jurisdiction. The objective of the toll collection for GLRTRs is not to earn profit but to meet loan repayment and road maintenance needs. COTRs refer to commercially operated toll roads where the facility is built and managed by domestic or overseas economic entities through either legal assignment of road operation rights or financing through toll-backed debt or by selling equity shares and building of tolled facility by the commercial entity. In either case, the objectives of the toll operations are to cover facility maintenance costs and to allow the commercial entity a reasonable return on investment. At present, most toll roads are GLRTRs. t Domestic Bank Loans. Local and provincial governments have made wide use of bank loans to pay for road projects. RMF and/or toll revenues have typically been used to guarantee these loans. t Foreign Capital. Foreign investment in local road projects has comprised a small percentage of total highway funding, mostly restricted to highway reconstruction projects in the southeast coastal area of the PRC.

2.4.3 Road Financing Share by Funding Source

Prior to the fuel tax reform, the largest share of total road funding was provided through domestic bank loans at 38.5% and local self-financing at 31.5%. The combined contribution from the two central government sources, the VPT and the central government budget, was only 14.9% (Figure 6).

Before the fuel tax reform, only 4% of ordinary national and provincial trunk road funding was provided by the central government. The remaining 96% was provided by provincial and local governments. When the entire road system, including expressways, was considered, the share of funding provided by the central government budget and VPT revenues had not been significantly higher, typically comprising only about 6% of costs, with 90% of funding provided by provincial and local sources and the remaining 4% coming from foreign capital and other miscellaneous sources.

For rural road construction, 90% of funding came from a combination of local self-financing (68%), VPT revenues (15%), and domestic bank loans (9%). The remaining 10% came from budgetary sources, enterprises, and other miscellaneous sources.6

6 Based on 3-year average: 2005–2007. 12 Financing Road Construction and Maintenance after the Fuel Tax Reform

Figure 6 Total Road Funding Sources, 2008 (%)

6.8 Domestic Bank Loans

8.3 Local Self-Financing 38.5 General Budgetary Revenue

Vehicle Purchase Tax 10.9 Enterprises and Institutional Entities

4.0 Miscellaneous Sources

31.5

Source: ADB consultants.

Funding sources for road maintenance included RMFs, toll charges, VPT revenues returned to local government, central and local government financial accounts, and bank loans. Typically, RMF revenues funded over 50% of maintenance costs for all roads, while toll revenues funded an additional 40% of road maintenance costs at the national level and 20% at the provincial level. The remaining costs at each level were funded through VPT revenue allocations, central and local government financial accounts, bank loans, and other miscellaneous sources. There has not been a stable funding source for rural and village road maintenance.

2.5 Program Delivery—Road Planning, Construction, and Maintenance Administration 2.5.1 Road Planning 2.5.1.1 Road Planning Responsibilities At the central government level, the MOT is the authority for transport under the State Council. The MOT is responsible for mid- and long-term national road system planning in conjunction with the relevant departments under the State Council and the provinces, autonomous regions, and municipalities directly under the central government. The plans developed by the MOT include objectives and priorities for various milestones within the planning period. Provincial transport departments, in conjunction with relevant local departments, are responsible for developing provincial road development plans, which are submitted to their respective provincial governments Road Programs in the People’s Republic of China 13 for approval. County-level transport departments are responsible for county and township road planning and submit development plans to their respective municipal and county governments for approval. Stakeholder and/or public participation is a basic requirement for road planning at all levels and includes consultations among the relevant government departments in the national, provincial, and regional levels.

2.5.1.2 Types of Road Planning Mid- and Long-Term Plan. The MOT, in conjunction with other agencies, usually prepares mid- and long-term road sector development programs for up to 10 years, such as the National Expressway Network System Plan and the Rural Road Development Program, based on the central government’s long-term socioeconomic development strategy. It occasionally develops regional road development plans, such as the road and transport development plans for the Yangtze Delta and Zhujiang (Pearl River) Delta areas.

Five-Year Plan. Based on the mid- and long-term plans described earlier, the MOT works jointly with the NDRC and relevant departments under the State Council to develop five-year plans, which are submitted to the State Council for approval. The five-year plans identify key projects and associated investment costs, and provide criteria for identifying construction projects and funding approaches in each of the provinces. Each year, the MOF is responsible for determining the central government’s budgetary investment level for road projects based on the annual budget and the five-year plan. Local governments also develop their jurisdictional areas’ five-year plans according to their roles in road administration.

Annual Plan. At the beginning of every year, for each province, the MOT issues an annual investment plan and the MOF issues an annual budget after it has been approved by the National People’s Congress. Each province then submits an accomplished funding application form to the MOT and the MOF based on the yearly progress of the projects. Once these plans are approved, the applied funding is appropriated to project accounts from the Central Treasury. Local governments also develop their respective annual road development plans according to their role in road administration.

2.5.2 Road Construction Administration

Project Prioritization and Selection Procedures. Projects identified in the five-year plan are generally prioritized and selected based on their available funding levels, relative importance, and level of demand relative to other national objectives and provincial and/or local interests. Where funding is insufficient to address all needs, projects are selected and prioritized based on their relative importance. As an underlying policy, the bases are (i) funding for minor repairs, maintenance, and staffing payments; (ii) commitments for projects, such as dangerous bridges and major and intermediate rehabilitation; and (iii) disaster prevention and control, in that order. In practice, however, highest priority is often given to new construction projects, and needed maintenance is often deferred.

Cost Estimation Methodologies. Cost estimates are based on practical experience with road construction and maintenance costs, including data on the cost of key project components, such as land acquisition, resettlement, construction activities, traffic management, and environmental 14 Financing Road Construction and Maintenance after the Fuel Tax Reform protection measures. The Road Engineering Cost Estimation Quota (JTG/TB06-01-2010) is the latest version of the standard regularly issued by the MOT that considers various factors to provide data to support project and program cost estimation.7

Funds Appropriation and Monitoring. At the beginning of every year, the MOF issues an investment budget based on the annual investment plan prepared and submitted by the MOT for each of the provinces. The provincial plans, which are essentially funding applications, are based on each province’s prior year progress on road projects. Once the funding application is approved, the funds applied are appropriated from the central government to the project account. For some small projects implemented by local governments, such as rural road projects, financial transfers are made directly from the central government to the local government’s finance departments, which are then responsible for project delivery according to relevant rules. Review and monitoring of funded projects is then conducted through systems established by the central government and the MOT, and is performed by inspection and audit departments at the central and local levels.

2.5.3 Project Delivery

The jurisdiction responsible for road construction differs depending on the type of project. It is usually determined by the applicable provincial transport department in consultation with provincial, municipal, and county highway bureaus. Generally, the provincial highway bureau or municipal transport bureau is responsible for national and provincial road projects, while the applicable municipal or county transport bureau is responsible for rural road projects. Actual project implementation follows an eight-step process, although the process can vary depending on the size and complexity of the project.8

2.5.4 Road Operations and Maintenance Administration

After completion of a road project, if it is a commercially operated toll road it is operated by the investor, which is also responsible for maintenance of the road. If the road is a government loan repayment toll road, it is operated by provincial or municipal highway bureau; non-toll roads are normally operated by local highway bureaus.

At the central government level, the MOT is responsible for issuing technical standards, specifications, and relevant guidelines for road maintenance. The MOT also establishes a five-year road maintenance administration plan to guide road maintenance work in each of the provinces. After the fuel tax reform, the MOF transfers the fuel tax revenues to each province to pay for maintenance activities every year based on the allocation formula.

7 Considerations include local conditions; the latest available technologies, equipment, and materials; environmental protection requirements; engineering quality; and other considerations. 8 The basic stages include (i) project proposal, (ii) project engineering pre-feasibility study, (iii) project engineering feasibility study, (iv) preliminary design, (v) construction plan design, (vi) construction, completion, and acceptance, (vii) project hand-over, and (viii) post project evaluation. Road Programs in the People’s Republic of China 15

At the provincial level, provincial highway bureaus have the discretion to manage routine and minor road maintenance work in their jurisdictional areas. The necessary funding is directly appropriated to each municipal financial bureau from provincial financial departments. Provincial highway bureaus are responsible for supervising road maintenance work. They issue performance targets, establish evaluation criteria, and conduct annual inspections of maintenance work. For intermediate and major maintenance work, each municipal highway bureau has the discretion to submit annual plans to provincial highway bureaus for examination and approval. Once plans are approved by provincial highway bureaus, corresponding maintenance plans and budgets are issued to municipal highway bureaus for implementation. Plan implementation is monitored and checked by provincial highway bureaus.

Provincial transport departments are responsible for developing and issuing rural road maintenance plans and monitoring rural road maintenance work. Before the fuel tax reform, the funding sources for rural road maintenance included municipal and county government financial accounts, RMF funds from farm use tractors and motorcycles, and subsidies from the provincial transport department.9

2.6 Existing Problems in Ordinary Road Development

In contrast with the rapid development of high-grade roads (i.e., expressways and class I roads) that has occurred over the last 2 decades, ordinary road development has lagged behind, creating a significant backlog in maintenance, reconstruction, and upgrade work (e.g., safety, flood damage prevention, and slope protection work) on the ordinary road network. The rural road system has been greatly expanded in recent years and has created greater demand for maintenance spending.

Network Coverage Gaps. By the end of 2009, the total length of the ordinary trunk road system reached 360,000 km, with a road density of 3.8 km per km2. There are six prefecture cities and over 600 counties not connected to the national road system, most of which are in economically underdeveloped regions of the country. Some border-crossing ports, major tourist areas, and important townships also lack direct connection to the national road system.

Road Capacity Improvement Needs. By the end of 2009, 65% of the PRC’s ordinary trunk road system comprised roads classified class II and above, with the remaining 35% classified class III and below. The 35% share includes over 50,000 km of class IV or substandard roads. Part of the ordinary trunk road system is also congested and requires upgrades to provide adequate mobility. The county, township, and village rural road systems comprised about 96% class III roads and below, many of which also require upgrades to provide needed mobility and accessibility improvements to serve citizens and businesses (Figure 7).

Poor Pavement Conditions. By the end of 2009, about 30,000 km of ordinary national and provincial trunk roads (7.4% of the total ordinary trunk road system) remained unpaved; most of these facilities are concentrated in the PRC’s western region. Over 500,000 km of county and

9 According to MOT regulatory documents, provincial transportation agencies using RMF revenues as a funding source must allocate a minimum of CNY7,000/km-year for county roads, CNY3,500/km-year for township roads, and CNY1,000/km-year for village roads. 16 Financing Road Construction and Maintenance after the Fuel Tax Reform

Figure 7 Classiﬁcation of Ordinary Trunk Roads (%)

2.7011.50 Class I 10.70 Class II

Class III

Class IV 21.90 Substandard

53.20

Source: Highway and Waterway Transport Development Statistics Bulletin, 2009.

Figure 8 Classiﬁcation of Rural Roads (County and Township) (%)

0.01 0.94 Class I 13.00 6.02 Class II

16.57 Class III

Class IV

Substandard

Expressway

63.46

Source: Highway and Waterway Transport Development Statistics Bulletin, 2009. Road Programs in the People’s Republic of China 17

Figure 9 Trafﬁc Congestion Examples

Source: ADB consultants.

township roads also remained unpaved, accounting for 35% of the total rural road system (Figure 8). Overloaded trucks and lack of adequate maintenance spending resulted in serious pavement damage and distress for some road sections. Rehabilitation or reconstruction of these facilities is urgently needed. The problem is exacerbated by the implementation of the fuel tax reform, which unintentionally has created incentives for trucks to divert from tolled expressways and class I roads to class II roads where tolls have been removed.

Dangerous Bridge Conditions. Many road bridges throughout the PRC are in dangerous condition due to lack of adequate maintenance spending, and pose a significant risk to road users. As of the end of 2009, a total of 4,600 bridges on the ordinary national and provincial trunk road system—a combined length of 250,000 meters—were considered dangerous, the majority of which are concentrated in the PRC’s central and western regions. There are also 900,000 dangerous bridges in the county and rural road system—a combined length of 2.5 million meters.

Figure 10 Examples of Poor Pavement Conditions

Source: ADB consultants. 18 Financing Road Construction and Maintenance after the Fuel Tax Reform

Lack of Rural Road Maintenance Systems. Despite significant investments to expand rural road networks, adequate road maintenance systems have not been established to look after these facilities. Under the Highway Law, county-level governments have the primary responsibility to maintain all rural roads—county, township, and village roads. Given the limited financial capacity of county-level governments, funds available for maintenance activities are often limited to paying for maintenance workers, and frequently no maintenance arrangements are made for newly built rural roads. As a result, the backlog in maintenance needs has inevitably climbed. For example, the estimated annual spending needs for rural roads of Tai’an City, Shandong Province, is CNY1,270 million ($194.4 million), but only CNY100 million ($15.3 million) was available for maintenance activities in 2009.

Unbalanced Road Development among Regions. In recent years, the central government has stressed balanced development among different regions, and thus provided preferential policies to the economically under-developed central and western regions of the PRC. Despite these efforts, disparities still exist in terms of road density, road system facilities, and road conditions due to poor original road infrastructure and limited financial resources of the associated local governments. While it is understandable and probably appropriate that different regions have different road density levels and types of facilities, the road systems in the PRC’s rural western provinces are clearly underdeveloped compared with those in the rest of the country; a more balanced density level and system performance needs to be determined. Table 3 provides a comparison of ordinary road development status in the PRC’s three primary regions.

Table 3 Comparison of Ordinary Road Development Status Eastern Central Western Road length (km) 1,045,281 1,264,539 1,485,946 Road density (km/100 km2) 98.4 76.2 21.6 % share of class II and above 15.5 8.6 6.1 Road category % share of all technical class 90.7 80.6 68.9 % share of high-grade pavement 64.7 52.2 21.4 Pavement % of simple pavement 14.2 12.8 15.0 condition % share of unpaved road 21.1 35.0 63.6

Source: ADB consultants. 3 The Fuel Tax Reform

3.1 Context for the Fuel Tax Reform

After years of study and discussions, the PRC enacted the fuel tax reform in December 2008 and began implementing it in January 2009. The initiative is an important public policy reform and reflects the PRC’s desire to address several important issues:

Energy Demand. The PRC’s demand for oil, and energy in general, had risen rapidly. In meeting this rising demand, the PRC was transformed from a net oil exporter to a net oil importer in 1993. Since 1993, the share of oil demand met by imports has continued to grow and currently stands at about 50%. While the rapid improvement in economic conditions and people’s living standards has led to increased oil consumption and growing energy demand, government officials believe there is a great amount of energy wasted in the PRC due to inefficient use of oil products, particularly by motor vehicles.

Environmental Concerns. The rapid growth in the PRC’s motor vehicle inventory has not only led to large increases in fuel consumption but also resulted in severe vehicle emissions and air quality problems. In many of the PRC’s major urban areas, over 80% of carbon monoxide (CO) and 40% of nitrogen oxide (NOx) emissions are from motor vehicles.

Fee and/or Tax Efﬁ ciency and Equity Concerns. The RMF and toll road charges played an important role in road financing before implementation of the fuel tax reform. However, these funding sources presented a number of problems as to the equity of the fees arising from irregular practices from one jurisdiction to another, and from loopholes in vehicle retrofitting and registration requirements. For example, truck owners would often register their vehicles in provinces with low road maintenance fees rather than in provinces where their operations were centered, or owners would post an inaccurate loading capacity rating on the nameplate of their trucks. Toll charges were perceived by the public as too high, and both the abundance of toll roads and the number of toll collection stations on class II roads led to road transport inefficiencies and public dissatisfaction.

Oil Product Pricing. The PRC started market-oriented price reforms for oil products in the 1980s. In 2003, however, to mitigate the economic and social impacts caused by major increases in the price of oil in the international market, the Government of the PRC implemented an oil products price control policy that decoupled domestic oil product prices from international oil prices. When international oil prices began to decline in the latter half of 2008, the government viewed it as an opportunity to implement the fuel tax reform without requiring an immediate substantial increase in prices paid by users.

19 20 Financing Road Construction and Maintenance after the Fuel Tax Reform

3.2 Main Points of Fuel Tax Reform 3.2.1 Goals and Principles

Normalization of Fee Collection. The wide variety of road maintenance fee levels and toll charges led to great inconsistencies and inequities across the PRC in how road users were charged and how much they paid. It was also easy for many system users to evade taxes and fees. The PRC hoped to establish a more consistent, transparent, and enforceable structure for charging road users and raising revenues for road construction and maintenance by creating a uniform national tax rate.

Promoting Energy Efﬁciency and Emission Reduction. It was anticipated that the fuel tax reform would make it feasible to provide fuel prices that better reflected the true cost of driving in terms of both infrastructure use and social impacts from energy consumption and pollution. This would promote more efficient travel behavior and vehicle selection, thereby conserving and reducing vehicle emissions.

Establishing Equitable Tax and Fee Burdens on Road Users. Compared to the fee collection system it replaced, the fuel tax reform was expected to encourage more efficient use of the road system and to be more equitable to users.

Simpliﬁcation and Efﬁciency of the Taxation System. The new fuel tax provided a relatively simple and cost-effective mechanism for increasing taxes, with limited opportunities for tax evasion.

Revenue Neutrality. The fuel tax reform rates were structured to raise a level of revenue and impose costs on users that were comparable to what was raised and charged under the prior road fee scheme.

