Economic Reforms and Public Finance In China

Chinese economic growth since the start of the reforms in 1978/9 has been very rapid, yet has encountered severe public finance problems. Incentives have been introduced but many markets are distorted and segmented. While the government has shed responsibilities for investment it has also lost a considerable fraction of its pre-reform tax base - enterprise profits. Subsidies on food (arising from higher rural prices but controlled urban prices) and to loss-making enterprises have mushroomed. Freedom to take decisions at the enterprise level has now resulted in high investment demand and rising wages. Many of the difficulties of changing tax bases, taxation in distorted markets, and long-term tax design arise in other transitional economies and the Chinese experience carries lessons for both opportunities and dangers. This paper provides a brief description of relevant aspects of the pre-reform Chinese economy and of the reforms since 1978/9. The trends of revenue, expenditure and deficits are analyzed both in magnitude and composition. Some aspects of the operation of the tax system are examined together with possibilities for reform through the transition and longer-term design. It is clear that the analysis of either industrial/enterprise reform or the fiscal system, one in isolation from the other, can be seriously misleading.