The author is a senior economist with Research Department of the World Bank. [File photo]

Fiscal decentralization or centralization is vital component of national economic policy. Many developing countries see fiscal decentralization as an important means to weaken central government's control and move towards sustainable development. This has been a long-term discussion in China. But I believe that China should be cautious of excessive fiscal decentralization.

First, in a political and fiscal environment lacking a transparent democratic supervision system and good local administration, excessive fiscal decentralization will lead higher rates of official graft. Local governments have closer, more direct relationships with local interest groups compared to the central government. Therefore, they have a higher probability of facing direct pressures from interest groups and are more likely of becoming corrupt. Moreover, the opaqueness of local administration and weak media and auditory oversight worsen the situation. For example, there are multiple accounts of power abuse in the distribution of local fiscal resources and public resources in China. This has shaken the public's trust in their government.

Second, excessive fiscal decentralization will widen China's wealth gap. Only the central government can narrow individual income gap. Fiscal decentralization will also affect the country's redistribution policy. Local governments' solutions for income inequality may not be fair, because the poor in underdeveloped regions should have more concerns from the government than those in developed regions. Neither are local governments' policies efficient: their policies are invalid due to the population mobility.

In addition, fiscal decentralization may imbalance regional development. Wealthier regions have a higher tax base. Therefore rich local governments can provide more public services than poor ones under the same tax rate. This makes rich governments richer, while poor local governments fall into a so-called "poverty traps."

Actually, imbalanced income distribution and regional development are major problems facing the Chinese economy. In the early 1980s, China's overall economic reform began with fiscal restructuring. In order to break unified state control over revenues and expenditures, the central government implemented fiscal contracting system throughout its provinces. However, with the growth of local fiscal power, regional economic imbalances are worse than ever. Reforming tax divisions between central and local governments in 1994 was intended to narrow the gap and realize a horizontal fiscal balance. But it ultimately failed.

Last but not least, excessive fiscal centralization will hinder the central government's macro-economic regulation and control of national fiscal policies. Fiscal decentralization demands a clear division of rights and duties between central and local governments, as well as the powerful budget binding to local governments. But central and local governments in many developing economies lack such clear divisions. Local governments often have huge debts and force the central government to bail them out. These kinds of relationships have severely affected the central government's regulation and control of economic planning. The Chinese central government is already been aware of the conflicts between local government expansion and macro-economic control. There are direct and indirect channels for them to transfer their budget deficits to the central governments.

This article was translated by Li Shen. The original unabridged version was published in Chinese.

Opinion articles reflect the views of the authors, not necessarily those of China.org.cn.

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