Stability. The fuel tax reform sought to maintain stable financial conditions for provincial and local governments to ensure that sufficient funding was available for road construction and maintenance. For example, the reform initiative acknowledged the likely adverse financial impact of removing tolls on class II roads. As such, it called for abolishing the tolls gradually and included a graduated schedule of loan repayment subsidies in areas where the financial impacts of the reform would need mitigation to ensure better stability.

3.2.2 New Tax Structure

Tax Base and Collection Steps. At present, fuel tax is imposed on oil product manufacturers and oil product importers based on the volume produced, sold, or consumed. The taxes are physically collected by the central government, and fuel tax proceeds go into the central government’s general financial account. Tax revenue is collected at either the production step (i.e., from the refinery) or the customs office (for imported oil products). As the excise tax system evolves, the tax will likely be collected at the wholesale step. Further, oil product tax reform was one of the major tasks to be addressed by the State Administration of Taxation in 2010.

Tax Rates. Prior to the reform, fairly negligible taxes were charged on oil products. For example, the tax per liter on gasoline was only CNY0.2 ($0.03) and on diesel CNY0.1 ($0.02). The new excise tax rate for each of the oil products is shown in Table 4. The Fuel Tax Reform 21

Table 4 New Excise Tax Rate for Various Oil Products Taxed Oil Products Tax Rate per Liter (CNY) Gasoline Unleaded gasoline 1.0 ($0.15) Leaded gasoline 1.4 ($0.21) Diesel 0.8 ($0.12) Airplane kerosene 0.8 ($0.12) Naphtha 1.0 ($0.15) Solvent naphtha 1.0 ($0.15) Lubricant 1.0 ($0.15) Fuel oil 0.8 ($0.12)

Source: ADB consultants.

Allocation of Funds. Once fuel taxes are collected by the central government, revenues for use on road construction and maintenance are allocated to each of the provinces, as well as to regions and municipalities directly under the central government, by financial transfer mechanisms already in place. At present, the formulas used to determine the allocations are based on the percentage share of total revenues each province or applicable jurisdiction collected in 2007, the base year, through the prior road funding mechanisms (e.g., the RMF and passenger and/or freight fees) multiplied by 110%.

Under the current plans, the allocation of fuel tax proceeds from the central government to each of the provincial governments includes two parts: (i) replacement of the abolished user fees and (ii) subsidy for increased demand.10 The replacement of the abolished user fees will continue to be based on the 2007 baseline. The subsidy for increased demand will be based on factors such as fuel consumption, road and waterway length in kilometers, road density, and system conditions (Table 5).11

Table 5 Fuel Tax Revenue Allocation Formula Fuel tax revenue allocated = baseline allocation + added allocation Baseline allocation = 2007 revenuesa × (1 + 10%) Added allocation = oil product consumption subsidy (OPCS) + road maintenance and construction subsidy (RMCS) + navigational channel maintenance subsidy (NCMS) Where: OPCS = national total added allocation × 60% × percent share of total national oil products consumption; RMCS = national total added allocation × percent share of total national user taxes in base year × percent of total national road length in kilometers × 20% + local road density index × 15% + local condition factor index × 5%; and NCMS = national total added allocation × percent share of total national (water) user taxes in base year × percent of national navigation channel length in kilometers × 40%. a Total revenue of the six fees collected in 2007. Source: ADB consultants.

10 The term “subsidy” is a misnomer implying that the investments it supports are not economically justified. In reality it is simply a direct translation of the Chinese term used to describe the allocation of additional revenues raised through increased fuel consumption. 11 Currently, no regular uniform statistics by province or other applicable jurisdiction exist. 22 Financing Road Construction and Maintenance after the Fuel Tax Reform

Annulment of Class II Tolls. By the end of June 2010, 17 provinces, including all provinces in the eastern and central regions, had abolished tolls on their class II roads. As a result, about 100,000 km of roads had been converted to non-tolled facilities; a total of 1,723 toll stations across the PRC had been removed. In the western region, however, only Chongqing Municipality and Guizhou Province abolished the tolls on their class II roads. There may be no detailed plan at the central government level to push for the abolishment of class II toll roads in other western jurisdictions.

In light of both the level of toll revenue provincial and local jurisdictions are expected to forgo as a result of the fuel tax reform and class II toll road annulment, and the level of outstanding debt associated with GLRTR initiatives, provincial and local governments now lack the financial capacity to meet associated debt service requirements. To ensure provincial and local governments can continue to make their full debt service payments, the central government has arranged to provide CNY26 billion ($4.0 billion) from the fuel tax revenue per year to a special fund that will provide provincial and local governments with debt service subsidies for existing loans.

The amount of annual subsidy for each of the provinces and/or regions will be determined by the MOT, NDRC, and MOF based on past toll revenues and length in kilometers of class II toll roads. The terms of the loan repayment subsidies also vary for different regions: for the eastern region, the subsidy will cover 40% of outstanding loan repayment needs; for the central region, the subsidy will cover 50%; and for the western region, the subsidy will cover 60%. To address current loan repayment commitments, the central government plans to provide an annual subsidy for several years. Once loan repayment has been completed, the special fund will be used to support ordinary road construction and maintenance.

3.3 Case Study 3.3.1 Hainan Province Pilot Project

In 1994, in response to road and/or highway construction and maintenance financing challenges, Hainan Province implemented a pilot project, the Motor Vehicle Fuel Surcharge Collection Management Measures in Hainan Economic Special Zone. The project essentially annulled existing tolls and road user charges in the province and were replaced with fuel surcharge fees implemented as follows:

Tax Collection. Conducted by a provincial road user fee collection bureau (staff of highway bureau under the provincial communications department), set at municipal and county levels. Taxes were collected at the pump.

Tax Rate. Initially set at CNY1.1 per liter ($0.17 per liter) for gasoline and CNY300 per ton ($45.90 per ton) for diesel products. From 2006 to 2008, the rates were raised to CNY1.42 per liter ($0.22 per liter) for gasoline and CNY390 per ton ($59.70 per ton) for diesel products.

Fund Management. As of 2001, revenues were included in the provincial budget management system used for various purposes and subject to review and approval.

Use of Revenues. Revenues were used for road maintenance, construction, debt repayment, tax collection, and other nonroad purposes. The Fuel Tax Reform 23

The fuel tax pilot project had the following positive effects:

Increased funding. Direct funding from the fuel tax, along with associated borrowing, led to an immediate tenfold increase in annual funding available for road investment, largely due to leveraging the revenues. The annual average growth rate for fuel surcharge revenues was about 10%.

Leveraging. The Hainan Provincial Communications Department, as the major agency representing the provincial government, was able to successfully leverage fuel surcharge revenues to guarantee bank loans.

Enforcement and administration. A total of 563 people were employed to administer and collect the Hainan fuel surcharge collection. The resulting cost of collection and administration (i.e., collection cost as a percentage of revenues) was lower than the national average cost for road charge administration.

Improved system operations and efﬁciency. After tolls were annulled and toll collection stations were removed, road traffic conditions improved greatly, resulting in higher operating speeds, lower vehicle operation costs, and enhanced transport efficiency.

The province also faced challenges with the fuel tax pilot project:

Declining Purchasing Power. The fuel surcharge rate was not increased due to public opposition to higher fuel prices. Although initial implementation of the fuel surcharge supported increased road investment, much of this was due to leveraging the new funding source. While fuel tax revenues themselves had grown rapidly due to increased fuel consumption, these did not keep pace with the combination of growing investment needs and inflationary impacts.

Loopholes in the Process of the Fuel Surcharge Collection.12 The fuel surcharge was set at 60% of the gasoline retail price in 1994–2006, wherein a number of problems arose: (i) fluctuations in oil prices made the revenue stream unstable; (ii) fuel surcharge fraud and abuse problems occurred (e.g., some pumping stations sold low-quality gasoline as “super” gasoline to gain benefits off the surcharge); and (iii) fuel sales volumes in remote mountain areas were higher, creating geographic equity issues.

3.3.2 Fuel Taxation in Different Countries

While nearly every country imposes some form of motor fuel taxes, tax mechanisms, rates, uses, and other factors vary widely. The following section provides an overview of some of the key similarities and differences in the implementation and uses of fuel taxes in developed countries.

Purpose of Fuel Taxes. In some countries, including Japan, New Zealand, and the United States (US), fuel taxes are primarily viewed as a means of directly charging road users for their system use, and providing for a dedicated source of funding to support both national and provincial road and/or other

12 To address some of the challenges, changes were made in March 2006 to collect the surcharge based on volume (i.e., CNY1.42 per liter) with regular adjustment based on indexes. 24 Financing Road Construction and Maintenance after the Fuel Tax Reform transportation spending. In many other developed countries, particularly those in Europe, fuel taxes are viewed as a source of revenues for general purposes and are partially imposed as part of broader value added tax (VAT) schemes. Additionally, several countries, including France, Italy, Norway, and the United Kingdom (UK), view fuel taxes as a means both for recovering the full social, environmental, and economic cost of driving, and for promoting greater fuel efficiency, reducing travel demand, and avoiding increased dependence on foreign oil imports.

Tax Categories. Most countries that impose excise-type fuel taxes differentiate between types of fuels.13 Different rates are typically set for diesel, gasoline, and other specialty fuels, such as gasoline blends, biodiesel, liquefied natural gas (LNG), propane, and kerosene. In addition, aviation and marine fuels are sometimes taxed at different rates and/or accounted for and used differently from road- based fuel taxes. In the US, taxes on gasoline and/or gasohol, diesel and/or kerosene, aviation fuel, and specialty fuels are all charged at different rates. Similar categories are used in most developed countries.

Tax Rates. Fuel tax rates vary widely throughout the developed world in terms of both the amount charged and the structure. The US has some of the lowest tax fuel rates: the combined national and state gasoline and/or gasohol rate is 45.6 cents per gallon (CNY0.802 per liter), and the combined diesel per kerosene rate is 46.4 cents per gallon (CNY0.897 per liter).14 Fuel taxes in Europe typically include both excise taxes and VAT, and are some of the highest in the world. For example, Germany imposes a gasoline tax of CNY5.763 per liter ($0.88 per liter) and a diesel tax of CNY4.142 per liter ($0.63 per liter); with the added 19% VAT, total gasoline prices are currently approaching CNY13.0 per liter ($1.99 per liter). Japan is somewhere in between, with a gasoline excise tax of CNY5.633 per liter ($0.86 per liter).

Tax Collection Step. Most countries collect fuel taxes at the highest point possible in the distribution process, with the cost of taxes carried through the rest of the distribution chain to the ultimate consumer. This approach is administratively efficient and helps combat tax evasion. In the US, for example, taxes are collected at the “rack,” which is the point where bulk fuel is distributed to wholesalers. This is highly efficient since taxes are collected only from about 1,400 businesses. A similar approach is used in the UK, where taxes are collected at a point in the distribution chain where it becomes clear that fuel will be used for road transportation purposes.

Tax Exemptions and Discounts. Several countries provide fuel tax exemptions and/or discounts to address off-road fuel use, encourage the use of certain fuels, or for other public policy purposes. In countries including the Netherlands, Norway, Spain, the UK, and the US, taxes on fuels used for farming are either eliminated or significantly discounted; fuel dyes are used to help thwart tax evasion. Other examples include the provision of fuel tax refund for public transit agencies that has been repealed, lower tax rates on ethanol in the US, and a 40% tax discount on biodiesel in the UK.

13 With respect to motor fuels, excise taxes refer to levies imposed as a fixed fee per unit of volume. 14 State-level fuel tax rates vary; these figures are based on a weighted average state gas tax of 27.2 cents per gallon (CNY0.478 per liter) and diesel tax of 26.6 cents per gallon (CNY0.468 per liter); national level fuel taxes in the US are 18.4 cents per gallon (CNY0.324 per liter) for gasoline and 24.4 cents per gallon (CNY0.429 per liter) for diesel. The Fuel Tax Reform 25

Use and Management of Fuel Tax Revenues. The use of fuel tax revenues varies in different countries. In Japan, New Zealand, and the US, revenues are dedicated for road investment and/or other transportation-related purposes through the use of trust funds or similar accounting mechanisms. In the US, for example, national fuel taxes, as well as revenues from a series of truck-related user fees, are deposited in the Federal Highway Trust Fund and have a different budgetary treatment than general funds. About 14% of the fuel tax revenues are allocated to fund public transit programs, with most of the rest allocated to states to build and maintain the federal highway system. Fuel taxes collected at the US state level are also generally dedicated for road and transit purposes and often deposited in state-level trust funds. In many developed countries, however, fuel tax revenues are viewed as a source of general government resources, and there is no direct correlation between what is raised and what is spent on transportation.

3.4 Assessment of Fuel Tax Reform Implementation 3.4.1 Benefits from the Reform

The fuel tax reform initiative is still very new and the full extent of its benefits and weaknesses may not be known for several years. Nevertheless, the reform has achieved many of the goals it was established to address and has provided several important benefits:

More Equitable Tax Burden and Normalization of Fees. The establishment of a single consistent tax level for oil products has eliminated many of the tax evasion issues and greatly reduced region- to-region cost differences for transportation, improving the equity of the tax system for a more direct relationship between the amount one drives and the amount of road charges one pays.

Improved Tax Collection Efﬁciency. The new fuel tax is far more efficient and cost effective to administer than the six prior funding sources.

Enhanced Central Government Planning and Policy Inﬂuence. By shifting to central government control over the allocation of most funding for road maintenance and construction, the tax reform has given the MOT, MOF, and NDRC greater ability to influence the manner subordinate jurisdictions balance their investment between national and regional and/or local priorities.

Facilitating More Effective and Efﬁcient Fuel Consumption. The shift to a fuel tax has established a much more direct means to influence people’s decisions on travel and vehicle choice, and thus can directly support broader government policies and goals related to energy conservation and vehicle emission reduction. It can also encourage truckers and shippers to rethink factors such as mode choice, vehicle combinations, and fleet makeup/management. This, in turn, can put more pressure on the automobile industry to produce more efficient vehicles.

Rationalizing the PRC’s Toll Road Strategy to Match Current Circumstances. The reform helps the PRC target tolling activities on strategic roads that provide substantial levels of toll revenues (e.g., class II toll roads previously accounted for 60% of tolled length in kilometers, but raised only 12% of total toll revenues). It also helps address some of the concerns on the accumulation of local debt burdens from GLRTR initiatives and mitigates the impact of tolling on local residents. 26 Financing Road Construction and Maintenance after the Fuel Tax Reform

3.4.2 Reform Impacts 3.4.2.1 Consumer and Market Reactions Changes in Vehicle Operating Cost. The impacts of the fuel tax reform on passenger road user charges (against costs pre-reform) differ depending on vehicle fuel efficiency, amount of travel, nature of travel, and type of road facility used. In general, overall costs are estimated to be slightly higher for low-efficiency vehicles, and 5%–10% cheaper for high-efficiency vehicles. To illustrate, the cost impacts on three different types of vehicles are summarized in Table 6.

Table 6 Pre- and Post-Reform Road User Charges Average Annual Road User Charges Average Fuel Consumption Rate Pre-Reform Post-Reform Difference Type of Vehicle (liter per 100 km) CNY $ CNY $ CNY $ Economy car 5.8 6,862 1,051 6,238 955 –624 –96 (0.8 liter engine) Mid-class car 7.0 8,009 1,226 7,529 1,153 –280 –43 (1.6 liter engine) Low-efficiency car 11.5 12,308 1,885 12,368 1,894 68 10 (2.0 liter engine)

Assumptions: All vehicles travel 17,000 km per year; use gasoline 93#; gas price is CNY6.37 per liter ($0.98 per liter). Note: Pre-reform charges include RMFs and passenger and freight surcharges, while post-reform charges include only fuel taxes. Source: ADB consultants.

Before the fuel tax reform, the RMF was levied based on rated loading tonnage or number of passenger seats. After the reform, the fuel tax has become proportional to fuel consumption, thus the more kilometers a vehicle is driven, the more the tax payment. For commercially operated vehicles, the impact of the fuel tax reform is likely far more significant than for passenger cars. Since commercially operated vehicles tend to be driven more than passenger vehicles, one impact of the fuel tax reform is it essentially shifts some of the road funding burden from passenger car users to commercial vehicle operators.

Changes in Driver Behavior and Vehicle Choice. At present, there are no regular statistics or survey reports in the PRC on driver or traveler behavior. As a result, the impacts of the reform on factors such as average trip length, trip chaining, modal shifts, carpooling, and time of travel are unknown. In light of the temporary reduction in the VPT on high-efficiency vehicles, it is difficult to estimate the impact the reform has had on vehicle choice. However, it is anticipated that the fuel tax reform will create incentives to use alternative or more fuel-efficient vehicles. This demand, in turn, may encourage the automobile manufacturing industry to develop innovations to help achieve energy savings and emission reduction.

3.4.2.2 Fuel-Related Effects Fuel Consumption Impacts. At present, no comprehensive statistics on road sector fuel consumption are available in the PRC. While it may be possible to estimate changes in fuel demand as a result of the fuel tax reform through sampling of data from selected provinces and municipalities, it is important to The Fuel Tax Reform 27 note that developing accurate estimates will be complicated and challenging for a variety of reasons. In particular, the PRC’s economy and society are evolving rapidly; recent global economic trends have had unique impacts on both individual behavior and fuel prices; and the PRC is simultaneously making major investments in high-speed rail. Isolating the impact of these and other factors to determine the distinct effects of the fuel tax reform on fuel consumption will be difficult.

