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Current Fiscal Situation and Current Fiscal Situation and Reform in ChinaReform in China

YUAN Guangrui

Deputy Director-General Administrative Department

Ministry of Finance, PRC May 26, 2005

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Current Fiscal Situation and Current Fiscal Situation and Reform in ChinaReform in China

1. Mechanism of stably increased fiscal income has initially been formed

2. Building up of public finance system has gained substantial progress

3. The macro-economy-management effect of financial policy is evidently strengthened.

4. Next step of the fiscal reform

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I.I. System of tax distribution System of tax distribution in fiscal mechanismin fiscal mechanism

The evolution of system of tax distribution

The fiscal management system of traditional plan economy: “centralized revenue collection and centralized fiscal transfers”.

China began the reform in fiscal contract system during the economic transitional period.

China carried on tax assignment system and different-level management system which are universally approved since 1994

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Different-level management system whereby tax revenues are shared by central and local authorities

Clarification of expending responsibility between the central and the local

Central finance mainly takes responsibility for the costs of national security, diplomacy and central government operation, regulates the structure of national economy, coordinates local development, carries on the necessary expense of macro-control, and social development expense controlled by the central.

Local finance mainly takes responsibility for the expense needed by the local government operation and cost of local economic and social development.

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Separate the central revenue from the local revenue

The central fixed revenue includes: tariff, value-added tax from import, consumption tax, income tax from the central enterprises and the non-bank financial enterprises, and the profit tax from the central enterprises.

The local fixed income includes: business tax, income tax payable and profit tax from the local enterprises, individual income tax, tenure tax payable, and direction-adjustment tax of fixed capital investment.

The income shared by the central and the local: value-added tax, resource tax, and stock-exchange stamp tax.

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II.II. System of fiscal transfer payment in System of fiscal transfer payment in governmentsgovernments

The tax assignment system in 1995\4 regulated the amount and form of fiscal transfer payment in governments, and emphasized the build of tax-return system (some tax revenue collected by the central government has been transferred back to local)

Since 1995, system of fiscal transfer payment in transitional period was built, and standard concept of fiscal income and outcome was applied.

Since 2000, central government set transfer payment in minority areas in order to settle special problems there

Since 2002, transfer payment in transitional period was renamed as general transfer payment.

At present, a kind of relatively standard inner-government transfer payment has been formed, including tax return, financial and special transfer payment targeted equality and balance.

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III.III. Reform of tax systemReform of tax system

Important reform of tax system in 1994 A new turnover tax system which takes value-ad

ded tax as its core with consumption and sales tax as its supplement has been established

Income tax payable of state-owned enterprises is unified

A unified individual income tax is established

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Other Tax Reforms the scope of resources tax was expanded, and its tax burde

n is adjusted. The salt tax was included in resources tax. VAT is levied on the use of land, to control the margin pr

ofit of the real estate sales. Some minor taxes were stopped, e.g. taxes on market tradi

ng, cattle trading, special tax on the use of oil, tax on bonus and salary adjustment.

Special consumption tax was included in consumption tax categories, and the administration of the taxes on livestock and banquet was delegated.

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Efforts are continued to improve tax system

Individual income tax on personal deposit interests was resumed. The tax for adjusting the direction of fixed-asset investment was st

opped temporarily. The business tax rate for the finance and insurance sector was redu

ced from 8 percent to 5 percent in three years. After a few reductions, the stamp tax rate on stock exchange trans

actions was cut down to 1‰ The tax on automobile purchase replaced the fee on such purchase. The tax and fee reform in rural areas were carried on, and the agric

ultural tax would be scrapped Tariff rate continued to reduce to fulfill China’s WTO commitmen

ts. The export rebate system was reformed last year, with the rebate r

ate cut down by 3 percentage points.

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Current Fiscal Situation and Current Fiscal Situation and Reform in ChinaReform in China

1. Mechanism of stably increased fiscal income has initially formed

2. Build up of public finance system has made substantial strides

3. Fiscal policy has been effective in term of macro-control.

4. Next step of the fiscal reform

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I.I. Unit budget-making continued to be Unit budget-making continued to be reformedreformed

Unit budget-making The reform of unit budget-making was started i

n 1999. In 2000, all central units made their unit bud

get, which included basic spending budget and project spending budget. 4 unit budgets were selected and reviewed by the National People’s Congress.

In 2003, the pilot reform on basic spending and “fixed number of person and fixed quota” system was expanded to 118 secondary quasi-government agencies。

In 2004, 5 central units were selected for the pilot reform of fixed quota of materials expenditure, and the time for budget-making was extended to 8 months.

