View metadata, citation and similar papers at core.ac.uk brought to you by CORE provided by Research Papers in Economics Dipartimento di Politiche Pubbliche e Scelte Collettive – POLIS Department of Public Policy and Public Choice – POLIS Working paper n. 66 January 2006 Fiscal federalism in big developing countries: China and India Angela Fraschini UNIVERSITA’ DEL PIEMONTE ORIENTALE “Amedeo Avogadro” ALESSANDRIA FISCAL FEDERALISM IN BIG DEVELOPING COUNTRIES: CHINA AND INDIA Angela Fraschini University of Eastern Piedmont - Italy Abstract In South and East Asian countries a highly centralized government prevails, although recently some trends are moving toward a greater degree of decentralization. Also the two giants China and India, which cannot rely on a merely centralized Government, have experienced a greater or lesser degree of fiscal unionism. As to China the local government system provides four levels: provincial level; city level; county level; township level. Intergovernmental fiscal relations were revamped by the 1994 reform that established a new tax sharing system and gave local governments more control over the administration of local taxes but no significant degree of tax autonomy and no substantial expenditure assignments. The local financial revenue mainly derives from local taxes, shared taxes, and non- tax revenue. As to India, the federal system is quite complex. The center-states relations are envisaged in the Constitution also for the financial aspects: two constitutional amendments adopted in 1992 made India one of the most politically decentralized countries among developing ones. However, the implementation of the decentralization program is still lagging: till now India seems to have considered decentralization mainly in terms of the local election system, without the transfer of all functions provided for devolution to local bodies. Only India set up a different system of local bodies in rural and urban areas with different expenditure responsibilities and financing powers. On the contrary, China has a unitary fiscal system. In India it is necessary to redesign the transfer system to improve accountability, incentives and equity, whereas in China, the fiscal revenue sharing schemes limit intergovernmental budget transfers. Finally, the rule of hard budget constraint in China is faced by all levels of government, while in India sub-national governments face soft budget constraint. JEL Classification numbers: H11, H71, H77 Key words: State and Local Governments, Intergovernmental Relations, Asia, China, India E-mail Address: [email protected] Tel +39-0131-283711 – Fax. *3704 1. Introduction China and India are the two biggest developing countries in South-East Asia. Although different as to their historical, institutional and cultural developments, these enormous countries cannot rely on a merely centralized Government, due to the extension and the striking existing differences among their regions, more than once populated by some hundred million people. Therefore, both the countries share a greater or lesser degree of fiscal federalism or, better, of fiscal unionism. We compare the different institutional arrangements of fiscal decentralization in China and in India, focusing on the financing (own resources, share to central taxes, grants, equalization systems) of sub-national layers. The two countries have different typology of decentralization. As to China the local government system provides four levels: provincial level, which is the highest local level and includes provincial, autonomous regions and municipal governments; city level, which includes cities under the jurisdiction of the provinces, autonomous prefectures and districts under the jurisdiction of municipal governments; county level, which includes autonomous counties, counties and towns; township level, which is the lowest level and includes towns and villages. Intergovernmental fiscal relations were revamped by the 1994 reform that established a new tax sharing system that fundamentally changed the apportionment of tax revenue between the central and provincial governments. The local financial revenue mainly derives from local taxes (such as business tax, personal income tax, tax on the use of urban land, tax on real estates, tax on agriculture and special agriculture products, etc.), shared taxes (value added tax, stamp tax and tax on resources other than the ocean petroleum resources) and non-tax revenue (fees, penalties, subsidies, other income, etc.). Notwithstanding the reforms, the fiscal system is still unitary. Nevertheless, local government is increasingly playing a part in local economic development and some local governments are beginning to exercise influence on central government. As to India, the federal system is quite complex, as a consequence of regional disparities and of both vertical and horizontal fiscal imbalances. The center-states relations are envisaged in the Constitution also for the financial aspects and the assignment of tax power is based on the principle of separation. Local governments have different institutional arrangements in rural and urban area, in accordance with the two 1992 constitutional amendments that made India one of the most politically decentralized countries among developing ones. However, in practice the implementation of the decentralization program is still lagging, especially in rural areas. Major taxes levied by urban local bodies, which have greater tax power than the rural ones, are tax on property including service levy for water supply, conservancy, drainage, lighting and garbage disposal; tax on entry of goods into a local area for consumption use of sale therein, known as octroi; tax on professions; tax on vehicles (other than motor vehicles). 1 Finally, in the last section we conclude by comparing fiscal federalism arrangements prevailing in these so big and still developing countries with the rules that should be followed to implement fiscal decentralization. 2. A short synopsis of administrative divisions and taxes by level of government Shortly speaking, the governmental systems that characterize the two countries are quite different: China is a communist state that is increasingly opening to areas of free-market, India is a federal democratic republic. Nevertheless, the countries have different levels of government and administrative divisions, as shown in Table 1. 3. China and India: a comparison China and India are the world’s two largest nations1 and, from an historical point of view, there are a number of similarities between the two countries: ancient civilizations that were, at one time, the richest in the world, declining in the second half of the second millennium and starting their way to modernity in the middle of the last century. Moreover, many general similarities existed between the economies of China and India at the time the Communists assumed power in China in 1949 and India achieved its independence in 1947. Until the 1980s of the last century the economic performance of China and India was not much different (also per capita GDP was similar) and both the countries experienced economic reforms that led to a growth’s acceleration. In particular, during the period 1952-80 the two countries grew at about the same GDP rate because the slow growth of the Chinese agriculture and service sectors smoothed its fast growing industrial sector. Under the leadership of Deng Xiaoping, in 1980 China initiated economic reforms, a decade earlier than India, and as a consequence its economy grew at double the rate of growth of India during the 1980s and the early 1990s. Thus since few years there is a growing gap between the performance of the two giant countries and in 2003 the per capita GDP2 was estimated to be $ 5,000 in China and $ 2,900 in India (see CIA, The World Factbook). This result is not only imputable to a 1 According to the estimated data of The World Factbook, on July 2004 the population of China was around 1,299 million and that of India was around 1,065 million. 2 GDP on a purchasing power parity basis divided by population as of 1 July for the same year. 2 faster GDP growth, but also to a lower population increase, thanks to the one-child policy implemented in China. For a short comparison of selected items see Table 2. Moreover, the two countries have a different government type though both have a multi-level government. China is a “socialist state under the people's democratic dictatorship led by the working class and based on the alliance of workers and peasants” (art. 1 of the Chinese Constitution). According to article 30 of the Chinese Constitution, the administrative division of the People's Republic of China is as follows: a) the country is divided into provinces, autonomous regions, and municipalities directly under the central government (these latter and other large cities are divided into districts and counties); b) provinces and autonomous regions are divided into autonomous prefectures,3 counties, autonomous counties and cities; c) counties and autonomous counties are divided into townships, nationality townships, and towns. The state may establish special administrative regions when necessary. As shown in Table 1, currently China has 23 provinces (considering Taiwan the 23rd), five autonomous regions and four municipalities, while Macau and Hong Kong are special administrative regions.4 Then the modern Chinese system5 includes a share of authority between the central and local governments, providing a partial basis for