Changes in Fuel Prices. The impacts of the fuel tax reform on fuel prices have been negligible, largely due to other interim government policies that have heavily influenced retail motor fuel prices. Following implementation of the fuel tax reform, the NDRC issued a (trial) directive on oil price administration measures to improve oil pricing mechanisms in the PRC. Per the measures, it is the responsibility of enterprises to determine the raw price of oil and oil product pricing based on international market prices and guidance from the PRC government. As part of its directive, the NDRC established a ceiling on the retail sale of gasoline and diesel for each of the provinces, regions, and major cities. Oil product retail sellers have flexibility to determine the retail price for gasoline and diesel, but prices cannot be set above the applicable price ceiling.15 Since the implementation of the fuel tax reform, the NDRC has made nine adjustments to the maximum retail sales price for gasoline and diesel, including 6 upward adjustments and 3 downward adjustments. The maximum retail price has been increased by CNY1.76 per liter ($0.27 per liter) for gasoline and CNY1.63 per liter ($0.25 per liter) for diesel (Table 7).

Table 7 National Development and Reform Commission Fuel Price Adjustments Maximum Retail Price Increase Average Gasoline Increase Average Diesel Increase Date per Ton per Liter per Liter CNY $ CNY $ CNY $ December 2010 +310 (gasoline) +47.5 +0.23 +0.04 +0.26 +0.04 +300 (diesel) +45.9 October 2010 +230 (gasoline) +35.2 +0.17 +0.03 +0.19 +0.03 +220 (diesel) +33.7 June 2010 –230 (gasoline) –35.2 –0.17 –0.03 –0.19 –0.03 –220 (diesel) –33.7 April 2010 +320 +49.0 +0.24 –0.04 +0.28 +0.04 November 2009 +480 +73.5 +0.35 +0.05 +0.41 +0.06 September 2009 –190 –29.1 –0.14 +0.02 –0.27 –0.04 September 2009 +300 +45.9 +0.23 +0.04 +0.25 +0.04 July 2009 –220 –33.7 –0.17 +0.03 –0.19 –0.03 June 2009 +600 +91.9 +0.44 +0.07 +0.52 +0.08 June 2009 +400 +61.2 +0.30 +0.05 +0.35 +0.05 March 2009 +290 (gasoline) +44.4 +0.21 +0.02 +0.16 +0.02 +180 (diesel) +27.6 January 2009 –140 (gasoline) –21.4 –0.10 –0.01 –0.14 –0.02 –160 (diesel) –24.5

Source: ADB consultants.

15 The NDRC policy is seen as an important step toward full-market-based pricing of oil products. As the PRC transitions to more open-market pricing of motor fuels, the impacts of the fuel tax reform on fuel pricing may become more significant. 28 Financing Road Construction and Maintenance after the Fuel Tax Reform

3.4.3 Impacts on Ordinary Road Development

Insufﬁcient Funding. Before the fuel tax reform, aggregate revenues from RMFs had been growing at an average annual rate of about 13%–15%. Fuel tax revenues, however, are expected to grow at an annual rate of only 7% between 2011 and 2015. As a result of these different growth rates, total fuel tax revenues are expected to fall short of the estimated RMF revenues by an annual average of CNY25 billion ($3.8 billion) over the next 5 years. Also, the abolishment of tolls on class II roads has removed an important source of maintenance funding for many jurisdictions and exacerbated provincial and/or local funding gaps.

Loss of Borrowing Capacity. Before the fuel tax reform abolished RMFs, local governments used passenger and freight surcharges as a source of funding for meeting the capital fund requirements to initiate road construction projects. The revenue from passenger and freight surcharges accounted for about 30% of the capital funds for road construction projects. The funds provided local governments with a means to guarantee bank loans and service the associated debt. Since the removal of the RMFs, and in light of the current budget law prohibiting the use of central government fuel tax allocations to secure bank loans, local governments have lost most of their capacity to deliver new projects through debt financing.

Lack of Prompt and Effective Financial Transfers. As part of fuel tax reform administration, funding is now allocated to provinces and local governments through financial transfers from the central government. Provincial and local officials are concerned their new reliance on central government transfers will create cash flow issues that limit their abilities to meet seasonal fluctuations in work demand and respond to emergency events arising from natural disasters or accidents and/or incidents.

Trafﬁc Diversion from Toll Roads. Following the implementation of the fuel tax reform, gradual abolishment of tolls on class II roads has resulted in significant but varying levels of traffic diversion from tolled expressways and class I roads to now non-tolled class II roads. Based on a survey organized by the MOT’s Highway Department, over 20%–30% of expressway and class I road traffic has diverted to class II roads, with selected road sections seeing diversion rates as high as 50%. Statistics available from Henan Province confirm these findings, showing average diversion rates of 22%–25%, and diversion rates of as high as 80% for some sections of the national road system. Of more concern, much of the diverted traffic involves trucks, causing fast deterioration of class II roads.16

Repayment of Debt from Class II Road Construction. At present, insufficient information is available on the total amount of outstanding bank loans associated with all class II toll roads. Under the fuel tax reform provisions, local jurisdictions shall submit to designated provincial authorities information on the status of their outstanding debt for review and audit before it is reported to the MOF. The process of collecting and validating the information at the provincial level, however, is time consuming; several provincial governments do not have the staff resources and/or have not received from local agencies the information on their debt situations needed for them to develop full estimates and report to the central government.

16 Based on anecdotal comments from provincial and local road officials surveyed as part of research for this project. The Fuel Tax Reform 29

Considerable differences exist in each of the provinces on the level of outstanding debt associated with class II toll roads. Table 8 provides details collected from selected provinces on outstanding loans for abolished class II toll roads.

Table 8 Examples of Provincial Debt Levels Outstanding Class II Toll Road Debt Province CNY (billion) $ (billion) Shandong 15.36 2.350 Henan 50.00 7.700 Hainan 3.00 0.459 Shaanxi 22.00 3.400

Source: ADB consultants. Future Revenues 4 and Needs

4.1 Road Development Strategy and Targets in the People’s Republic of China

Since the 1980s, the PRC has established a number of national highway development programs based on assessments of broad national economic and social development goals. Major plans were established in conjunction with the development of the Tenth Five-Year Plan, including the National Trunk Road Skeleton System Development Plan, the National Expressway Network Plan, and the Rural Road Development Program.

In light of the current status of plan development initiatives, the estimates for ordinary road spending needs provided in this section are based on the existing development plan made in the Tenth Five-Year Plan period, with adjustments based on relevant studies and deliberations associated with Twelfth Five-Year Plan development. Based on these inputs, it is estimated that the long-term target for total road system length in the PRC, including expressways, ordinary trunk roads, and rural roads, is about 5 million km (currently 3.79 million km),17 of which 4.85 million km are ordinary trunk roads and rural roads (currently 3.73 million km). Subtargets for system elements are provided in Table 9.

Table 9 Long-Term System Road Length Targets vs. Current Road Lengths (km ‘000) Total System Ordinary Road Networks Road Category New Target Current New Target Current National 300 159 200 105 Provincial 500 266 450 255 Rural 4,200 3,369 4,200 3,369 Total 5,000 3,793 4,850 3,729

Source: ADB consultants.

30 17 Excludes accommodation roads. Future Revenues and Needs 31

4.2 Ordinary Road Construction and Maintenance Demand

The long-term road system development targets identified above provide a good basis for determining the PRC’s intermediate-term or 10-year construction and maintenance spending needs. To provide estimates of the potential range of road spending requirements the PRC will face between now and 2020, the following section considers two investment scenarios: t Unconstrained Needs Scenario. Assumes the central government’s proactive policies will be significantly expanded in the coming years to accelerate road system improvements. This includes major investment in ordinary national and provincial road construction and upgrades and/or reconstruction to achieve 100% of long-term national, provincial, and rural road development targets by 2020. t Baseline Growth Scenario. Assumes the central government will undertake policies to gradually improve the ordinary road system to meet the demand for expressway development and increase investment in ordinary road construction and maintenance at a level similar to that of investment required to meet prior development targets made in the Tenth Five- Year period.18 This includes a more modest investment strategy, or increased emphasis on expressway development, to achieve 55% of long-term national development targets, 100% of provincial road targets, and 88% of rural road targets.19 This will equate with a road system in 2020 of about 4.45 million km, including 4.30 million km of ordinary roads. Subtargets for specific system elements are provided in Table 10.

Table 10 Long-Term System Road Length Targets vs. Current Road Lengths under the Baseline Growth Scenario (km ‘000) Total System Ordinary Road Networks Road Category New Target Current New Target Current National 200 159 110 105 Provincial 500 266 450 255 Rural 3,700 3,369 3,700 3,369 Total 4,450 3,793 4,310 3,729

Source: ADB Consultants

4.2.1 Ordinary Road Construction Demand

Ordinary National Road Construction Demand. It is expected that after the new round of road development planning, the new target for ordinary national road length will be 200,000 km. To achieve this target by 2020 (i.e., under unconstrained needs scenario), a total of 95,000 km of ordinary

18 Road development targets for both the tenth and eleventh five-year plans were based on the same long-term system development targets. 19 Based on the National Trunk Road Skeleton System Development Plan, the National Expressway Network Plan, and the Rural Road Development Program made in the Tenth Five-Year Plan. 32 Financing Road Construction and Maintenance after the Fuel Tax Reform national roads will have to be built or reconstructed and/or upgraded in the next 10 years.20 Under the baseline growth scenario, such expansion will be decreased to 55% of the long-term target, thus only 5,000 km of roads will need to be added.

Ordinary Provincial Road Construction Demand. Based on PRC development objectives and associated policies, future provincial road investment will mainly focus on ordinary road system development, along with some expressway construction in areas with high traffic growth. To achieve the full target for provincial ordinary road system development by 2020, the PRC will need to build or reconstruct and/or upgrade 234,000 km of ordinary roads. Because ordinary road system expansion is high priority, the target is the same for both scenarios.

Rural Road Construction Demand. By the end of 2009, the total length of the rural road system reached 3,369,100 km, significantly exceeding the 2010 target set in the Rural Road Development Plan. Nonetheless, to achieve the new development target, the PRC will need to build an additional 831,000 km of rural roads and address significant reconstruct and/or upgrade needs. Under the baseline growth scenario, it is anticipated that the PRC will still strive to achieve almost 90% of its rural road system targets and add 331,000 km.

Ordinary road construction demand under the unconstrained needs scenario and the baseline growth scenario is summarized in Table 11.

Table 11 Scale of Annual New Road Construction and Upgrades and/or Reconstruction, 2010–2020 (km ‘000) Unconstrained Needs Scenario Baseline Growth Scenario Upgrade and/or Upgrade and/or Ordinary Road Networks New Construction Reconstruction New Construction Reconstruction National Class I 0.727 2.727 0.182 1.227 Class II 1.091 6.364 0.273 2.864 Provincial Class I 2.727 2.727 2.182 2.182 Class II 6.364 10.909 5.091 8.727 Rural Class I 0.455 0.455 0.227 0.227 Class II 2.273 1.364 1.136 0.682 Class III 4.545 4.364 2.272 2.000 Class IV 68.182 27.455 26.364 21.636 Source: ADB consultants.

20 By the end of 2009, a total of 25,000 km of ordinary national roads in the PRC were classified class III and below. According to the latest Road Development Program, these facilities will all need to be upgraded to class II and above. Future Revenues and Needs 33

Table 12 Maintenance Road Length Share, 2010–2020 National Road Provincial Road County Road Township Road Village Road Year (%) (%) (%) (%) (%) 2009 99.73 99.44 99.40 98.65 91.79 2010 100 100 100 99 94 2015 100 100 100 100 98 2020 100 100 100 100 100

Source: ADB consultants.

4.2.2 Ordinary Road Maintenance Demand

The length of road requiring maintenance has increased along with expansion of the road network.21 The maintenance burden will continue to grow as additional roads are constructed. According to MOT data, overall maintenance length in 2009 was slightly less than 3.7 million km, accounting for 95.5% of the total road system.22 As shown in Table 12, most nonmaintenance road length is located in the village road system, and it is assumed that by 2020 all roads will be considered for maintenance.

Tables 13 and 14 identify the annual estimated maintenance length for each level of the road network between 2010 and 2020. These estimates are based on the anticipated road development targets for each of the road classification categories under the unconstrained needs and baseline growth scenarios.

Table 13 Maintenance Length of Each Classiﬁed Road by Category under Unconstrained Needs Scenario, 2010–2020 (km ‘000) Year National Road Provincial Road County Road Township Road Village Road 2009 105 255 519 1,020 1,830 2010 106 270 540 1,060 1,900 2011 115 288 556 1,084 1,930 2012 125 306 572 1,108 1,960 2013 134 324 588 1,132 1,990 2014 144 342 604 1,156 2,020 2015 153 360 620 1,180 2,050 2016 162 378 636 1,204 2,080 2017 172 396 652 1,228 2,110 2018 181 414 668 1,252 2,140 2019 191 432 684 1,276 2,170 2020 200 450 700 1,300 2,200

Source: ADB consultants.

21 Maintenance kilometerage is the number of kilometers of road maintained; not all roads are maintained due to lack of maintenance funding. 22 This figure is based on a total system of 3.86 million km. The figure in Table 9 (3.793 million km) does not include substandard roads. 34 Financing Road Construction and Maintenance after the Fuel Tax Reform

Table 14 Maintenance Length of Each Classiﬁed Road by Category under Baseline Growth Scenario, 2010–2020 (km ‘000) Year National Road Provincial Road County Road Township Road Village Road 2009 105 255 519 1,020 1,830 2010 106 270 540 1,060 1,900 2011 106 293 546 1,064 1,910 2012 107 316 552 1,068 1,920 2013 107 339 558 1,072 1,930 2014 108 362 564 1,076 1,940 2015 108 385 570 1,080 1,950 2016 108 408 576 1,084 1,960 2017 109 431 582 1,088 1,970 2018 109 454 588 1,092 1,980 2019 110 477 594 1,096 1,990 2020 110 500 600 1,100 2,000 Source: ADB consultants.

4.3 Road Construction and Maintenance Funding Demand 4.3.1 Road Construction Funding Demand

Estimates of road construction financing demand under unconstrained needs and baseline growth scenarios were made based on the aforesaid ordinary national and provincial trunk road and rural road development targets, using average national unit costs for each of the classified roads. The results, along with key underlying assumptions, are provided in Table 15.

As identified in Table 15, the PRC’s total ordinary road construction costs from 2010 to 2020 are estimated to total CNY6.23 trillion (annual average of CNY566 billion) under the unconstrained needs scenario, and CNY3.82 trillion (annual average of CNY346.9 billion) under the baseline growth scenario.

4.3.2 Road Maintenance Funding Needs

The estimation of road maintenance funding needs takes into account the costs of all activities closely associated with road maintenance work, including maintenance engineering and road maintenance management system development costs. Road maintenance engineering activities include minor repairs, intermediate maintenance, major maintenance, and other engineering work, such as dangerous bridge reconstruction, safety engineering, natural disaster prevention and control, greening engineering, road signs, and markings. The maintenance management system development costs mainly include administration, road patrol, maintenance machinery and spare parts, materials storage facility construction, maintenance research and development, personnel Future Revenues and Needs 35

Table 15 Estimated Ordinary Road Construction Funding Needs, 2010–2020 (CNY billion)

Unconstrained Needs Scenario National Road Provincial Road Rural Road Reconstruction Reconstruction Reconstruction and/or and/or and/or Year New Upgrade Subtotal New Upgrade Subtotal New Upgrade Subtotal Total 2010 24.4 70.9 95.3 111.8 98.2 210.0 103.6 29.5 133.1 438.4 2011 25.6 74.5 100.0 117.4 103.1 220.5 108.8 30.9 139.7 460.3 2012 26.9 78.2 105.0 123.3 108.2 231.5 114.3 32.5 146.7 483.3 2013 28.2 82.1 110.3 129.4 113.7 243.1 120.0 34.1 154.1 507.5 2014 29.6 86.2 115.8 135.9 119.3 255.3 126.0 35.8 161.8 532.8 2015 31.1 90.5 121.6 142.7 125.3 268.0 132.3 37.6 169.9 559.5 2016 32.6 95.0 127.7 149.8 131.6 281.4 138.9 39.5 178.4 587.4 2017 34.3 99.8 134.1 157.3 138.2 295.5 145.8 41.4 187.3 616.8 2018 36.0 104.8 140.8 165.2 145.1 310.3 153.1 43.5 196.6 647.7 2019 37.8 110.0 147.8 173.5 152.3 325.8 160.8 45.7 206.5 680.0 2020 39.7 115.5 155.2 182.1 159.9 342.1 168.8 48.0 216.8 714.0 Total 346.1 1,007.4 1,353.5 1,588.6 1,394.8 2,983.4 1,472.3 418.5 1,890.8 6,227.7 Baseline Growth Scenario National Road Provincial Road Rural Road Reconstruction Reconstruction Reconstruction and/or and/or and/or Year New Upgrade Subtotal New Upgrade Subtotal New Upgrade Subtotal Total 2010 6.1 31.9 38.0 89.5 78.5 168.0 44.1 18.5 62.6 268.6 2011 6.4 33.5 39.9 93.9 82.5 176.4 46.3 19.4 65.7 282.0 2012 6.7 35.2 41.9 98.6 86.6 185.2 48.6 20.4 69.0 296.1 2013 7.1 36.9 44.0 103.6 90.9 194.5 51.0 21.4 72.5 310.9 2014 7.4 38.8 46.2 108.7 95.5 204.2 53.6 22.5 76.1 326.5 2015 7.8 40.7 48.5 114.2 100.2 214.4 56.3 23.6 79.9 342.8 2016 8.2 42.8 50.9 119.9 105.3 225.1 59.1 24.8 83.9 359.9 2017 8.6 42.8 53.5 125.9 110.5 236.4 62.0 26.0 88.1 377.9 2018 8.6 44.9 56.1 132.2 116.0 248.2 65.1 27.3 92.5 396.8 2019 9.4 49.5 59.0 138.8 121.8 260.6 68.4 28.7 97.1 416.7 2020 9.9 52.0 61.9 145.7 127.9 273.7 71.8 30.1 102.0 437.5 Total 86.5 453.3 539.9 1,270.9 1,115.9 2,386.7 626.4 262.8 889.2 3,815.8