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The reform of category of government income and spending

In 2001, the category of budgetary spending was improved according to economic classification.

In 2002, the 12 categories of budgetary spending were increased to 44 categories.

In 2003, The plan for Reform of Category of Government Income and Spending was completed, and the new system consisted of income categories, functional spending categories and economic spending categories.

In 2004, top categories and items under functional spending categories were adjusted to reflect the functional activities of the government agencies in a more detailed manner. State Development Planning Commission, Ministry of Commerce ， Ministry of Water Resources，Ministry of Science and Technology made their budget of 2004 using the new categories.

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Reforming the administration of “separately managing the revenue and expenditure”

In 2002, 15 central units were selected for pilot reform of the collection of non-tax revenue. By the end of 2003, 35 central units and 26 provinces had implemented the pilot reform.

In 2004, more than 7 central units joined the pilot reform, and 62 fees collected by 26 units were included in the budget management.

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II.II. The reform of centralized treasury revenue The reform of centralized treasury revenue and payment progressed steadilyand payment progressed steadily

The reform of centralized treasury payment

The reform of centralized treasury payment was started in 2000. by the end of 2003, 80 central government agencies had joined the reform, and in 2004 60 more joined.

By the end of 2004, 140 out of 160 central government budget-making units and more than 2600 local ones joined the reform. Over RMB 250 billion on budget were involved in this reform.

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The reform of treasury income management From 2002, 35 central government agencies join

ed the reform by three steps, whose non-tax income is transferred directly to the fiscal account.

By the end of 2004, 47 out of 60 central government agencies who has non-tax income had joined the reform.

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Advancing reform in local governments 30 provinces, over 1500 provincial government a

gencies and over 6000 lower level agencies have joined the reform of centralized treasury payment.

Over 150 local government agencies (lower than provincial level) joined the reform of centralized treasury payment.

10 provinces are carrying out their reforms on non-tax revenue.

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III.III. Deepening reform on government Deepening reform on government procurement systemprocurement system

The government procurement system expanded rapidly

in 1996, the pilot reform of government procurement system was started in some provinces.

The promulgation of Law of Government Procurement on 1 Jan, 2003 marked the full implementation of the government procurement system.

The government procurement system now covers county and municipal governments.

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The scope and amount of government procurement increased

The scope of government procurement expanded from commodities to construction projects and services.

The amount also increased, from RMB 13 billion in 1999, RMB 65.3 billion in 2001, RMB 150 billion in 2003, to over RMB 200 billion in 2004.

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More healthy management of government procurement

Execution is separated from the management system of government procurement. By the end of 2004, 26 out of 36 provinces and cities in plan had had separated execution bodies from the management bodies. Such separation plans are being studied and outlined in other local governments.

The procurements are more transparent and fair. In 2004, more than 60 percent of the procurement was achieved through open bidding, and over 70 percent of all procurements were centralized ones. Spending was saved by about 10 percent in doing so.

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IV.IV. The fiscal structural reform The fiscal structural reform progressed steadilyprogressed steadily

The function of public finance was adjusted. Direct investments in the competitive sectors were reduced, and spending in the public sectors were secured.

The structure of spending was optimized. Spending on public security, technology advancement, education, agriculture and social welfare were increased. Less and less public finance is involved in the fields of manufacture or business, reflecting the characteristic of public finance.

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Current Fiscal Situation and Current Fiscal Situation and Reform in ChinaReform in China

1. Mechanism of stably increased fiscal income has initially formed

2. Build up of public finance system has made substantial strides

3. Fiscal policy has been effective in term of macro-control.

4. Next step of the fiscal reform

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I. From1993 to 1997:I. From1993 to 1997: Moderately Moderately tight fiscal policy tight fiscal policy

The excessive economic growth in 1993 Excessive monetary supply with financial instability: From January to

June 23, the net issuance of RMB amounted to 58.5 billion, an increase of 53.2 billion on year ago.

Both investment and consumption boosted: from Jan to May, investment by SOE in fixed-asset increased by 69.3 percent on year ago; the banks’ cash disbursement for personal remuneration and other personal businesses increased by 36.4 percent; the administrative units’ overhead cost in cash increased by 89.4 percent. These indicators all exceeded the economic growth by far.

More constraints caused by lack of infrastructures and industrial production: the railways then was only able to meet 30 percent to 40 percent of the total need for railway transportation.; the price of steel, cement and timber hiked due to excessive demand.

Inflation accelerated: from Oct last year, the growth of consumer price increased on a monthly basis, exceeding 10 percent in March and reaching 12.5 percent in May. In the first five months, the raw material price index increased by 43 percent.

