The diminishing incentive of ecological fiscal transfer on local government environmental expenditure — Evidence from National Key Ecological Function Zone in China

Ecological Fiscal Transfer (EFT) has proven an effective policy instrument to promote nature conservation through various implementations worldwide. China has introduced EFT in the National Key Ecological Function Zone (NKEFZ) since 2008. While this system aims to compensate for the opportunity cost and incentivize environmental protection, it may face the challenge of limited incentives. This article constructs a utility function for local government fiscal response upon receiving EFT and innovatively incorporates natural regeneration process to examine the marginal utility of local government environmental expenditure (LGEE). The derived hypotheses were empirically tested through two-way fixed effects quantile regression and threshold regression models using balanced panel data from 23 NKEFZ provinces from 2009 to 2022. The results indicate the marginal effect of EFT on LGEE tends to diminish at higher percentiles of LGEE and the policy incentives also significantly drop upon a forest coverage rate threshold of 23.40 %. Further analysis reveals significant EFT incentives on productive spending, suggesting strategic allocation behaviors. This study provides new insights into the effectiveness of EFT policy, highlighting the need for policymakers to adjust policy design to encourage sustained ecological investments, as well as the importance of clarifying local government environmental responsibilities to ensure effective environmental governance.