Assumptions (a) Annual average inﬂation rate is 5%. (b) Assuming a unit cost per km for newly built road in 2010 is CNY20 million ($3.07 million) for class I road and CNY9 million ($1.4 million) for class II road; a unit cost for reconstructed road of CNY12 million ($1.8 million) for class I road and CNY6 million ($0.9 million) for class II road. The unit cost for newly built rural road is CNY18 million ($2.8 million) for class I road, CNY8 million ($1.2 million) for class II road, CNY2 million ($0.31 million) for class III road, and CNY1 million ($0.15 million) for class IV road; that for reconstructed road is CNY10 million ($1.5 million) for class I, CNY5 million ($0.75 million) for class II, CNY1 million ($0.15 million) for class III, and CNY0.5 million ($0.08 million) for, class IV road. (c) The details of newly built and reconstructed national, provincial, and rural roads and their lengths in annual average under the unconstrained needs and baseline growth scenarios are shown in Table 11. (d) Estimated costs for road construction and maintenance are national averages that take into account and weigh regional differences in economic development and program delivery costs. 36 Financing Road Construction and Maintenance after the Fuel Tax Reform training and education, road condition and traffic surveys, maintenance workshop and/or office and accommodation facilities, staff pensions, and labor insurance. Estimates of maintenance spending needs were developed based on 2009 unit cost data; the maintenance length in kilometers; estimates discussed above; the maintenance quota for major, intermediate, and minor23 maintenance length in kilometers; and the maintenance quota. Table 16 provides the estimated maintenance unit costs for these three maintenance engineering work components.24 According to findings from the field survey, the percentage share of ordinary national and provincial roads’ other engineering costs account for about 10% of total minor, intermediate, and major maintenance costs. Other engineering costs for rural roads account for 5% of total minor, intermediate, and major rural road maintenance costs. The results of the estimation, along with key underlying assumptions, are shown in Tables 17 and 18.

Table 16 Average Cost of Ordinary Maintenance Engineering Work, 2009 (CNY per km)

Road Category Minor Repair Intermediate Repair Major Repair National 30,000 500,000 1,500,000 Provincial 25,000 400,000 1,000,000 County 15,000 200,000 600,000 Township 10,000 150,000 400,000 Village 6,000 50,000 100,000

Source: ADB consultants.

4.4 Revenue Estimates Requirements

As a result of the fuel tax reform, there are now three primary sources of funding for ordinary road construction and maintenance: (i) fuel tax receipts, (ii) VPT revenues, and (iii) government budget allocations. As identified in Table 19, total funding from these sources for ordinary roads is expected to grow at an annual average rate of 9.6% and provide a total funding of CNY3.95 trillion ($604 billion) from 2010 to 2020, an average of CNY359 billion ($54.98 billion) annually. The following section provides a detailed description of the estimates for each of the three funding sources.

4.4.1 Fuel Tax Revenue Estimates

Based on MOF data, total fuel tax revenue in 2009 was CNY165.3 billion ($25.3 billion). However, since detailed statistics on the consumption of specific oil products are not available, revenue estimates are based on the correlation between overall oil products consumption growth and the growth of GDP.

23 Minor maintenance refers to routine maintenance and remedy repair work to pavement and related facilities along the road. 24 The estimation of average minor, intermediate, and major maintenance costs for ordinary national, provincial, and rural roads in 2010 is based on the costs in 2009 combined with 5% growth of consumer price index. Future Revenues and Needs 37 Total System Managing Development Other Costs Engineering Major Repair Subtotal Minor Repair Intermediate Major Repair Subtotal Maintenance Engineering Work Maintenance Engineering 2010–2030 (CNY billion) Minor Repair Intermediate Major Repair Subtotal National Road Road Provincial Road Rural 70.5 94.0 176.3 340.8 137.5 176.0 275.0 588.6 503.0 231.1 397.8 1131.9 149.5 478.8 2689.5 Minor Repair Intermediate Table 17 Table under Unconstrained Needs Scenario, Estimated Costs for Ordinary Maintenance Engineering Work the total county road maintenance mileage. Township road intermediate and major maintenance mileage percentage shares are 4% and 2%, respectively, of the total township road maintenance mileage. Village road of the total township road maintenance mileage. respectively, road intermediate and major maintenance mileage percentage shares are 4% 2%, Township the total county road maintenance mileage. of the total village road maintenance mileage. respectively, intermediate and major maintenance mileage percentage shares are 2% 1%, (a) Annual average inﬂation rate is 5%. (b) respectively. and 100%, 8%, total maintenance mileage) is 5%, and minor maintenance mileage for national provincial roads (as a percent of each system’s intermediate, Major, (c) and major maintenance costs for national provincial roads; 5% rural roads. intermediate, Other engineering costs are equal to 10% of combined minor, (d) of respectively, County road intermedia te and major maintenance mileage percentage shares are 5% 4%, total maintenance mileage) is 100%. Minor maintenance for rural roads (as a percent of each system’s Total 2020 10.3 13.7 25.7 49.6 19.2 24.6 38.5 82.4 62.8 29.1 50.3 142.1 20.3 54.9 349.3 2019 9.3 12.4 23.3 45.0 17.6 22.5 35.2 75.3 58.7 27.1 46.9 132.8 18.7 52.3 324.0 2018 8.4 11.2 21.1 40.8 16.1 20.6 32.1 68.7 54.9 25.3 43.7 124.0 17.1 49.8 300.4 2017 7.6 10.2 19.0 36.8 14.6 18.7 29.3 62.6 51.3 23.6 40.8 115.7 15.7 47.4 278.2 2016 6.9 9.1 17.1 33.1 13.3 17.0 26.6 56.9 47.9 22.0 38.0 107.9 14.4 45.2 257.5 2015 6.2 82.0 15.4 29.7 12.1 15.4 24.1 51.6 44.8 20.5 35.3 100.6 13.2 43.0 238.2 2014 5.5 7.3 13.7 26.6 10.9 14.0 21.8 46.7 41.8 19.1 32.9 93.8 12.0 41.0 220.1 2013 4.9 6.5 12.2 23.7 9.8 12.6 19.7 42.1 39.0 17.8 30.6 87.4 10.9 39.0 203.1 2012 4.3 5.8 10.8 20.9 8.9 11.3 17.7 37.9 36.4 16.6 28.4 81.4 10.0 37.2 187.3 2011 3.8 5.1 9.5 18.4 7.9 10.2 15.9 34.0 33.9 15.4 26.4 75.7 9.0 35.4 172.6 Year 2010 3.3 4.5 8.3 16.1 7.1 9.1 14.2 30.3 31.6 14.3 24.5 70.5 8.2 33.7 158.8 Source: ADB consultants. ADB Source: Assumptions: 38 Financing Road Construction and Maintenance after the Fuel Tax Reform System Managing Development Total Other Costs Engineering Major Repair Subtotal d 2%, respectively, of the total township road maintenance mileage. Village road of the total township road maintenance mileage. respectively, d 2%, Rural Road Rural Minor Repair Intermediate Major Repair Subtotal 2010–2020 (CNY billion) Provincial Road Provincial Maintenance Engineering Work Maintenance Engineering Minor Repair Intermediate Major Repair Subtotal National Road Table 18 Table under Baseline Growth Scenario, Estimated Costs for Ordinary Maintenance Engineering Work 48.4 64.6 121.0 234.0 147.7 189.1 295.5 632.3 464.6 211.5 363.4 1,039.4 138.6 478.8 2,523.1 Minor Repair Intermediate the total county road maintenance mileage. Township road intermediate and major maintenance mileage percentage shares are 4% an Township the total county road maintenance mileage. intermediate and major maintenance mileage percentage shares are 2% and 1%, respectively, of the total village road maintenance mileage. respectively, intermediate and major maintenance mileage percentage shares are 2% 1%, (a) Annual average inﬂation rate is 5%. (b) respectively. and 100%, 8%, total maintenance mileage) is 5%, and minor maintenance mileage for national provincial roads (as a percent of each system’s intermediate, Major, (c) and major maintenance costs for national provincial roads; 5% rural road. intermediate, Other engineering costs are equal to 10% of combined minor, (d) of respectively, County road intermediate and major maintenance mileage percentage shares are 5% 4%, total maintenance mileage) is 100%. Minor maintenance for rural roads (as a percent of each system’s Year 20102011 3.32012 3.5 4.52013 3.7 4.72014 3.9 4.92015 4.1 8.3 5.22016 4.3 8.8 16.1 5.52017 4.6 9.3 17.0 5.82018 4.8 7.1 9.8 17.9 6.12019 10.3 5.1 8.1 18.9 6.4 9.12020 10.9 5.4 9.1 19.9 10.3 10.3 6.8Total 11.4 5.6 21.0 11.6 11.7 14.2 7.1 12.1 22.1 13.2 12.9 16.2 7.5 30.3 12.7 14.8 23.3 14.4 18.3 34.6 13.4 16.5 24.6 31.6 20.6 15.9 39.1 33.4 23.1 14.1 18.4 25.9 44.1 17.6 14.3 35.3 25.8 49.4 20.4 27.3 15.2 19.4 37.3 28.7 55.2 22.5 39.4 16.0 21.4 24.5 31.8 61.4 24.9 16.9 41.6 25.9 17.9 35.2 68.1 70.5 27.4 44.0 27.4 74.5 18.9 38.8 75.4 29.0 46.4 78.8 30.7 20.0 42.8 8.2 83.1 49.1 83.3 8.9 32.5 21.2 91.5 88.0 51.8 9.6 34.4 22.4 10.5 93.1 54.7 33.7 11.3 36.4 23.6 98.4 35.4 12.3 38.5 104.0 25.0 37.2 39.0 158.8 13.3 40.7 109.9 41.0 170.3 14.3 43.1 116.2 43.0 182.6 15.5 195.7 122.8 45.2 209.7 16.7 47.4 224.5 18.0 49.8 240.4 52.3 257.2 54.9 275.1 294.2 314.5 Assumptions: Source: ADB consultants. ADB Source: Future Revenues and Needs 39

Table 19 Central Government Revenues for Ordinary Roads, 2010–2020 (CNY billion)a

Year Fuel Tax VPT Others Total 2010 123.8 87.2 28.0 239.0 2011 132.5 101.0 29.4 262.9 2012 141.8 111.1 30.9 283.8 2013 151.7 122.2 32.4 306.3 2014 162.3 134.4 34.0 330.7 2015 173.7 147.9 35.7 357.3 2016 183.4 159.7 37.5 380.6 2017 193.6 172.4 39.4 405.4 2018 204.5 186.2 41.4 432.1 2019 216.0 201.2 43.4 460.6 2020 228.1 217.2 45.6 490.9 Total 1,911.4 1,640.5 397.8 3,949.7

a The analysis of revenues was developed in the midst of both the global economic crisis and shifting government policies on VPT rates, and thus has a high margin for error. Information made available as this report was going to press suggests that actual VPT and fuel tax revenues may be growing at a signiﬁcantly higher rate. These estimates will be revisited and, if necessary, revised as part of the Phase II study. Source: ADB consultants.

Over the last decade, oil product consumption in the PRC has risen rapidly. As reflected in Figure 11, the compound annual growth rate for consumption of all fuels for 2000–2007 was 6.9%. Over the same period, the PRC’s GDP increased at a compound annual growth rate of 10.2%, thus oil product consumption grew at 70% of the GDP growth rate. Based on projections that the PRC’s GDP will grow at average annual rates of 10% from 2010 to 2015 and 8% from 2016 to 2020, fuel consumption is thus expected to grow at 7% annually in the short term and 5.6% in the medium term.25

Based on the methodology described above and the actual revenue data from 2009, gross fuel tax revenue over 2010–2020 is expected to total CNY2.73 trillion ($418 billion) and average CNY248 billion ($37.9 billion) annually. Not all of the gross revenues from motor fuel taxes, however, will be available to replace RMF revenues and support ordinary road investment. It is expected about 30% of these annual fuel tax revenues will be used to support waterway transport development and other activities. Net revenues available for ordinary road investment will therefore total CNY1.9 trillion ($292 billion) from 2010 to 2020, or an annual average of CNY174 billion ($26.6 billion). Yearly details of these estimates are provided in Table 20.

4.4.2 Vehicle Purchase Tax Revenue Estimates

The estimates of VPT revenues are based on forecasts of both vehicle sales volumes and average VPT revenue per vehicle, as shown in Table 20. From 2000 to 2009, vehicle sales in the PRC have

25 The forecast was developed by calculating the ratio of the PRC’s compound annual growth. 40 Financing Road Construction and Maintenance after the Fuel Tax Reform

Figure 11 Oil Product Consumption Trends, 2000–2007a

25,000

20,000 Gasoline 15,000 Diesel Kerosene 10,000 Fuel Oil Total 5,000

0 2000 2001 2002 2003 2004 2005 2006 2007

a The forecast was developed by calculating the ratio of the PRC’s compound annual growth rate for fuel consumption to the PRC’s GDP compound annual growth rate for 2000–2007, multiplying this ratio by projected future PRC GDP growth rates. Sources: 1. Data for 2000–2006: China Energy Statistical Yearbook 2007, China Statistics Press. 2. Data for 2007: China Statistical Yearbook 2009, China Statistics Press.

grown at an annual average rate of 23.2%, resulting in a high rate of growth for total VPT revenues; and average VPT revenues have grown an annual average rate of 20.6%.

It is anticipated that VPT revenue growth will be more modest than in recent history: (i) it is expected that growth in annual vehicle sales volume will slow to a level more consistent with the PRC’s GDP growth, thus an annual growth rate of 10% is assumed for 2010–2015 with 8% in later years; and (ii) it is important to note that the average VPT revenue per vehicle has been somewhat erratic over the last decade, going from a high of CNY11,300 ($1,730) per vehicle sold in 2002 to a low of CNY8,500 ($1,301) in 2009 due to changing economic conditions and changes in government tax policies.26

Table 20 Estimated Fuel Tax Revenues, 2010–2020 (CNY billion) Year 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Gross revenue 176.9 189.3 202.5 216.7 2,31.8 248.1 262.0 276.6 292.1 308.5 325.8 Other uses 53.1 56.8 60.8 65.0 69.5 74.4 78.6 83.0 87.6 92.6 97.7 Net revenue 123.8 132.5 141.8 151.7 162.3 173.7 183.4 193.6 204.5 216.0 228.1

Source: ADB consultants.

26 To promote the development of automobile industry and vehicle emission reduction, and to support the economic stimulus package, the VPT rate was reduced from 10% to 5% for passenger cars with displacement of 1.6 liter or less at the beginning of 2009. The rate was adjusted to 7.5% at the beginning of 2010, and returned to 10% at the start of 2011. Future Revenues and Needs 41

Table 21 Vehicle Purchase Tax (Fee) Revenue over 2000–2009

Sales Volume VPT Revenue Revenue CNY ’000 Year ’000s Growth (%) CNY billion Growth (%) per Vehicle 2000 2,091 13.9 21.6 20.1 10.3 2001 2,363 13.0 25.5 18.1 10.8 2002 3,225 36.5 36.4 42.5 11.3 2003 4,397 36.3 47.5 30.6 10.8 2004 5,068 15.3 53.5 12.6 10.6 2005 5,778 14.0 58.2 8.9 10.1 2006 7,221 25.0 68.7 18.1 9.5 2007 8,791 21.7 87.7 27.6 10.0 2008 9,381 6.7 98.9 12.7 10.5 2009 13,645 45.5 116.4 17.7 8.5

Sources: 1. Sales volume data are from China Automobile Industry Yearbook 2009. 2. VPT revenue 2000–2009 data are from www.mof.gov.cn

With the expiry of the government incentive program, it is expected that average VPT revenues per vehicle will return to the previous level of CNY10,000 ($1,531).

Historically, about 90% of VPT revenues, including VPT revenues allocated directly from the central government to local governments for road use, have been used for road construction.27 Of the remaining 90%, about 40% is allocated to support expressway initiatives, thus only about 54% of gross VPT revenues are available for expenditure on ordinary roads. Assuming these percentage shares remain constant in the future, the total VPT revenues available for ordinary road improvements between 2010 and 2020 will be CNY1.64 trillion ($251 billion), or an average of CNY149 billion ($22.8 billion) per year. Table 22 provides yearly estimates of VPT revenues for ordinary roads.

4.4.3 Other Funding Sources

The government budget is also an important source of funding for ordinary road construction (Table 23). Specific sources include the central government budget, state bond revenues, local government budgets, and state bond debt transferred to local governments.