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Moderately tight fiscal policy

Holding down the fiscal deficit by moderately cutting down the spending, controlling investment in fixed asset and the purchasing power of groups.

To reform the tax system, tax rates and structures were adjusted, and the tax deductions and exemptions were under strictly control, and the expired preferential tax policies were terminated without extensions.

Divided tax collection system was implemented, to increase tax income.

A tighter fiscal regulation and administration, esp. on the fund out of budget.

Supporting the reform of exchange rate, implementing a regulated, single floating exchange rate based on market demand. Improving the export rebate system to boost export.

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Moderately tight fiscal policy effective

A “soft landing” of the national economy in 1996, a 9.6 percent GDP growth, retail price index up by 6.1 percent.

A 8.8 percent GDP growth in 1997, retail price index up by 0.8 percent, a lower price growth rate than the economic growth rate as expected in the Ninth Five Year Plan.

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II. Pro-Active Fiscal Policy Since 1998II. Pro-Active Fiscal Policy Since 1998

In 1998, the Chinese economy was affected by the Asian financial crisis

The increase of outside demand was slowing down: In the first quarter of 1998, the exports increased 12.8%. Since then, the speed of increasing is slowing down. The increase in April, May and June is 7.9% ， -1.5% and 1.6% respectively. The increase in the first half of the year was only 7.6% ， falling 18.6% than the same period last year.

The speed of economic growth was slowing down: both the consumer demand and invest demand were all sluggish, the GDP growth of the first half year was 7%, falling 2.5% than the same period last year.

Trend of deflation ： the CPI has been negative since October, 1997. In the first half year in 1998, the CPI was falling 2.1% than the same period last year.

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proactive Fiscal Policy Measures Issuance of long-term construction treasury bonds, and pushing

up the social investment : from 1998 to 2004, the accumulated issuance mount was 910 billion RMB ， mainly invested to infrastructure and technical innovation. In 2003, the investment from the private sector was stimulated successfully.

Adjusting the tax policy, and pushing up the demand ： For the domestic equipments investment in the technical innovation projects according with the industrial policy, 40% of the investment domestic equipment may be credited from the annual increased parts of the enterprise income tax. To encourage the foreign and domestic investment, imported equipments may be exempted from custom tax and value-added tax . The fixed assets investment direction tax was abolished. The individual income tax of saving deposit interest was resumed, and the tax refund rate for export was increased several times.

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Adjusting income distribution policy, and improving the consumers expectation ： adjusting the wages of employees in the government agencies four times, setting up allowance system for those working in the poor region, and doubling the bonus by the end of each year for employees in the government agencies. The average wages per month for employees in public sector almost double. At the same time, the social security payout also increased. In 1998, the payout for those unemployment used for their basic living expenditure, endowment insurance subsidy, and low income subsidy were 12.3 billion RMB. This figure increased as 107.86 billion RMB in 2004, 7.8 times as the year before.

Formalizing the administrative charge system, lessening the social burden: from 1998 to 2003, there were 1805 administrative charge items were cancelled, thus the social burden were lessened 141.7 billion RMB. At the same time, the reform of rural tax and charge was also deepening and formalizing. The burden of farmers lessened for the farmers was above 30%.

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Great Achievements of proactive fiscal policy

The economic growth was pulled up 1 to 2 percent per year. This made the GDP growth stabilize between 7 ％ to 9 ％ each year.

The Chinese economy was walking out of the deflation shadow. In 2003, the CPI increased 1.2% than last year.

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Since the second half year in 2003, the has been over-heating in some area

The supply and demand of food was straining Sharp increase of fixed assets investment Too much increase of loan Supply of coal, electricity and oil was scarce The price was keeping upward Bubble showed in assets prices Huge deficit emerged in foreign trade

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In 2004, the extent and emphasis of active fiscal policy were adjusted

the support of “agriculture, rural areas and farmers ” was increased

The implementation of “two tax reductions, and three subsidies ” spent the central government 45 billion RMB

The expenditure of controlling bird flu was 8.48 hundreds million RMB. A series of supporting policies relating to tax and charges reduction, funds and subsidies were implemented.

Government bonds used for agriculture was 38 billion RMB, accounts for 34.5% in the total increment of government bonds this year.

Increasing the agricultural integrated developing expenditure, implementing the lowest purchasing price for food. The expenditure for education, sanitation, and culture was also increased, mainly being used in rural area. Keeping the price of agricultural materials stable, and supporting the training for rural labor migration.

