Local fiscal pressure and government expenditure efficiency: the reform of income tax sharing as a quasi-natural experiment

XU Chao PANG Yumeng LIU Di

【Abstract】Since the establishment of the tax-sharing system in 1994, the relationship between China’s central and local governments has evolved according to the principle of an upward shift of fiscal power and a downward shift of administrative power. Several major fiscal and tax system reforms, such as the income tax sharing reform, the abolition of the agricultural tax and the replacement of the business tax with a value-added tax, have greatly weakened the original fiscal power of local governments. In addition, because many government expenditure responsibilities are derived from the restructuring of state-owned enterprises and the process of urbanization, local fiscal pressure is becoming increasingly apparent. On the supply side, unprecedented tax and fee reductions have occurred in various regions, making the challenges that local finances face more severe. Finance is the foundation and an important pillar of national governance. Fiscal pressure has weakened the ability of local governments to perform macroeconomic regulation and to supply public services, which is not conducive to local economic development and social stability. Therefore, it is urgent to seek solutions to the problems that local governments face in their finances. Theoretically, local governments can ease their fiscal pressure by increasing their tax collection efforts, increasing land finance and other sources of revenue or by improving the efficiency of the use of fiscal funds. Most scholars focus on the various income-increasing ways, ignoring the efficiency of fiscal expenditures, which is not conducive to the comprehensive interpretation of the strategies that local governments use to cope with fiscal pressure. This focus also makes it difficult to grasp the self-decompression space for local governments accurately. Against this background, we systematically examined the impact of local fiscal pressure on government expenditure efficiency and revealed the transmission mechanism between the two. We performed a quasi-natural experimental analysis based on panel data of prefecture-level cities in China with exogeneity coming from the 2002 income tax sharing reform. We have obtained the following results. (1) The relative fiscal pressure caused by the income tax sharing reform significantly improves the expenditure efficiency of local governments and the effect of the reform shows an inverted U-shaped evolution trend. (2) The impact of local fiscal pressure on the efficiency of government expenditures is not constant; the impact of local fiscal pressure on the efficiency of government expenditures decreases with the improvement in the efficiency of expenditures and increases with the intensification of inter-governmental competition. (3) Under “pressure-type” fiscal incentives, local governments tend to improve their expenditure efficiency by strengthening government audit supervision rather than by optimizing the expenditure structure. This study has important reference value for the comprehensive interpretation of local governments’ behavior in response to the “pressure-type” of financial incentives and provides an important theoretical basis for the implementation of preferential support policies by the central government. We have made four contributions in this paper. First, unlike most studies focus on local governments’ strategies of reducing pressure by increasing revenue, we systematically examined the impact of local fiscal pressure on government expenditure efficiency. This focus parallels research on local government behavior under the Chinese “pressure-type” system and is a horizontal expansion of this theme. Second, we used the 2002 income tax sharing reform as an opportunity to capture an exogenous change in financial pressure and overcome the endogeneity problem. Compared with the literature, we fully considered the tax-sharing problem between the provincial and lower levels of government and the pressure index we constructed was more accurate and effective. Third, using the dual perspective of fiscal fund allocation and supervision, we examined how local fiscal pressure affects the efficiency of government expenditures and provided a preliminarily answer to the key question of how to improve the efficiency of local government expenditures with “pressure-type” fiscal incentives. Finally, we revealed the potential incentives behind the audit and supervision of local governments from the perspective of political economy.

【Keywords】 fiscal pressure; efficiency of fiscal expenditure; structure of fiscal expenditure; audit supervision;


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Vol 55, No. 06, Pages 138-154

June 2020


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