Statistics show that the central government’s direct budgetary investment in road construction decreased from CNY20.3 billion ($3.1 billion) in 2002 to CNY8.0 billion ($1.2 billion) in 2007 (Figure 12). In 2008, however, in response to the global financial crisis, a proactive financial policy was adopted by the central government, which resulted in significantly increased government budget resources allocated to road construction.

27 About 10% of VPT revenues are used to support other activities, such as water resource development fund, vehicle replacement and upgrades, etc. 42 Financing Road Construction and Maintenance after the Fuel Tax Reform

Table 22 Estimated Vehicle Purchase Tax Revenue, 2010–2020 VPT Revenues Available for Vehicle Sales VPT Revenue per Vehicle VPT Revenue Ordinary Road Construction Year (’000) (CNY ’000) (CNY billion) (CNY billion) 2010 17,000 9.5 161.5 87.2 2011 18,700 10 187.0 101.0 2012 20,570 10 205.7 111.1 2013 22,630 10 226.3 122.2 2014 24,890 10 248.9 134.4 2015 27,380 10 273.8 147.9 2016 29,570 10 295.7 159.7 2017 31,930 10 319.3 172.4 2018 34,490 10 344.9 186.2 2019 37,250 10 372.5 201.2 2020 40,230 10 402.3 217.2

Source: China Automobile Industry Yearbook. Beijing.

Table 23 Road Construction Financing from Central Government Budget and Other Sources, 2002–2009 Total Road Spending Spending from Other Funding Sources Share of Total Road Spending Year (CNY billion) (CNY billion) (%) 2002 299.7 20.4 6.8 2003 344.4 13.1 3.8 2004 439.0 13.6 3.1 2005 488.1 11.7 2.4 2006 548.2 8.2 1.5 2007 574.5 8.0 1.4 2008 639.8 16.0 2.5 2009 876.8 35.1 4.0

Source: Highway and Waterway Transport Development Statistics Bulletin 2002–2009, MOT.

It is assumed that as the financial capacity of the central and local governments expands, the direct budgetary investment in road construction can reach CNY40 billion ($6.1 billion) in 2010, and will keep growing at an annual average rate of 5% through 2020. Assuming that 70% of this funding will be used for ordinary road construction (the remaining 30% of which will be used for expressway investment and other activities), a total of CNY398 billion ($60.9 billion) will be available for ordinary road construction from government budget sources over 2010–2020, or an annual average of CNY36.2 billion ($5.5 billion).28

28 Per historical data on annual budgetary investment and the infrastructure investment trend in the PRC. Future Revenues and Needs 43

Figure 12 Government Budget Spending for Road Construction 400

350

300

250

200

150 Road Expenditure (CNY billion) 100

0 2002 2003 2004 2005 2006 2007 2008 2009 Year Source: Highway and Waterway Transport Development Statistics Bulletin 2002–2009, MOT.

4.5 Funding Gap

Based on the estimates of both ordinary and rural road spending needs and available revenues from the fuel tax, VPT, and other sources under the two development scenarios, the estimated annual funding shortfall for road construction and maintenance for 2010–2020 is shown in Table 24.

Based on these high-level needs, revenue, and gap analyses, it can generally be concluded that the PRC faces great financial demands to fund needed ordinary road construction and maintenance. Thus, it is also important to recognize the limitations of the analyses: t Construction Needs. The needs figures are based on preliminary new long-term system development targets. As such, little or no documentation is available on the analysis and decision-making processes used to develop and justify the new targets. In particular, it is not clear which needs are critical and which are more discretionary in nature. t Maintenance Needs. The maintenance needs were developed using very general, historically based assumptions about average costs for different classifications of roads. A more robust analysis of needs, perhaps based on a true inventory of facilities or at least sampling, is needed to understand how various factors, such as facility age, existing conditions, facility design, traffic volumes, and geography, influence or will influence maintenance costs. t Debt Costs. No comprehensive information is available on how much road-related debt is held by provincial and local governments, thus the needs estimates may not fully account for them. 44 Financing Road Construction and Maintenance after the Fuel Tax Reform

Table 24 Estimated Funding Gap over 2010–2020 (CNY billion) Unconstrained Needs Scenario Baseline Growth Scenario Funding Demand Funding Funding Funding Demand Funding Funding Year Construct MaintainAvailable Gap Construct Maintain Available Gap 2010 438.4 158.8 239.0 358.2 268.6 158.8 239.0 188.4 2011 460.3 172.6 262.9 370.0 282.0 170.3 262.9 189.4 2012 483.3 187.3 283.8 386.8 296.1 182.6 283.8 194.9 2013 507.5 203.1 306.3 404.3 310.9 195.7 306.3 200.3 2014 532.8 220.1 330.7 422.2 326.5 209.7 330.7 205.5 2015 559.5 238.2 357.3 440.4 342.8 224.5 357.3 210.0 2016 587.4 257.5 380.6 464.3 359.9 240.4 380.6 219.7 2017 616.8 278.2 405.4 489.6 377.9 257.2 405.4 229.7 2018 647.7 300.4 432.1 516.0 396.8 275.1 432.1 239.8 2019 680.0 324.0 460.6 543.4 416.7 294.2 460.6 250.3 2020 714.0 349.3 490.9 572.4 437.5 314.5 490.9 261.1 Total 6,227.7 2,689.5 3,949.7 4,967.5 3,815.8 2,523.1 3,949.7 2,389.2

Source: ADB consultants.

t Central Government Revenue Estimates. The revenue estimates have several weaknesses. The combination of the PRC’s short history with fuel taxes at current levels and the unavailability of detailed fuel consumption data and/or projections make it difficult to develop meaningful trend analyses. The approach used in this section—estimating revenue growth based on the historical relationship between fuel consumption and GDP—is useful for rough analysis purposes, but a more detailed analysis, such as one based on travel projections, changes in vehicle fuel efficiency, and price elasticity considerations, is needed to improve the credibility and accuracy of fuel revenue estimates. There are several factors that could affect the accuracy of the VPT revenue estimates. In particular, historical data on the average tax revenues per vehicle are erratic and do not lend themselves to developing trend analyses. The assumption that average VPT revenues per vehicle would return to CNY10,000 ($1,531) and remain there for the foreseeable future may be reasonable, but it should be noted that factors such as changes in inflation rates, currency values, and consumer behavior could change this average and cause VPT revenue levels to come in significantly higher or lower than expected. The estimates of government general budget allocations are at best a guess. Without an explicit multiyear commitment by the PRC’s central government on these allocations, it will be difficult to assess the accuracy of these estimates. t Provincial and/or Local Revenues. The analysis makes no assumptions on the level of nonnational funding that may be contributed to pay for ordinary road construction and maintenance. Instead, it is assumed that all revenues will come from central government allocations. This assumption needs to be explored and, potentially, mechanisms need to be developed for forecasting provincial and local road funding contributions. t Provincial and/or Other Jurisdiction-Level Analysis. As a general rule, the study was unable to obtain needs and allocation or revenue data at the provincial and/or other relevant jurisdiction level. This type of detailed information is needed to gain a better understanding of how funding gaps vary in different regions. Fuel Tax Reform 5 Policy Issues

5.1 Introduction

The fuel tax reform raises several important policy issues for the PRC’s highway programs: t inadequate funding, t lack of provincial and local revenue mechanism for roads, t declining purchasing power of fuel taxes, and t limited organizational capacity on program administration and performance.

5.2 Inadequate Funding

The preceding analysis of construction and maintenance needs (under the unconstrained needs scenario) and revenues for ordinary roads reveals that under the current approach to road financing, the PRC’s annual funding gap could grow from CNY358 billion ($54.8 billion) in 2010 to CNY572 billion ($87.6 billion) in 2020, and reach a cumulative total of nearly CNY5 trillion ($766 billion) over 2010–2020. Even under the more conservative baseline growth scenario for needs, the estimated gap is CNY188 billion ($28.8 billion) in 2010 and CNY261 billion ($39.9 billion) in 2020.

The findings make it clear that the current approach to road financing is inadequate for the PRC to both maintain its current road network and continue to build or upgrade facilities to support ongoing economic development, improve accessibility, and provide better mobility. Under the current structure, adequately addressing ordinary road maintenance needs alone will consume roughly two-thirds of all available central government road funding, leaving only enough remaining funds to address about 20% of annual construction needs under the unconstrained needs scenario, and 37% under the baseline growth scenario. These percentages could decline further if (i) the PRC experiences sustained inflation above the 5% annual rate assumed in the analysis, (ii) revenue growth fails to meet expectations, and/or (iii) poor maintenance practices lead to accelerated deterioration of facilities.

It is not certain that all of the investment needs identified in either of the two scenarios evaluated in Section 4 are high-priority needs that must be addressed in the next decade. However, given the magnitude of needs and associated gap even in the baseline growth scenario, it is clear that the current funding approach alone will provide insufficient revenues to support a sustainable national highway program where existing system assets are well managed and maintained, and critical investment needs can be accommodated. Additional road funding, whether it is raised at the national level or through new taxing or charging authority provided to provincial and/or local governments, is needed. Otherwise, the likely consequences are insufficient road investment to 45 46 Financing Road Construction and Maintenance after the Fuel Tax Reform support economic growth and poor road system operations with deteriorating road conditions that will threaten safety, increase operating costs, lower productivity, and lead to even greater long-term reconstruction costs.

5.3 Lack of Provincial and Local Revenue Mechanisms for Roads

Closely related to the issues of inadequate funding is that the fuel tax reform eliminated all dedicated provincial and local funding sources for ordinary and local roads. It is anticipated that the annual funding allocations provincial and local governments will receive from the central government’s fuel tax revenues will not grow as fast as RMF revenues did. The elimination of the RMFs and annulment of class II road tolls has greatly reduced the ability of provincial and local governments to finance road improvements through bank loans.

If the goal of the fuel tax reform is to absolve provincial and local governments of any responsibility for funding roads themselves, the current policies and funding structure are probably appropriate provided road development targets, maintenance standards, and central government funding levels are better aligned.

However, there are reasons such a strategy could be inappropriate: (i) Drastically reducing development targets and/or maintenance standards will be both politically unviable and poor public policy; (ii) It may be unrealistic to assume that central government revenue sources can be increased sufficiently to address all road development demands—current fuel tax rates will need to be increased one-and-a-half to twofold just to address the estimated funding gap under the baseline growth scenario; and (iii) A program funded solely by the central government can lead to inefficient and ineffective use of funds because provincial and local governments tend to care less in spending money perceived as not their own. In light of these factors, the next logical step in the fuel tax reform initiative is to develop a source of revenue that can be collected and used at the provincial and/or local levels.

5.4 Declining Purchasing Power of Fuel Taxes

Another issue closely related to the adequacy of funding is the structure of the new motor fuel taxes. While the taxes have many attributes as a funding source for roads, these also have shortcomings. Most notably, as an excise tax imposed as a fixed amount per liter, the purchasing power of tax revenues erodes over time due to inflation.29 As illustrated in Figure 13, the current motor fuel taxes established in 2009 have already lost 5% of their purchasing power, and by 2020 will provide only 60% of the real investment they supported when first established. Conversely, adjusting fuel taxes each year for inflation, using 2009 as the base year, will raise an additional CNY750 billion ($114.8 billion) between 2010 and 2020, addressing 31% of the baseline growth scenario gap and 15% of the unconstrained needs scenario gap.

29 It is important not to confuse growth in fuel tax revenues due to increased travel, and thus fuel consumption, with growth in revenues to keep up with inflation impacts on construction and maintenance, since travel growth also generates additional construction and maintenance needs. Fuel Tax Reform Policy Issues 47

Figure 13 Cumulative Change in Fuel Tax Purchasing Power Assuming 5% Annual Inﬂation Rate 100 90 80 70 60 50 40 30 Current Fuel Tax Yield % of 2009 Purchasing % Power 20 10 0 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Year Source: ADB consultants.

While the problem of declining purchasing power can be addressed through commensurate adjustments to fuel tax rates, the experiences of developed countries show the political difficulties of doing so. The last increase in US motor fuel tax rates was in 1993, resulting in a decline in the purchasing power of its fuel tax revenues by 40%. Even with the current virtual insolvency of the US Federal Highway Trust, US lawmakers are highly reluctant to raise the tax for fear this will be unpopular with the electorate. Japan has also not increased its fuel taxes since 1993 and has experienced similar declines in purchasing power. European countries have had more success in raising fuel tax rates in recent years, but the UK’s initiative to index fuel tax rates to inflation met with significant opposition and was short-lived.

5.5 Program Administration and Performance

A major benefit of centralizing the collection of road charges and the allocation of road funding is it provides the central government with justification and means to ensure limited road resources are spent efficiently, effectively, and in accordance with national goals and priorities. To date, however, the bulk of the fuel tax reform has focused on imposing the new tax and allocating the funding. Less attention has been given to how roles, responsibilities, and structures for road program delivery shall evolve to support more sustainable, higher-performing programs. Key issues where additional reform may be warranted include the following:

Program Structure. At present, central government allocations are essentially treated as block grants to provinces and local governments, with little or no direction on how the funds should 48 Financing Road Construction and Maintenance after the Fuel Tax Reform be spent. The MOT or other central government agencies may wish to consider taking a more active role in directing that money be spent on specific functions, such as expansion, modernization, safety, maintenance, and operations.

Funding Allocation Methods. The current approach for allocating funds was intended as an interim structure served to replicate the annual level of funding jurisdictions would have received through their RMFs. It is not clear whether this approach is an instrument for realizing national goals and objectives—e.g., does it adequately address the central government’s desire to subsidize road investment in the PRC’s central and western provinces?

Reorganization. The reform has essentially transformed the central government from having a minor role supporting ordinary and rural road development to being the major source of road funding. With this new function comes the responsibility for ensuring that money is spent efficiently and effectively. What is not clear is whether the central government fully understands its potential new role and/or has the organizational capacity (e.g., staffing levels, expertise, and field presence) to perform potential new functions such as audit and oversight.

5.6 Reform Implementation Issues

As can be expected with any major public policy change, the fuel tax reform has led to a range of both anticipated and unanticipated consequences. In particular, the fuel tax reform appears to encourage trucks to divert from tolled expressways and class I roads to now non-tolled class II roads. Local and provincial officials expressed concerns that the new funding disbursement structure following the reform is creating short-term cash flow problems. As with the existing provincial and/or local debt issue, these are real concerns and should not be ignored, although they do not directly relate to creating more sustainable road programs in the PRC and are thus not addressed further in this report.

Another issue of considerable concern is the level and status of provincial and local debt associated with both past borrowing against the RMFs and class II toll road revenues. The study was unable to develop comprehensive data on provincial and local road-related debt levels and annual debt service requirements. However, anecdotal evidence and comments by several PRC officials suggest that existing debt burdens and the inability of governments to repay their debt are serious concerns. On the other hand, the outstanding debt is a legacy of leveraging practices, not a product of the reform. This issue should certainly not be ignored, but should not directly influence the discussion about additional road funding reforms. Rather, it should be addressed in conjunction with broader policy debates on provincial and local government finance, including provision of relief for current provincial and local debt burdens.

5.7 Longer-Term Funding Considerations

Although the short-term prospects for the fuel tax are strong, there is a possibility that the transition to electric and high-efficiency vehicles will eventually reduce fuel consumption and limit the sustainability of the fuel tax as the primary mechanism for financing ordinary roads. Moreover, there is a chance that this can occur sooner than expected. Several developed countries now consider Fuel Tax Reform Policy Issues 49 this inevitable and are resolved that distance-based taxes (i.e., VMT taxes) will one day need to supplant fuel taxes. A major problem, however, is the technology needed to implement a VMT tax— many experts anticipate that vehicles will need to be equipped with global positioning system (GPS) units that facilitate implementation of the tax, and the only cost-effective way to achieve this is by having the units built into new vehicles. Thus, it can take some years before a country’s vehicle fleet will have sufficient penetration of GPS units to enable implementation of a VMT tax. The PRC may wish to explore whether the VMT tax is an option and, if so, consider steps that will need to be taken in the next few years to facilitate a smooth tax transition. Policy Options and 6 Recommendations

6.1 Introduction

The following section presents options and recommendations to address many of the identified policy issues. The options cover a broad range of financial, policy, and administrative topics highly interrelated. In particular, there is a great deal of interplay between the definition of roles and responsibilities, potential financial structures, financial capacity, goals and objectives, and program administration considerations. For example, the PRC’s decision about creating a new provincial or local road funding mechanism will influence how road financing responsibilities can be distributed among different levels of government. Thus, the roles of MOT, MOF, and NDRC are directly related to how ordinary road funds are allocated. Moreover, the need for increased central government road funding and/or new provincial and local road financing mechanisms is directly related to the roles and responsibilities each level of government is expected to perform.

The development of recommendations and policy options is based on the following guiding principles: t User-Pays Principle. Road investment should generally be funded through revenue mechanisms that charge users for the benefits they receive, except where the fuel tax rate or other tax and/or fee levels needed to fully recover road construction and maintenance costs would not be affordable for users (e.g., in rural areas). t Regular and Long-Term Financing. Annual maintenance and operating costs should be covered from road user charges on a pay-as-you-go basis. Long-term investment costs might require long-term financing instruments, such as bonds, loans, and other options, with the associated annual debt servicing costs funded through user charges. t Additional Funding Needs. A precise quantification of the PRC’s road funding needs, current revenues, and associated gap is not possible through this study. Instead, it could be acknowledged that a large gap exists and that mechanisms to provide additional funding for ordinary roads should be explored. t Existing Debt. The level of road-related provincial and local debt, and the potential challenges governments face to repay this debt, are a great concern but are also a historical problem that should be explored and addressed through avenues outside of this study. t Maintenance Focus. Policy options should consider pragmatic approaches to both expand the road system and ensure that adequate resources are available to maintain and operate it. t Fuel Tax Increase. Increasing the motor fuel tax, whether through indexing, converting to an ad valorem tax, or other options, should be considered and explored as a leading option for addressing some or all of the entire ordinary road funding gap.