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Holding the direction and strength of fiscal investments appropriately

According to the principle of “five balanced aspects ”( 五个统筹 ), the expenditure structure of government bonds was adjusted.

The payout progress of government bonds and government investment was slowing down. This year the payment was 45.69 billion RMB.

The payout structure of land transfer revenue was adjusted. Some of the land transfer revenue was used to develop the agricultural land. This policy controlled the expansion speed of cities construction effectively.

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Reform the export tax refund system steadily

The 243.6 billion RMB ,that government owe for tax refund , has been almost paid up

Ensuring the timely pay of new refund tax. The export was accelerated rapidly.

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Increasing the support for the employment, social security, and public sanitation

Increasing the re-employment subsidies of 2. 225 billion RMB from the central budget

The subsidies of basic living expenditures for unemployment were 14.4 billion RMB

Special transfer payment for endowment insurance was 52.4 billion RMB

Supporting the pilot reform of social security system of cities and towns in Jilin and Heilongjiang province.

Supporting the building of new rural cooperation medical and remedy system

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Support the reform of state-owned enterprises actively

Arranging subsidies for bankruptcy and closedown Supporting the pilot reform of separate the social functio

n from the enterprises, in China National Petroleum Corporation (CNPC),, Sinopec, and Dongfeng automobile company.

Supporting national commercial banks in their the financial restructuring and IPO , including Bank of China, China Construction Bank, and Bank of Communication.

Pilot reform of value-added tax in north-east region

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III. Implementation of III. Implementation of prudentialprudential fiscal policy fiscal policy since 2005since 2005

Great changes have taken place in Chinese economy

the independence economic growth mechanism was formed primarily

The function of market mechanism was strengthening obviously: now the mechanism of supply and demand, price mechanism, and competition mechanism were the basic elements in the resource allocation. The private economy was the main force to push the economic growth.

The pace of urbanization was accelerated: in recent years, the people in Chinese town increased 1.4% per year. In 2003, the urbanization rate was 40.5% ， showing that China was in the process of the important period of accelerated urbanization.

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The upgrade of consumer structure was accelerating: In 2003, GDP per capita in China was 1090 US dollars. The consumer structure was in the stage of transforming from “eating, wearing and using” to “living, traveling and touring”. The trend of heavy chemical industry was also emerging.

Developing the opening economy further: In 2004, the reliance of foreign trade was about 70%. China has become the third largest trade country in the world. At the same time, as the main destination of FDI, the china outbound direct investment was also increased rapidly.

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The economic growth entered the upward stage of a new cycle

The economic growth was close to the potential level: In 2003, the GDP growth rate was 9.3%. In 2004, the growth rate was 9.5%. The emergence of bottle-neck constrain or resource constrain showed that, the GDP growth has been close to the potential level.

The price was upward: In 2003, CPI and CRI increased 1.2% and -0.1% respectively than last year. In 2004, the two figures were 3.9% and 2.8% respectively.

The increase of unemployment rate was slowing down: In 2003, the employment in cities increased 8.59 million, and the registered unemployment rate in cities was 4.3%. In 2004, the above-mentioned two figures were 9.8 million and 4.2% respectively. The unemployment rate decreased 0.1 percent than the year before.

Surplus of balance of payment: In 2003, the foreign trade surplus was 25.5 billion US dollars. By the end of this year, the foreign reserves in China were 403.3 billion US dollars. In 2004, the above-mentioned two figures were 32 billion and 609.9 billion US dollars respectively.

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Emergence of serious problems in economic development

Gap enlarged in the process of development: according to the fact of unbalanced and disharmony development in China, Chinese government brought out five balanced aspects, including balancing urban and rural development, balancing development among regions, balancing economic and social development, balancing development of man and nature, and balancing domestic development and opening wider to the outside world

The conflict between economic growth manner and resource constraints was severe ： Chinese GDP in 2003 accounted for 4% of the whole world, but the resources consumption proportional to the whole world were as follows: petroleum 7.4%, coal 31%, iron ore 30%, steel 27%, alumina 25% ， cement 40%.

The reform of economic system lagged : the changing of government functioning was inadequate. The government was still involved in the resource allocation in competition area. The price mechanism in factor market was imperfect, thus underestimated private cost of investment seriously. The reform of enterprises lagged behind, and the budget constraint was still soft. There existed distortion in the enterprises’ operation.

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Basic contents of prudential fiscal policy

Control of deficits: decreasing the central fiscal deficits appropriately, keeping the balance of increment, with tightening and loosing suitably.

