Rising Chinese regional income inequality: The role of fiscal decentralization

This article examines the quantitative effects of the Chinese fiscal system on the increasing regional income inequality in China, from 1978 to 2007. Fiscal decentralization is a multifaceted concept not likely to be captured by a single measure. This paper investigates the evolution of three aspects of fiscal decentralization including spending decentralization, revenue decentralization, and autonomy power, and tests the effects of each aspect on the regional income inequality in China in the past thirty years. Several critical findings were obtained through econometric analysis. The fiscal decentralization on spending side in China has contributed to rising income inequality over the last three decades. On the revenue side, the fiscal system became more decentralized from mid-1980s to 1994, and re-centralized after the 1994 tax sharing reform. The econometric analysis shows that the increase in revenue share of local governments from mid-1980s to 1994 indeed increased regional inequality, while the revenue re-centralization in 1994 only had a modest effect on reducing regional inequality. In terms of autonomy power measured by how public spending at local level of government is maintained by its own revenue, the degree of fiscal decentralization decreased since mid-1980s, and experienced a sharp reduction in 1994 due to the tax sharing reform. The autonomy power has mixed effects on regional inequality in the two periods, before and after the 1994 reform, depending on the targeting of fiscal transfers and the incentives of local governments. As it turns out, fiscal decentralization may not be automatically equalizing or anti-equalizing, whereas how fiscal decentralization is promoted is important for how it impacts regional inequality.