50 Policy Options and Recommendations 51

6.2 Division of Roles and Responsibilities 6.2.1 Background and Policy Objectives

The PRC’s central government road program has focused on conducting overall system planning and provided limited funding to provincial and local governments to construct and maintain ordinary roads. It also has been setting road standards for construction and maintenance and providing technical assistance to road agencies. Provincial and local governments have had responsibility for funding most of the road construction and maintenance costs, and for planning, prioritizing, and implementing actual road system improvements. While this approach has succeeded in fostering a fast rate of system expansion, it has provided limited means for the central government to direct investment to national priorities, and there has not been strong accountability on how central government funds are spent.

The fuel tax reform has centralized the collection of road user charges and the funding of road programs, but there has been little change in the division of roles and responsibilities between the central, provincial, and local governments. An important next step in the fuel tax reform initiatives is to explore means of changing the roles and responsibilities for delivering ordinary road programs. Specifically, the PRC needs to consider the future role of the central government—MOT, MOF, and NDRC—in disbursing ordinary road funding. Similarly, greater clarity is needed on the division among different levels of government of future responsibilities for funding national, regional, and local road development priorities and maintenance needs.

Based on the overall objectives of the fuel tax reform, any changes to policies influencing the division of roles and responsibilities for ordinary road programs should contribute toward achieving the following over-arching objectives: t Better align decision making related to the use of central government funding with national road system development priorities. t Enable provincial and local governments to address their unique regional and local road development needs. t Establish a high level of accountability for use of central government funding. t Ensure that the assignment of responsibilities for funding and performance of ordinary road maintenance is rational, sustainable, and consistent with the user-pays principle. t Define responsibilities for raising revenues and funding road spending consistent with the financial capabilities of the associated jurisdictions.

Key factors that should be considered to assess how well different policy options would contribute to achieving these objectives include the following: t National vs. Regional and/or Local Travel Role. By their nature, all major roads serve a combination of national, regional, provincial, and local needs, with higher classifications of roads supporting a larger proportion of interregional and regional movements. An important consideration is the relationship between the level of interregional traffic on a given road classification and the share of construction and/or maintenance costs covered through allocations by the central government. As a general rule, the central government should provide 52 Financing Road Construction and Maintenance after the Fuel Tax Reform

for the share of construction, and perhaps maintenance costs, associated with national- level connectivity interests. What should be debated is the portion of costs associated with the remaining regional (or intraprovincial) and local travel to be borne by different levels of government. t Maintenance Cost Responsibilities. Provincial and local road agencies have responsibility for maintaining and operating the ordinary road systems, but it is uncertain who should pay for these activities and how revenues would be raised, particularly if they are considered provincial and/or local responsibilities. t Revenue Capacity of Subordinate Governments. The cost responsibilities of the central government should, at some level, be influenced by the capacity of provincial and local governments to raise revenues; it is neither practical nor will goals be achieved if the costs for constructing and maintaining the highway system are beyond the means of the governments that deliver the programs. t Influence and Control. The ability of the central government to control and/or influence how road funding is spent at the provincial and local government levels is directly related to the share of funding provided. In areas where the central government wants to have greater control over road policies, project prioritization, standards (design, construction, maintenance, etc.), and/or system operations, a greater share of central government cost may be appropriate. Conversely, a more limited central government share is likely warranted where there is less national concern on how programs are implemented. t Changing Needs. As the PRC extends its road system and the system ages, needs will shift from funding construction to maintaining, rebuilding, and operating the system. This, in turn, will influence the future spending needs and responsibilities of the central government. t PRC Context. The central government’s role in funding roads should also consider the Chinese context and historical precedent for the overall spending roles of different levels of government. In particular, the ability of provincial and local governments to spend money on roads is likely influenced by their broader cost responsibilities for other government services. Any changes in central government road funding responsibilities should consider how the new policies influence provincial and local spending in other areas. t External Factors and Goals. Central government spending on road infrastructure must be considered within the context of how it supports broader national-level goals and concerns. This may include macro-level fiscal policies (e.g., whether the central government is trying to stimulate the economy or rein in national spending) and economic development goals, and the relationship between road investment and other national-level initiatives related to energy use and greenhouse gas reductions.

6.2.2 International Experience

Developed countries vary widely in how they divide the various roles and responsibilities associated with financing and delivering their road systems among the different levels of government. In particular, there does not appear to be any set formula for percentage of road construction or maintenance to be funded by different levels of government, and there are broad differences on how national governments influence transportation decision making at different levels. On the other hand, a few commonalities appear to exist. All countries provide some level of national government funding Policy Options and Recommendations 53 for roads, and national governments typically have lead responsibility for functions such as setting system-wide development and performance goals, establishing standards, determining planning processes, and coordinating road policies with broader social goals. Additionally, the share of construction and maintenance costs covered by national governments tends to decrease as the function of the facilities becomes more local.

United States. Responsibilities for highway program delivery in the US are highly decentralized. The national government establishes national transportation policies, imposes federal fuel taxes and other user charges, provides funding to state and local governments for investments in the national system, sets standards, and creates planning practices for facilities eligible for federal funding. The national government also establishes program categories that define how different portions of funding can be spent as regards system (e.g., interstate vs. other national roads) and/or function (e.g., safety, congestion mitigation, or bridges). In general, the national government is responsible for up to only 80% of construction costs of the national system, including major rehabilitation, reconstruction, and replacement, and does not support any general maintenance spending.

States and, to a much lesser degree, local governments own the national facilities and are responsible for planning new construction and system improvements, matching national funds for eligible projects with nonfederal dollars, and implementing projects. With a few exceptions, they are generally responsible for performing and paying for all maintenance and operating activities. State and local governments also own the nonfederal roads and have sole responsibility for funding investment, planning and implementing improvements, and maintaining and/or operating all associated facilities.

Throughout the development of the interstate system, the division of responsibilities in the US was thought to have worked well. The national government bore the major financial responsibility for system expansions and, in return, was able to focus resources on national priorities. Due to the federal nature of the US political system, state and local road agencies were able to establish their own funding mechanisms with which to fund overall maintenance and operations and invest in improvements to nonfederal system elements. Over the last 2 decades, however, the division of responsibilities has become unbalanced as responsibilities for both funding a large share of road investment and making decisions on how funds are spent have largely devolved to state and local governments. Some argue that this has resulted in a loss of focus on national priorities and led to an unwillingness of the Congress to provide needed funding increases.

Germany. The roles and responsibilities for highway system planning, finance, and program delivery are spread across the different levels of government. At the national level, the Federal Ministry of Transport, Building, and Housing leads development of the federal master plan, owns the federal roads (i.e., motorways and the country’s trunk system), and provides funding and financing to the lander (the German equivalent of states or provinces) to build and maintain the facilities. Lander and local governments suggest projects for the federal system, provide data to support evaluation, and control many of the legal elements of project development, like land acquisition.

Lander and local governments are directly responsible for planning, building, financing, maintaining, and operating their road elements. Germany also invests heavily in rail and inland waterways, thus their highway investment decisions tend to be integrated with broader modal considerations. As part of the European Union (EU), many of Germany’s major transportation investment decisions are coordinated with the Trans-European Transport Network program and other EU guidelines on transportation planning and system development. 54 Financing Road Construction and Maintenance after the Fuel Tax Reform

Japan. The National Ministry of Land, Infrastructure, and Transportation administers national expressways and some national roads, and sets all road charge rates and fees. States and major cities administer “subsidiary” national roads and state roads, and minor cities administer municipal roads. As identified in Table 25, for toll roads the costs for road construction and maintenance are borne by expressway companies or national expressways.30 For other roads the costs are shared between the national government and the relevant subordinate government levels based on the types of facility.

Table 25 Japanese Road Funding Responsibilities by Level of Government National Government Share Prefecture/Local Share Road Category (%) (%) National expressway Toll road n/a (toll financed) n/a (toll financed) Nationally owned 75 25 National road Nationally owned 66 33 Subsidiary 50 50 Prefecture road 50 or less 50 or more Municipal road 50 or less 50 or more

Source: Ishii, S. 2010.

6.2.3 Policy Options

Potential options for the PRC central government’s future role in funding road investment are discussed below. Table 26 provides a summary of the advantages and disadvantages for each option: t Maintain Current Approach. Continue to provide provincial and local governments with funding from the fuel tax, VPT, and other taxes, with few restrictions or requirements on money disbursement. t Targeted Spending Share. The central government could set target levels for the share of road construction and maintenance costs it will fund. This could vary by type of investment, classification of road, and/or jurisdiction (e.g., provincial vs. local or western vs. eastern region). It would then be up to provincial and local governments to raise their share of matching funds. t Focus Central Government Funding on a Core Set of Roads. Establish a system of “central government-eligible” ordinary roads, presumably a subset of the current class II road system, to target central government spending on national-priority facilities below the national

30 This is a general explanation of toll roads in Japan, but there are cases where tolling is combined with government financing for various categories of roads. In practice, there are many toll roads not managed by the National Expressway Corporation. Policy Options and Recommendations 55

Table 26 Evaluation of Policy Options with Respect to Roles and Responsibilities Policy Options Advantages Disadvantages t Provides provinces and local governments with t Has limited control over how funds are spent maximum flexibility to address their needs Has little accountability Current Approach t t Has program continuity and consistency t Is straightforward and easy to understand t Encourages increased provincial and local spending t Is not viable without a source of funding to match on roads central government funds t Increased provincial and/or local cost responsibility t Determining the “right share” can be challenging promotes efficiency Has no emphasis on core system Target Share t t Is fairly straightforward t Has no guarantee system maintenance will be t Can facilitate better accountability carried out t Can be combined with other program approaches t Requires a major shift in program delivery t Has equity concerns t Directs central government funds to national priorities t Is not viable without a source of funding for t Emphasizes core system “noncore” roads t Can facilitate accountability t Noncore roads may be neglected Core System Focus t Can be combined with other program approaches t Selecting the “core system” can be difficult t Eligibility determination can get complex t Has no guarantee system maintenance will be carried out t Can be used to designate funds for maintenance or t Eligibility determination can get complex other priorities t Reduces provincial and/or local agency flexibility Has strong central government control over how Can lead to inefficient spending Funding Categories t t funds are spent t Can be complex and/or costly to administer t Can facilitate accountability t Can be combined with other program approaches Source: ADB consultants.

expressway and trunk road system levels. Funding for construction and maintenance of other roads would then be the responsibility of provincial and local governments. t Establish Funding Categories. Allocate funds to provinces with directions (either specific or in terms of general targets) that define how central government funds could be spent as regards factors such as different categories of roads and/or different types of spending, including new construction, existing facility expansion, rehabilitation and/or replacement, maintenance, and operations.

6.2.4 Recommendation and Next Steps

Except for the option of maintaining the current approach, the identified options could be implemented individually or in combination. Based on the PRC’s issues and the experiences of the US and to a lesser extent Japan, it is recommended that the central government establish a target share for its contribution to road funding. Such an approach would likely have to be implemented in conjunction with creation of a new provincial and/or local road funding mechanism. It would provide incentives for provincial and local governments to increase their spending on roads and avoid the perception of central government funding being “free money.” 56 Financing Road Construction and Maintenance after the Fuel Tax Reform

The central government should also consider establishing funding categories. The current approach, where few strings, if any, are attached to how money is spent, provides little assurance that central government road funding will be spent on national priorities. Categories could be established to require a certain percentage of funding to be spent on maintenance, safety, or other high priorities.

These recommendations would represent a major policy change for the PRC and should not be entered into lightly. Potential follow-on research and next steps to support implementing these recommendations could include (i) assessing what might be an appropriate central government cost share for different parts of the system and different types of spending (e.g., capital vs. maintenance); (ii) determining how a central government share approach could be implemented within the PRC’s administrative framework; and (iii) determining the program categories and structural issues needed to best support achievement of national road goals and objectives.

6.3 Funding Allocation 6.3.1 Background and Policy Objectives

The method a central government uses to allocate highway funding is controversial. There are perceived winners and losers with the approach used and reasonable justifications for any number of alternative approaches. Prior to the fuel tax reform, the allocation of road resources to provincial and local governments was not a major issue since most spending was provided through the six fees imposed and collected at the local level. With the imposition of the fuel tax reform and centralization of collection and disbursement of road funding, however, the approach for determining the allocation of funding is now a critical concern for all levels of government.

Under the fuel tax reform, policies were put in place and formulas were developed to ensure provincial and local governments receive as much funding as they raised for their road maintenance and construction prior to the reform, and to allocate additional revenues based on a combination of fuel tax revenues contributed by the region, road length by kilometers, road density, and road conditions. This approach initially worked well as an initial means for implementing the fuel tax reform, but it could have some key impacts the central government might wish to consider: t The “baseline” funding levels for provinces and local governments are pegged to estimated 2008 revenue levels, with any additional funding considered “extra” and allocated based on formulas. As total funding grows over time, a larger percentage of fuel tax revenues will fall into the “extra” category. t The current formulas for the allocation of “extra” funding are heavily influenced by fuel consumption—quite rationally, since the more fuel consumed in a province or local area, the more money it receives for roads. Such an approach can create disincentives for provincial and local governments to support central government environmental and energy policies. t The current allocation formulas favor jurisdictions with higher road densities and high road maintenance needs. The combined result is that jurisdictions can effectively be encouraged to build as many roads as possible regardless of the need and neglect maintenance. Over time, urban areas and provinces with greater population densities will receive an increasing share of the funding. Policy Options and Recommendations 57

Any revisions to the current allocation approach will need to balance a few key objectives: t Provide provinces and local jurisdictions with a fair return of the fuel tax and VPT revenues they generate and any future dedicated road user charges. t Provide rural areas in the PRC’s western provinces with adequate funding to address road development needs. t Ensure the central government has the ability to direct resources toward national-level priorities for connectivity, access, and other considerations. t Establish a transparent methodology that can provide predictable and stable allocation levels.

6.3.2 International Experience

The approaches different countries use to allocate national funding for roads appear to be highly tied to both how a country funds its road programs and the division of responsibilities between different levels of government. In countries where road funding generally does not come from dedicated sources (e.g., most European countries), allocations to subordinate levels of government are either incorporated into broad transfers or are based on a combination of needs, politics, and precedents. The experiences of these countries have little to offer to the PRC.

In countries where a national dedicated source of road funding exists and subordinate governments play a strong role in delivering roads programs, allocation approaches strive to balance consideration of national priorities and “fair share,” meaning a jurisdiction getting back what it pays in. In Japan, this is accomplished by having a portion of fuel taxes considered “local taxes.” The US approach centers on the development of complex formulas that allocate nearly all national road funds to states and, to a much more limited degree, local governments. These formulas vary by funding program, but generally consider overall factors such as national system mileage, fuel and truck tax contributions, traffic volume, and population, along with factors specific to individual programs such as pollution levels and number of border crossings. Additionally, the US program typically includes discretionary funding pools distributed by the Secretary of Transportation.

Prior to the early 1990s, the US allocation approach was largely based on need—the funding formulas and discretionary grants targeted build-out of the interstate system and, in some instances, favored states with low population densities. With the system now relatively complete, the allocation process has shifted to a focus on fairness and become extremely contentious, with some states that have traditionally been “donor states” calling for devolution.31 This has led to the “equity factors” that ensure a state receive a share of national road funding close to the states’ percentage contribution to the national highway trust fund. A major criticism of the US approach is the lack of relationship between allocations and performance; some argue that the approach provides little incentive for states to address national priorities.

A lesson that can be drawn from almost all developed countries is that the allocation issue is never simple. Strong arguments can be made to justify approaches that vary from emphasizing return of

31 Under devolution, either the national fuel taxes would be eliminated, or states would simply receive back what they paid in. 58 Financing Road Construction and Maintenance after the Fuel Tax Reform funding paid in to allocations based solely on needs or central government priorities. While there appears no “right” method for allocations, it is clear that approaches must strive to balance an emphasis on national goals and needs, and perhaps the need for subsidies in some areas, with considerations of fairness and equity.

6.3.3 Policy Options

Given the PRC’s use of dedicated user fees for road funding, and the precedent already established as part of the fuel tax reform, a formulaic approach to allocations seems both appropriate and politically necessary. The outstanding policy question is whether and how the current approach should be restructured, and if so, what the restructuring should strive to achieve. Table 27 provides a summary of the advantages and disadvantages of each option: t Current Approach. The PRC could simply continue to use the current interim allocation approach established as part of the fuel tax reform. t Prior Year Consideration. One way to establish better accountability for how funds are spent and ensure proper incentives is to tie future funding to how a jurisdiction spent money in the prior year. For example, if the national goal is to increase maintenance spending, future year allocations could be influenced by what a jurisdiction spent on maintenance in the prior year. The main challenges to such an approach are that it could require significant additional accounting and it might be difficult to uniformly apply to all provinces and localities. t Consistent Baseline Share. As noted above, the relative share of total fuel tax funding allocated through the formulas will likely increase rapidly. This, in turn, could create perceived “winners” and “losers” as some areas would receive a greater or lesser share of the total annual funding disbursed. One way to counter this issue would be to maintain a target percentage split between funding allocated through the “baseline” and “extra” formulas.