Structure adjustments: according to “five balanced aspects”, adjusting the structure of fiscal expenditure and government bonds funding payout

Pushing the reform forward: changing the traditional way of the economic growth, that mainly depends upon the investment from government bonds funding, and supporting the reform of economic systems and innovation of instruction.

Increasing revenue and reducing expenditure: collecting tax strictly and legally, and ensuring the stable growth of fiscal revenue. Strictly managing the fiscal expenditure, and enhancing the efficiency of using fund.

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The fiscal situation and reform The fiscal situation and reform in Chinain China

II、、 The mechanism of stable growth of fiscal The mechanism of stable growth of fiscal revenue has formed preliminarilyrevenue has formed preliminarily

IIII 、、 The building of public fiscal system The building of public fiscal system stepping forward effectivelystepping forward effectively

IIIIII、、 The function of macro adjustment of The function of macro adjustment of fiscal policy was strengthening obviouslyfiscal policy was strengthening obviously

IV、 Basic thoughts of next step reform

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I. Improving the fiscal management of I. Improving the fiscal management of tax assignment system system

Improving the transfer payment manner, and increasing the scale of ordinary transfer. Optimizing the transfer payment structure, and improving the public service level in undeveloped area, to attain the goal of getting rich together.

Improving the local fiscal management of tax assignment system, leading the provincial governments to bear the responsibility of adjusting and distributing the fiscal resources, and enhancing the ordinary transfer payment to fundamental government.

 

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II. Optimizing the tax system furtherII. Optimizing the tax system further

Improving the enterprises income tax system Checking and formalizing the different tax policy for d

omestic and foreign investors, especially the preferential tax policy to foreign investors. The tax policy should be unified with no discrimination for ownership.

In the process of unifying the enterprises income tax for domestic and foreign investors, the preferential tax for the foreign investors now could be retained temporarily for some time. After tax unifying totally, some preferential tax policies would be replaced by industrial preferential policies. In some areas, the preferential rights could be strengthened.

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Reform of individual income tax system Implementing the integrated and classified person

al income tax system steadily. Combining the main income items into the integrated income, and adopting the progressive tax rate.

Adjustment of the tax rate,expenses reduced, tax exemption ,tax collecting and administration ， in order to bring the function of income distribution into play, and to minimize the gap of the individual income.

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Implementing the consumption-based VAT reform

The production VAT did not reduce fixed assets investments, thus dual impose existed

From now on, the production-based VAT would be changes as consumption-based VAT. There would be pilot reform in 8 industries in north-east region, including equipment manufacturing industry. The reform would be expanded to all-over the country steadily. The tax included in the price of the new purchase of equipments would be added to the reduction item of VAT.

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Improving the consumption tax system

Enlarging the imposing scope. The products harmful to the environmental protection, and some luxury consumption goods should be imposed.

According to the economic development and consumption structure, some products consumption tax rate with obvious heavy burden should be decreased. The rates for those products needed to be adjusted further should be increased, in order to form a more reasonable tax rate structure and level.

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Improving the tariff system Fulfilling the promise of entering WTO, the general cus

tom rate level this year would be 9.9%, compared with 10.4% last year. The reduction of tariff has almost been finished.

Studying the property tax There are many tax for real estate in transaction items i

n china now, with fewer tax for the ownership of real estate and the tax burden is low . It is not good for the healthy development of real estate. Therefore, it is necessary to study the reform of property tax, to lead the housing consumption and adjust the wealth gap among residents.

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III. Reform of budget management III. Reform of budget management systemsystem

In budget making, the departmental budget system should be improved further

Pushing forward the classification reform of government revenue and expenditure. Formalizing the classification of revenue, expenditure function, and expenditure economics, to reflect the budget arrangement of each responsibility taken by the governments comprehensively and directly.

Implementing the performance evaluating system for fiscal expenditure, and setting up unified and formalized evaluating rules. Building up performance evaluating index system, basic information database of performance budget , and performance budget system.

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In the aspects of budget executing, the emphasis should be focused on reform of exchequer collective buying & payment system, and the government procurement system

Integrating all the budget unit into the exchequer collective buying&payment system. Formalizing the single account system of exchequer further, studying the way to improve the operation of the exchequer collective buying and payment.

Building and improving the dynamic real time supervision system throughout the country, strengthening the supervision of the whole process of budget execution. Studying the rule of managing the exchequer cash, to improve the efficiency of the operation of exchequer fund.

Fully implementing the reform of government procurement system. Through public bidding and asking, the scope and scale of government procurement could be further enhanced. Formalizing the procurement procedure and manner, improving the management of budget planning of procurement.

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