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Vertical Fiscal Imbalance and Local Fiscal Discipline: Empirical Evidence from China

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Abstract

Using a nationwide city-level panel dataset for China for the years 1999-2009, this paper examines the effects of vertical fiscal imbalances (VFI) on local fiscal discipline and explicitly explores the institutional conditions under which these effects may take place. We find that higher VFI levels induce fiscal indiscipline by reducing tax effort of local governments. We exploit the unique Chinese fiscal institution of assigning taxing power for local taxes and shared taxes to two separate authorities (i.e., the local tax bureau and the central tax bureau, respectively) in several ways. We show that local governments respond to the presence of the VFI by lowering their tax effort on local taxes, but do not do so for shared taxes. In addition, we show that the (in)disciplining effect of the VFI is not present for extra-budgetary revenues, which reflects the institutional fact that extra-budgetary revenues are not considered for the determination of central fiscal transfers to local governments, thus creating no incentive for local governments to respond in this area.

Suggested Citation

  • Junxue Jia & Yongzheng Liu & Jorge Martinez-Vazquez & Kewei Zhang, 2017. "Vertical Fiscal Imbalance and Local Fiscal Discipline: Empirical Evidence from China," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1717, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    • Handle: RePEc:ays:ispwps:paper1717
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    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism

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