Table 27 Evaluation of Funding Allocation Options Policy Options Advantages Disadvantages t Provides consistency with prereform funding levels t Potentially rewards overbuilding and poor maintenance Current Approach t Requires no change in policy t May create geographic inequities t Has large influence of legacy spending unrelated to needs Has ability to reward and/or incentivize May encourage “gaming” of the allocation process Prior Year t t desired actions t Is backward looking, therefore slow to respond to Consideration changing priorities t Growth in national funding allocations will be more t Is not responsive to changing priorities—increases consistent across the PRC amount of funding without regard to need Consistent t Has reduced incentive for undesirable t Has no direct tie to national priorities Baseline Share investment policies t Institutionalizes notion that baseline is an entitlement t May still reward overbuilding and poor maintenance t May create widening “winner” and “loser” issues t Has ability to direct funding to national priorities t Debate over formula revisions can be contentious Increased Formula t Is highly adaptable as needs and priorities change t Can create fairness concerns Emphasis t Avoids creating “entitlement mentality” around t Can lead to divisive political debates current baseline

Source: ADB consultants. Policy Options and Recommendations 59

t Increased Formula Emphasis. As an alternative to the consistent baseline share option, officials may determine they want less of the funding to be driven by “guarantees” and more of it to be influenced by national road goals and priorities, system performance, or other factors. In particular, it may be appropriate to revise the allocation formulas to better support the Twelfth Five-Year Plan once it is adopted.

6.3.4 Recommendation and Next Steps

While the US experience clearly shows pitfalls to a heavily formula-driven allocation approach, it appears to be the best approach for addressing many of the road program challenges the PRC faces, particularly if implemented in conjunction with a more robust program structure. Specifically, a combination of program categories and formulaic allocations could be used to both direct a targeted level of funding and redirect appropriate levels of funding to underdeveloped regions.

It should also be recognized that the fuel tax reform represents a major shift in how the PRC funds and implements its roads. As such, it will likely take time for all government levels to understand the implications of the current allocation approach and work within its confines. Additionally, the fuel tax reform has been implemented during a severe economic downtown that has severely dampened revenues under the old, locally implemented tax structures. Some of the concerns on allocations under the reforms may be more related to poor economic conditions than to shortcomings in the current approach. It is therefore suggested that any changes to allocations be done cautiously and incrementally.

Given the fact that changes in the PRC’s road funding allocation approach will determine the level of central government road funding for provinces and local governments, and create perceived winners and losers, the debate on what is the right approach is likely to be contentious. As such, it will be important to fully explore and understand (i) road development and maintenance needs on at least a province-by-province basis; (ii) province-by-province revenue projections for motor fuel taxes, VPT, and any new road user fees; and (iii) the likely province-by-province central government funding distributions that will occur under different formulaic options for allocating funds.

6.4 Adjusting Current Funding Sources 6.4.1 Background and Policy Objectives

The fuel tax reform established a fixed-rate excise tax on motor fuels that will need to be adjusted regularly to ensure that revenues keep up with inflation and other factors.32 The objectives for policy options to address this issue are fairly straightforward: t Maintain the long-term purchasing power of the current road funding sources and any future approaches implemented; and t Establish an adjustment approach that adheres to the user-pays principle and is both predictable and politically viable.

32 Presumably, there is less need for regular adjustments to the VPT since revenues from the tax should grow as the price of vehicles (the base for the tax) increases with inflation, although the average tax revenues per vehicle sales have been flat in recent years and forecasts do not show average VPT revenues per vehicle sale increasing for at least several years. 60 Financing Road Construction and Maintenance after the Fuel Tax Reform

6.4.2 International Experience

The concept of developing a mechanism to ensure fuel excise taxes, or other road funding instruments, maintain their purchasing power is often discussed. However, the record of developed countries actually implementing sustained indexing policies is poor.

In the US, national fuel tax rates are established by Congress and have not been increased since 1993. While indexing the fuel taxes to inflation or converting to an ad valorem tax (similar to a sales tax) is often proposed, lawmakers have been unwilling to proceed further with such proposals. At the state level, fuel tax rate increases have also generally been treated on an ad hoc basis, although a few states have used limited indexing, which establishes a ceiling to limit rate increase in a given period or adds a sales tax component to their fuel tax structure that provides a form of indirect indexing. Similar to the US, Japan last increased its fuel tax rates in 1993, and efforts to increase the tax have been met with stiff public and political opposition.

European countries have generally been willing to increase their fuel excise taxes more regularly, but most do so also on an ad hoc basis. However, because a VAT is imposed on motor fuels in most European countries, there is a sales-tax-like component that adjusts in relation, although not directly tied, to inflation. Moreover, both Germany and the UK have experimented with fuel tax indexing. The UK established an “escalator” in the 1990s, which adjusted fuel tax rates at 5% per year, but repealed the mechanism in 1999 in response to large public protests. Germany implemented an inflation-based adjustment in the late 1990s but also repealed the approach after a few years due to public concerns on the rapid increase in fuel prices.

6.4.3 Policy Options

Mechanisms for adjusting road user tax rates in the PRC can be accomplished through either stand-alone approaches or blended together in some form of hybrid approach: t Indexing. Tax rates could be tied to some measure of changes in spending needs. This could include inflation (e.g., increasing fuel tax rates each year by the CPI), economic growth (i.e., GDP growth), increases in travel demand, or projected rate of growth that would have occurred under the six prior road fees. t Needs-Based Adjustment. Tax rates could be adjusted to meet all or a target percentage of road spending needs. For example, needs forecasts associated with the development of the five-year plans for roads could become the basis for establishing a fuel tax rate schedule for the same period. t Fuel Price Share. The fuel tax rate could be established as a set share of the price of motor fuels. Thus, the current tax portion of the tax for gasoline (11.4%) would be maintained. Such an approach would likely need to be implemented based on an average price for a given period (e.g., quarterly or annually). This would essentially convert the current excise tax to a sales tax. t Occasional Rate Adjustments. The appropriate agencies and/or authorities could simply adjust the tax rates regularly as they see fit but unrelated to, or at least not directly tied to, any specific set of considerations. Policy Options and Recommendations 61

Table 28 Evaluation of Tax Adjustment Options Policy Options Advantages Disadvantages t Ensures purchasing power is sustained and predictable t Can make it difficult to also make increases based t Easy to administer on need Indexing t Institutionalizes need for fuel rates to regularly adjust t Price impacts can potentially accelerate inflation t Tax rate increases and/or decreases could be controlled t Decouples fuel taxes from broader public policy with rate floors and/or ceilings debates t Aligns tax policy with road system goals and objectives t Determining needs is highly subjective Ensures purchasing power is sustained and predictable Decouples fuel taxes from broader public policy Needs-based t t t Is highly consistent with user-pays principle debates adjustment t Tax rate increases and/or decreases could be controlled t Can lead to inefficiency and abuse with rate floors and/or ceilings t Provides at least some relationship between rate and t Is confusing to consumers—tax amount may not inflation be clear t Short-term predictability can be a challenge Has little relationship to need Fuel price share t t Creates equity issues if fuel prices vary by region t Depending on how it is implemented, can make tax administration more costly and increase exposure to tax evasion t Political leaders likely to consider most acceptable t Has no direct link between funding levels and needs t Creates very stable short-term funding t Has poor long-term funding-level predictability Ad hoc adjustment t Political debate heightens leader and public awareness t Creates resistance to increases about highway investment needs t International experiences show lawmakers resist raising rates

Source: ADB consultants.

6.4.4 Recommendation and Next Steps

As identified in Table 28, all of the potential tax rate adjustment approaches have strengths and weaknesses. While regularly adjusting tax rates based on assessments of needs will be ideal from a transportation policy perspective, it is probably not politically viable since it will essentially require lawmakers to turn over tax-setting authority to transportation officials. The next best option, which is recommended, is to index current fuel taxes and any future base rate increases to inflation. To implement indexing, it is also recommended that the PRC undertake research to address the following questions: t Forecasts. What would be the potential schedule of tax rate increases and the associated new revenues under various assumptions about inflation? t Basis for Change. What should drive changes to the fuel tax rate; should it be a specific index, a new index, or even a broader set of considerations than just inflation? t Precedent and Models. Are there other places in the PRC where excise-type taxes and fees are adjusted at regular intervals? If so, what lessons could be learned from them? t Legal Parameters. How viable is indexing within the context of the PRC’s existing legal, policy-making, and administrative frameworks? What would need to be changed, and what are the barriers and/or requirements associated with achieving this change? 62 Financing Road Construction and Maintenance after the Fuel Tax Reform

t Structural Considerations. What policy structures should be considered as part of the solution (e.g., establishing a floor or ceiling to annual increases)? t Impacts. What impacts could raise the excise tax rate at regular intervals and have on different segments of the PRC’s economy and on different geographical regions? Would there be winners and losers? If so, what could be done to make the impacts more equitable? t Implementation. What practical steps and actions would be required to implement indexing?

6.5 New Funding Options 6.5.1 Background and Policy Objectives

The level of funding that will be provided through the current central government road funding mechanisms will be inadequate to meet future road expansion and maintenance needs. Moreover, whether one accepts the analysis findings of an annual average funding gap of CNY220 billion ($33.69 billion) to CNY450 billion ($68.9 billion), the mere fact that ordinary road maintenance needs alone could consume almost two-thirds of all available funding reflects the strong need for the PRC to raise additional revenues if it is to have a sustainable transportation system and meet even modest development goals.

To raise additional revenues at the central government level, the PRC can either increase existing dedicated taxes or establish new mechanisms to supplement the fuel tax and VPT. If the central government will share some of the responsibility for funding road construction and maintenance with other levels of government, one or more new tax or fee mechanisms will need to be authorized for provincial and/or local government use. As noted in the discussion of guiding principles at the beginning of this section, strong adherence to the user-pays principle is a primary objective for identifying potential new funding sources for roads. Other objectives associated with the establishment of any new or expanded funding mechanism include the following: t Provide substantial and sustainable funding levels. t Avoid creating social or geographical equity issues and/or other undesired side effects. t Select an approach that is easy and efficient to administer. t Pursue only politically viable options.

6.5.2 International Experience

Developed countries employ a range of road user fees. In some countries, such as in Japan, New Zealand, US, and to a more limited extent Germany, revenues from these fees are dedicated for transportation investment. Most European countries, along with Canada and Australia, impose fuel taxes and other road user charges, but revenues are treated as general-purpose resources. National-level support for road investment is then provided through their general budget accounts.

The most commonly imposed user fees are motor fuel charges, which nearly every country imposes. The PRC’s current motor fuel tax rates are clearly at the low end of the spectrum when compared Policy Options and Recommendations 63 with those in most developed countries—gas and diesel excise taxes in many European countries are three to four times the rates in the PRC. Other user charges commonly imposed include vehicle registration and other related fees; VAT on motor fuels, vehicle sales, auto parts, etc.; vehicle and/ or vehicle parts sales taxes; heavy vehicle surcharges; distance-based fees; and cordon pricing.33 The following is a more detailed discussion on road financing approaches in selected countries:

United States. The US relies heavily on motor fuel taxes to fund road investment. Nearly 90% of the revenues in the US Federal Highway Trust Fund come from gasoline and diesel taxes. Other sources include General Fund contributions and truck user fees in the form of a heavy vehicle use tax, a truck and trailer sales tax, and a truck tire tax (Figure 14).

US states and local governments raise funding for highways from a variety of mechanisms and approaches, which vary from jurisdiction to jurisdiction. All states have their own fuel taxes imposed on top of federal fuel taxes and are typically dedicated for transportation purposes. Many states also collect some form of vehicle registration fee for highways; other state-level highway funding sources include sales tax proceeds, bonding, and general budget allocations. In few instances, surplus revenues from toll road operations are used to fund general road system development and maintenance activities. At the local level, very little road funding comes from user fees; most is allocated from general budgets and comes from sources such as property and general sales taxes.

Figure 14 Federal Highway Trust Fund Revenues by Share: Fiscal Year 2007 (%)

25 Diesel and Special Fuels

Tires

Trucks

1 Heavy Vehicle 62 Gasoline 9 Other Income 3

Source: Financing Federal–Aid Highways, 2007 US DOT, FHWA.

33 Most developed countries also have toll roads operated either by government agencies or through private concessions. Because revenues from the tolls are typically dedicated for debt repayment and maintenance and/or operations of tolled facilities, and are mostly applicable to expressway financing, these are generally not discussed here. 64 Financing Road Construction and Maintenance after the Fuel Tax Reform

Germany. Until the mid-1990s, Germany financed its highway and maintenance activities from the general federal budget. In 1995, Germany introduced time-related charges on heavy goods vehicles (trucks of over 12 tons gross vehicle weight) on its entire motorway system. These charges raised an average of €450 million (CNY4 billion) annually, which has been dedicated for road investment. In 2005, the heavy goods vehicle tax program was expanded to levy distance-based fees, which currently generate an additional €4.4 billion (CNY40 billion) annually, also dedicated for road purposes.34 Germany has also begun making wide use of public–private partnerships and tolling to pay for expansion of its expressway system.

Japan. Japan’s central government imposes a range of highway user charges on different parties ranging from vehicle manufacturers and dealers, in the form of consumption taxes, to the vehicle user through vehicle fees and fuel taxes. Revenues from these charges are transferred from dedicated highway funding sources to a special account to support implementation of five-year plans. The sources of funding for roads in Japan include dedicated user fees, toll revenues and toll-backed debt, and general fund appropriations. Details of current dedicated funding sources and their associated rates and revenue levels are provided in Table 29.35

Table 29 Japan’s Highway Taxes and Uses Share Allocated Tax Rate Annual Reserves (FY2006) to Roads Tax (%) ¥ CNY ¥ (billions) CNY (billions) National Revenue Sources Gasoline tax 100 48.6 per liter 3.6 per liter 2,957 218 Motor vehicle LPG tax 50 17.5 per kg 1.3 per kg 14 1 Motor vehicle ton tax 51.7 2,500/0.5 per ton 184.6 per ton 571 42 Subtotal 3,543 262 Local Revenue Sources Local road transfer tax 100 5.2 per liter 0.4 per liter 311 23 Motor vehicle LPG tax 50 17.5 per kg 1.3 per kg 14 1 Motor vehicle ton tax 33 2,500/0.5 per ton 184.6 per ton 371 27 Diesel fuel transaction tax 100 32.1 per liter 2.4 per liter 1,062 78 Motor vehicle purchase tax 100 5% of price n/a 474 35 Subtotal 2,232 165 Total 57,750 4,265

Note: Exchange rate CNY1 = ¥13.5 as of May 2010. Source: Ishii, S. 2010. Fuel Tax. Presentation for the International Road Finance Workshop. Beijing. September, 2010.

34 Directive 1999/62 EG provides the legal basis for the pricing scheme and allows a maximum allocation of total infrastructure costs, taking the average cost for each vehicle category as a benchmark for charging. It is possible to vary the charges according to congestion rates and environmental performance of the vehicles (Euro-emission standards). A road infrastructure cost allocation for Germany resulted in a benchmark figure of €0.15 (CNY1.38) on average per vehicle-km, which is spread according to the vehicle axles and Euro emission categories. 35 This description does not cover recent developments in Japan’s road financing approach. For example, the special account for dedicated highway funding sources was abolished in 2009. Policy Options and Recommendations 65

In recent years, a few developed countries have undertaken major national-level studies to explore options for addressing road spending needs. These include the US National Surface Transportation Infrastructure Financing Commission, Germany’s “Pällmann Commission,” and the UK Eddington Study. All three studies concluded that the long-term road needs of their respective countries could best be met through a greater reliance on road pricing schemes to recover a larger percentage of road use costs, including congestion and environmental costs. The German and US studies also emphasized the need for increased private investment in road infrastructure.

