Fiscal decentralization and local expenditure poli

FiscaldecentralizationandlocalexpenditurepolicyinChina☆JunxueJIA1,QingwangGUO2,JingZHANG⁎ChinaFinancialPolicyResearchCenter,SchoolofFinance,RenminUniversityofChina,59ZhongguancunStreet,Beijing100872,ChinaarticleinfoabstractArticlehistory:Received24March2012Receivedinrevisedform10January2014Accepted10January2014Availableonline21January2014Sincethetax-sharingreformin1994,theChinesefiscalsystemhasexhibitedamarkedverticalfiscalimbalance—amismatchbetweenexpenditureandrevenueassignments—atthelocallevels,whichmaycausethecommon-poolprobleminlocalgovernments'behavior.Usingalargefiscaldatasetatthecountylevelfrom1997to2006,thispaperstudiestheeffectsoffiscaldecentralizationonlocalexpenditurepolicyandanalyzeshowtheverticalfiscalimbalanceshapestheseeffects.Theestimationresultsshowthatexpendituredecentralizationincreasesgovernmentspendingandleadstoafundallocationwithalargerweightoncapitalconstructionandsmallerweightsoneducationandadministration.Incontrast,revenuedecentralizationhaslittleinfluenceonlocalgovernmentexpenditures.Weshowthatthedifferencesintheeffectsofexpenditureandrevenuedecentralizationcanbeattributedtothedistortionaryeffectscausedbytheverticalfiscalimbalanceand,thus,offersupporttotheimportanceofthecommon-poolproblematthecountylevelofChina'sfiscalsystem.©2014ElsevierInc.Allrightsreserved.Keywords:FiscaldecentralizationLocalexpenditurepolicyCommon-poolproblemVerticalfiscalimbalance1.IntroductionConventionalwisdomholdsthatfiscaldecentralizationenhancesgovernmentefficiencybyrestrainingthesizeofpublicsectorsorbyprovidingpublicgoodsthatbettercatertolocalresidents'preferences(Brennan&Buchanan,1980;Hayek,1948;Oates,1972;Qian&Roland,1998;Tiebout,1956).However,whetherthebenefitsoffiscaldecentralizationdomaterializedependsoncomplementaryinstitutionsinacountry(Rodden,Eskeland,&Litvack,2003).Infact,onestrandoftheliteraturearguesthatfiscaldecentralizationcouldboostgovernmentsizeifgovernments'expenditureandrevenueresponsibilitiesarenotadequatelybalanced,whichhasbeendescribedasthecommon-poolproblem(Ehdaie,1994;Grossman,1989;Rodden,2003;Stein,1999).Inadditiontotheoveralleffects,howdifferentcomponentsofgovernmentexpenditures(forexample,spendingoncapitalconstruction,educationorsocialsecurity)reacttofiscaldecentralizationisanotherimportantissuethatisunder-explored.Understandingtheeffectsoffiscaldecentralizationonspecificcomponentsoffiscalexpendituresshedslightonthepreferenceofthelocalgovernmentswhentheyaregrantedmoreautonomy.Indeed,ithasbeenconjecturedthatlocalgovernmentstendtoinvestintheexpenditurecategoriesthatareusefulforattractingmobilefactorsandtoneglectthosebenefitingimmobilefactors(Keen&Marchard,1997).Whetherthisconjectureholdsisofinteresttobothresearchersandpolicyadvisors.Theexistingempiricalevidenceontherelationsbetweenfiscaldecentralizationandgovernmentexpenditureismainlybasedoncross-countryorstate-leveldata(forexample,Ehdaie,1994;Fiva,2006;Jin&Zou,2002;Oates,1972,1985;Rodden,2003;Stein,1999).3Nevertheless,itisreasonabletoexpectthatacountry'spolitics,history,culture,andotherinstitutionscansimultaneouslyaffectthelevelsoffiscaldecentralizationandgovernmentexpenditure.Forinstance,anewgovernorwhosupportsthefreemarketandcompetitionwouldalterthefiscalstructurebyallowingamoredecentralizedgovernancemode.Meanwhile,becausethenewChinaEconomicReview28(2014)107–122☆TheresearchissupportedbytheFundamentalResearchFundsfortheCentralUniversities,andtheResearchFundsofRenminUniversityofChina(2013030214).⁎Correspondingauthor.Tel.:[phone];fax:[phone].E-mailaddresses:[e-mail](J.Jia),[e-mail](Q.Guo),[e-mail](J.Zhang).1Tel.:[phone];fax:[phone]Tel./fax:[phone]Thesestudiesincludecross-sectional,timeseriesandpaneldataanalysis.1043-951X/$–seefrontmatter©2014ElsevierInc.Allrightsreserved.(WorldBank,2002;Xu,2011;Zhang,2006).Particularly,sincethe1994tax-sharingreform,China'sfiscalsystemhasdemonstratedastrongmismatchbetweenexpenditureandrevenueresponsibilities,thatis,verticalfiscalimbalance.Thisspecificgovernancestructurewithasignificantverticalfiscalimbalanceprovidesuswithaninterestingcontexttoexaminetherelevanceofthecurrenttheoriesoffiscaldecentr