6.5.3 Policy Options

There is a wide array of policy options the PRC could employ to raise additional revenues for ordinary road investment. The following are deemed to be the most viable: t Increase the Fuel Excise Tax. The current fuel tax rate, and associated allocations to provincial and/or local governments, could simply be increased. t Sales Tax on Motor Fuels. A tax imposed on the sales price of motor fuels, as opposed to a fixed rate per liter. Such tax would likely need to be collected at the pump, as opposed to the refinery or major distribution points. t Heavy Vehicle Surcharge. An annual fee imposed on trucks over a certain rated vehicle weight as a means for recovering some or all of their associated additional road wear costs. t Truck and/or Automobile Tire Tax. A tax or fee imposed on the purchase of all new tires, either as a percentage of the sale price or as a fixed amount per tire. The tax could be applied to replacement tires or to tires on new vehicles. t Vehicle Fee. Similar to the fees that supported the RMF, vehicle owners could be charged an annual registration or related fee for their vehicles. Such a fee could be a flat amount, could vary on the vehicle value (also known as vehicle personal property tax), or could be based on other factors such as vehicle weight or capacity and fuel efficiency. t Weight and Distance Tax. A tax on freight-related road use through the imposition of an excise tax either based on the weight of freight moved (a ton-based tax) or as a function of both weight and distance (a ton-mile tax). t Distance-Based Pricing (Vehicle Kilometer-Traveled Tax). Drivers can be charged for the distance they travel, regardless of the road used or the time of day. The fee could be charged in a number of ways, varying from high-tech approaches that use GPS units in cars to track travel distance by facility and time of day to simple approaches based on vehicle odometer readings. Several developed countries have begun to develop distance-based charges as a means to finance road investment and manage travel demand. t Carbon Tax. The creation of a tax on carbon or some other program aimed at creating economic disincentives for carbon emissions could generate significant revenues, all or a portion of which could be allocated for transportation spending. t Cordon Pricing. The imposition of a charge on vehicles to access specific areas through tolls at certain boundaries or through the sale of passes to drive in the cordoned area. Cordon pricing would most likely be implemented at a local level. While the principal function of cordon pricing is to manage demand and reduce congestion, like during peak hours, and not to finance road construction and maintenance, it also generates some revenues. 66 Financing Road Construction and Maintenance after the Fuel Tax Reform

Table 30 Evaluation of Funding Options Policy Options Advantages Disadvantages t Has no tax development or implementation costs t Has disproportionate impact on commercial vehicle operators t Has high user-pays correlation t May not be sustainable in the long term Increased fuel t Can raise significant revenues t Is regressive tax excise tax t Promotes fuel efficiency t Has geographical equity issues t Has low risk of tax evasion t Major increase was just imposed t Unless indexed, loses purchasing power over time t Revenues generally rise with inflation t Has disproportionate impact on commercial vehicle operators t Has high user-pays correlation t Can be viewed as double taxation t Can raise significant revenues t If PRC moves to full market pricing of fuels, revenues levels Fuel sales tax t Promotes fuel efficiency can be volatile t Has strong revenue growth in near- to mid-term t Is more susceptible to fraud and tax evasion than fuel t May be well suited as a provincial and/or local excise taxes revenue mechanism t Has high user-pays correlation t Has disproportionate impact on commercial vehicle operators Heavy-vehicle fee t Can help reduce pavement wear t Can be expensive to administer t Is highly sustainable t May not raise substantial revenues t Has high user-pays correlation t Can have negative safety impacts t Is highly sustainable t Has disproportionate impact on commercial vehicle operators Can be used as a provincial and/or local May not raise substantial revenues Tire tax t t funding source t Can potentially be used as an indirect means to base fees on vehicle weight t Is highly sustainable t Has weak correlation between taxes paid and system use t Can raise significant revenues t Recent elimination of RMF and other registration fees may Tends to be politically popular increase public and political opposition Vehicle t t Can be used to provide various incentives t Collecting at the national level may not be practical and/or disincentives t Equity and evasion issues can reemerge t Can be complex and/or expensive to administer t Has high user-pays correlation t Has disproportionate impact on commercial vehicle operators Weight and t Is highly sustainable t Is expensive and challenging to administer distance tax t Can raise significant revenues t Can have unintended market impacts on the cost of goods and services t Has high user-pays correlation t Is expensive and challenging to administer t Can raise significant revenues t Is not immediately viable Is highly sustainable Has disproportionate impact on commercial vehicle operators Mileage-based t t t Can be used to provide various incentives pricing and/or disincentives t Odometer tax can provide simple implementation approach t Has high user-pays correlation t Administration can be complex Carbon tax t Promotes efficiency t May not provide a sustainable revenue source t Can have undesirable impacts on development and land use t Helps reduce congestion and spread out time t Is not suitable as a national funding source of travel t Will have a disproportionate impact on businesses and Cordon pricing t Can be a local funding source people working in metropolitan areas t Ring road architecture will aid implementation t Is highly sustainable Source: ADB consultants. Policy Options and Recommendations 67

6.5.4 Recommendation and Next Steps

The decision to select one or more mechanisms to fund public spending is not easy. As identified in Table 30, all tax and fee mechanisms have a range of consequences, and decision makers should closely weigh the advantages and disadvantages of each option. The objectives listed above are converted into a set of seven core evaluation criteria, the suitability of each of the funding options was rated on a scale of 1 (low), 2 (medium), and 3 (high). Based on the preliminary analysis illustrated in Table 31, raising the current fuel tax emerges as the best option—among other benefits, it has high user-pays correlation, can raise a lot of funding, and helps promote energy efficiency. The motor fuels sales tax and carbon tax, being similar in nature, also score high; and cordon pricing can be a potential solution for addressing local funding needs, but only for a handful of jurisdictions. While the tire tax scored relatively high in most categories, it is not recommended because of its likely low revenue potential.

Table 31 Evaluation of Potential Sources of Additional Road Funding

Evaluation Factor Tax Fuel Increase on Sales Tax Motor Fuels Vehicle Heavy Surcharge Tire Tax Fee Vehicle and Weight Distance Tax VMT Tax Carbon Tax Pricing Cordon

User-pays principle 3 3 3 3 2 3 3 3 3

Revenue potential 3 3 2 1 3 3 3 3 2

Sustainability 2 2 2 3 3 3 3 2 3

Acceptability/viability 2 2 1 2 1 1 2 2 2

Ease/cost of 3 2 1 3 2 1 1 2 2 administration

Side effects 3 3 2 1 2 1 3 3 2

Equity 1 1 1 2 2 1 1 1 1

Overall Score 17 16 12 15 15 13 16 16 15

Scoring key: 1 = low, 2 = medium, 3 = high. 68 Financing Road Construction and Maintenance after the Fuel Tax Reform

Key areas where additional research is needed to select final options and implement one or more of these options include the following: t Legal Parameters. How viable are the various options within the context of the PRC’s existing legal, policy-making, and administrative frameworks? What would need to be changed and what are the barriers and/or requirements for achieving this change? Are there different legal considerations for what can be imposed at the central vs. provincial or local level? t Revenue Potential. What should be the basis for determining viable tax rates for each of the shortlisted options? Based on these rates, how much annual revenue could be raised at the national and provincial and/or local government levels? t Impacts. What impacts could the revenue mechanisms have on different segments of the PRC’s economy or on different geographical regions? Would there be winners and losers? If so, what could be done to make the impacts more equitable? Could the options have positive and/or negative externalities and/or unintended consequences? t Implementation. What practical steps and actions would be required to implement the various options? What timeline would be realistic? t Pilot Program Design. Particularly with respect to options for provincial and/or local mechanisms, how could a pilot program be structured and what would be required to implement it to test the viability of one or more high-potential options?

6.6 Rationalizing Use of Debt Financing 6.6.1 Background and Policy Objectives

The use of debt, such as bank loans, to finance ordinary road programs has largely occurred at the discretion of provincial and local governments. It appears that in many cases, bank loans have been treated as a general source of funding for road programs, and thus proceeds were often used for both capital and maintenance and/or operating purposes. As a result of the fuel tax reform, provincial and local governments have now lost the ability to obtain bank loans secured and repaid with dedicated road funding.

Given the speed of economic development in the PRC and the huge need for road system expansion to accommodate it, there is clearly a place for debt financing as a tool to support delivery of ordinary road programs. The key questions are (i) How should the borrowing capacity of provincial and local agencies be restored? and (ii) What parameters or constraints should accompany this restored capacity? Objectives or considerations that should drive the development of a new initiative to enable provincial and local road agencies to resume issuing debt should include: t Cost Implications. The level of additional costs associated with borrowing, both in terms of issuance and/or initiation costs and ongoing interest, should be minimized. t Use of Debt Proceeds. Debt should be allowed only for capital projects that meet certain criteria, like a positive benefit–cost ratio. t Debt Ceilings. The amount of road-related debt a jurisdiction can issue should be limited to ensure debt service requirements remain manageable and do not impinge on the capacity of agencies to meet their maintenance activities on a pay-as-you-go basis. Policy Options and Recommendations 69

6.6.2 International Experience

International experiences appear to offer limited ideas on provincial and local road-related debt practices applicable to the PRC’s circumstances. In the US, for example, state and local governments issue debt as they see fit and as their legislative bodies allow, using their own revenue sources to secure and repay debt. The US federal government has little oversight or involvement in these activities, other than providing tax advantages to lenders and debt holders.36 The main exception is a relatively small federal program that provides loans or loan guarantees for high-profile highway and transit projects.37

6.6.3 Policy Options and Recommendations

At this point, it is premature to explore specific options for reestablishing road-related debt capacity for provincial and local agencies until it is determined how jurisdictions will be able to secure and service new debt. Specifically, will the central government authorize new tax mechanisms for road funding that can be implemented at provincial and/or local levels, and if so, will the revenues the new sources generate be targeted, at least partially, at capital improvements? Also, does the PRC intend to change current banking laws to allow central government road funding allocations to serve as a guarantee and repayment source for bank loans?

Assuming the answer to one of the above-posed questions is supportive of provincial and local debt programs, research and analysis will be needed to support development of rules, policies, and guidance. Examples of questions this research and analysis will need to address include: t Debt Levels. What standards or requirements should be established to ensure provincial and local governments do not become overleveraged (e.g., total annual debt service to be not more than some percentage of total annual revenues)? How could these standards or requirements be set and who should enforce them? t Use of Debt. What types of projects are suitable for debt financing? Should agencies have to meet specific requirements to use debt financing for a project (e.g., showing they have adequate funding streams to pay for ongoing maintenance and operations on a pay-as-you- go basis)? t Sources of Debt Repayment. What funding sources should be used to secure debt and/or provide debt service payments? What legal, policy, or other changes are needed to facilitate this use? t Central Government Role. What should be the role of MOT, MOF, or other central government agencies in monitoring or directing the use of debt by provincial and local roads agencies?

36 State and local government debt issues are typically tax-exempt, meaning debt holders do not have to pay taxes on interest earnings. 37 The US federal credit program is known as the Transportation Infrastructure Financing Investment Act or TIFIA. 70 Financing Road Construction and Maintenance after the Fuel Tax Reform

6.7 Fund Management 6.7.1 Background and Policy Objectives

Revenues from both the VPT and the new fuel taxes are now deposited in the general treasury of the PRC’s central government, with annual spending levels approved by the National People’s Congress. While annual spending on roads is generally based on the level of revenues from the VPT and fuel taxes, there is no direct accounting mechanism to isolate these revenues (and possibly revenues from other sources) and ensure they are spent on their intended purposes.

The lack of a well-defined accounting mechanism for road funding (e.g., a road trust fund) leads to reduced clarity and greater uncertainty on whether all user charges will be allocated for road purposes and what level of annual funding will be available for distribution. This uncertainty has generated concerns among provincial and local officials in that they may not receive sufficient resources to fulfill plans and meet demand for improvements, maintenance, and debt repayment. It also has made construction planning and effective asset management more difficult. This, in turn, can impair the ability of provincial and local road agencies to plan and implement their programs effectively, and may create barriers to leveraging centrally collected road revenues through the issuance of bank loans. As such, objectives for establishing a better methodology to manage and account for central government road funding may include: t Institutional Consistency. Establish a fund management mechanism that works within the context of current PRC laws, policies, and practices. t Transparency. Provide a visible and understandable accounting of all relevant road funding sources. t Predictability. The fund management approach should assist provincial and local road agencies in estimating the level of funding they will receive. t Flexibility. The mechanism should provide the central government with appropriate flexibility to integrate the treatment of centrally collected road funds with broader government-wide financial or other policies.

6.7.2 International Experience

Because most developed countries fund transportation from their general budgets rather than from dedicated sources, there is limited international experience on the management of road user taxes. In addition, the structural needs for a dedicated highway fund and the potential benefits depend on the unique policy-making and budgetary processes of individual countries.

That said, Japan, New Zealand, and the US all maintain special budgetary accounts that hold revenues from road user fees and help ensure highway taxes are not diverted to nonhighway purposes. In the US case, the Federal Highway Trust Fund (FHTF), created in 1956, is used to manage and account for all revenues from dedicated national motor fuel taxes and truck user fees and is viewed as a key to the success in expanding the interstate system. The FHTF allows the US Department of Transportation to make multiyear funding commitments to state and local Policy Options and Recommendations 71 governments for programs and projects, and thus enhances the transparency, predictability, and stability of road funding. It should also be recognized, however, that funding sources for the FHTF have not been increased in nearly 15 years and that the FHTF is currently insolvent without general fund transfers.

6.7.3 Policy Options

Options for improving the transparency and certainty of road fund management include: t Minor Revisions to Current Structure. Maintain the basic current structure for collecting, accounting for, and disbursing road funding, but establish more transparent accounting and reporting practices. t Establish a Trust Fund. Create a national road trust fund and establish policies and procedures for implementing it.

6.7.4 Recommendation and Next Steps

In general, the improved transparency and level of additional commitment provided by having some form of road trust fund will be superior to minor structural changes in how funding is accounted for. It is therefore recommended that the PRC adopt a special fund for central government road user charges.

It should be noted, however, that the lack of a road trust fund or similar accounting mechanisms is not the only consideration: i. The fuel tax reform is new and thus has no history, so officials do not know what to expect. However, they should be more comfortable with the tax and the implementation methodologies as time passes. ii. The central government has only limited ability to estimate future annual fuel tax revenue levels, but this should improve as more historical data become available and estimating methodologies are improved. iii. The fact that the tax reform was implemented during an economic downturn has led to less overall fuel tax revenue being collected than expected. This has created a gap between expectation and reality that will likely go away as the economy recovers and growth in fuel consumption, and hence fuel tax revenue growth, returns to a brisk pace. Nonetheless, officials must also learn to accept that there is inherent variability in the annual revenue levels the fuel tax will provide.

Additional research is needed to inform the further exploration of fund management options. Specifically, the potential benefits and structural requirements of a road trust fund or similar fund management mechanism need to be evaluated within the context of the PRC’s broader policy development and budgeting processes. 72 Financing Road Construction and Maintenance after the Fuel Tax Reform

6.8 Organizational Capacity 6.8.1 Background and Policy Objectives

The current organizational structure and institutional capacities of the MOT, relevant sections of the MOF, and provincial and local road agencies were established to support a highly decentralized, locally funded highway program. Depending on the directions the central government takes on some of the other policy issues discussed in this report, these structures and capacities may not be suitable or adequate to meet future role and responsibility requirements. At this point, too little is known about future policy changes that could influence organizational requirements to develop specific options. As options and preferences become clear, however, significant consideration should be given on how organizational elements and resources need to evolve. In doing so, the PRC would need to consider objectives it wants associated central government agencies to achieve in the following areas: t Accountability. What is the central government’s interest and role in ensuring national road funding is spent efficiently and effectively? t Oversight and Compliance. What organizational changes are needed to ensure provincial and local road agencies comply with national policies, standards, and requirements when using central government road funds? t Alignment with National Priorities. How can the central government best ensure that national road funding is used to accomplish national-level transportation and broader priorities? t Technical Assistance. How will the MOT position itself to better respond to changing technical assistance needs resulting from a more centralized road funding approach?

6.8.2 International Experience

Developed countries vary widely in the roles and associated organizational capacity of their national government road agencies. The UK’s Road Agency is directly responsible for operating, maintaining, and improving the UK’s strategic road network. As such, it has a large staff, about 3,800 people, composed of both headquarters and field personnel directly involved in implementing projects and operating the system. Germany’s Road Directorate has similar responsibilities and a comparable structure.

The US Federal Highway Administration does not implement most highway projects—projects are primarily implemented by state and local transportation agencies. Instead, the agency develops national road policies and provides technical assistance to state and local agencies, and conducts a significant level of state- and local-level accountability and oversight activities to ensure federal road funds are spent as intended and all federal requirements are met. To accomplish this dual role, it has a staff of about 2,800 divided between headquarters, five regional resource centers, and division offices in every state. Policy Options and Recommendations 73

6.8.3 Next Steps

A major benefit of centralizing the collection of road charges and the allocation of road funding is that it provides the central government with justification and means to ensure limited road resources are spent efficiently, effectively, and in accordance with national goals and priorities. To date, the bulk of the fuel tax reform is focused on imposing the new tax and allocating the funding. As implementation of the fuel tax reform evolves and the central government’s understanding of what it wants to achieve as regards the areas identified above becomes clearer, additional research will be required to assess and develop a plan for addressing the MOT’s, and possibly the MOF’s, changing organizational capacity needs. Specific areas where research may be warranted include the following:

t Organizational Capacity. Are the MOT and other relevant central government agencies such as MOF organized appropriately, and do they have the staff skills, management systems, and resources to effectively oversee and support a centralized road funding program? What changes are needed and what are the implications of implementing these changes? t Performance Management. Should performance targets be established for different elements of the road system (e.g., congestion, pavement condition, bridge condition, safety, etc.) and/or program administration (e.g., program administration costs, on-time and/or on-budget projects, etc.)? If so, how should the measures be applied and how would this influence program administration and organizational considerations? References

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74 Financing Road Construction and Maintenance after the Fuel Tax Reform

This study explores several fundamental issues associated with the implementation of the fuel tax reform initiative in the People’s Republic of China and the improvement of the sustainability of the country’s highway programs. It identifies and explores high-level policy issues, options, and future research needs associated with financing ordinary and rural road construction and maintenance. The research includes an assessment of the impacts, successes, and challenges of the fuel tax reform to date, and identifies areas where additional steps and actions may be required to improve program sustainability and effectiveness. The study also examines applicable experiences from developed and developing countries and suggests policy recommendations.

About the Asian Development Bank

ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes, it remains home to two-thirds of the world’s poor: 1.7 billion people who live on less than $2 a day, with 828 million struggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth, environmentally sustainable growth, and regional integration. Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants, and technical assistance.

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