Summary of Key Points
This article focuses on two central issues: the relationship between the central and local governments in finance, and the role of land-based finance. By analyzing the fiscal contradictions resulting from the tax-sharing system reform, the practical deviations in transfer payments, the evolution of land-based finance, and the associated risks, it proposes a solution for the coordinated reform of fiscal, tax, and land systems. The article argues that the current tax-sharing system leads to a situation where the central government collects more revenue while local governments have to spend more, forcing them to rely on land-based finance. Transfer payments, which are intended to ensure equal access to public services, are often used to support government staff rather than to improve people's livelihoods. Land-based finance has evolved from a mechanism for generating revenue to one for financing, leading to debt risks and imbalances in urbanization. Only by coordinating fiscal and tax reforms at the provincial level with reforms in the land sector (breaking local monopolies) can we transition from a development model based on land to one that promotes harmony between people and land.
I. The Tax-Sharing System: The Battle Over Money between the Central and Local Governments
The 1994 tax-sharing system reform marked a turning point. The central government took 75% of major taxes, such as value-added tax, while local governments were only left with minor taxes like business tax. As a result, the central government's share of fiscal revenue soared from 22% to 55.7%, yet local governments were still responsible for managing essential services such as education, healthcare, and infrastructure, creating a contradiction between centralized revenue collection and decentralized spending.
What did local governments do to address their funding shortages? They turned to "new sources of revenue." Land became a lifeline: local governments monopolized the primary land market, selling industrial land at low prices to attract businesses (with the hope of future tax revenue) and commercial and residential land at high prices for quick profits—this was the "Land Finance 1.0" model. However, this model later became distorted, leading to the financialization of land, with local governments using land as collateral to borrow money and accumulating hidden debts.
II. Transfer Payments: Idealistic Intentions, Realistic Constraints
Transfer payments were designed to be a mechanism for the central government to distribute funds to local governments to ensure that all citizens receive similar levels of public services, regardless of their location. In practice, however, most of the money is used to maintain government operations and salaries of employees within the system.
Why is this the case? Because the evaluation of local officials includes a strict requirement to avoid wage arrears, while improving public services is considered a less important goal. As a result, more transfer payments lead to the creation of idle positions within local governments, with the funds remaining within the system and not benefiting ordinary residents, especially migrant workers. For example, migrant workers in cities often cannot afford to send their children to school or buy homes, forcing them to leave their rural homes and contributing to the hollowing out of rural areas.
III. The Evolution of Land-Based Finance: From a Boon to a Risk
Land-based finance has gone through two stages:
- Version 1.0: Before 2010, local governments used high prices for commercial and residential land to subsidize low prices for industrial land, attracting factories and driving up the value of surrounding land. This strategy helped China rapidly become a global manufacturing hub, and housing prices rose along with incomes, benefiting everyone.
- Version 2.0: After the 2008 financial crisis, stimulus packages led local governments to start using land as a source of financing. They established urban development companies to mortgage land to banks and spend money from future land sales. Land transfer fees increased significantly, with local finances becoming increasingly dependent on land sales. However, this led to rapid urbanization in some areas without a corresponding increase in population, resulting in the hollowing out of new urban areas and soaring housing prices, which increased the risk of bubbles.
IV. Reforming the System: A Collaborative Approach for Finance and Land
To solve these problems, we need to address both fiscal and land policies simultaneously:
- Fiscal and Tax Reforms: Provincial governments should be given more authority to allocate transfer payments based on local needs. The central government should focus on setting minimum standards and conducting audits to ensure that funds are used for public welfare.
- Land Reforms: Local monopolies on land should be broken. Rural collective land should be allowed to enter the market directly, and affordable housing should be built for migrant workers. The requirement that 40% of land must be used for public purposes should be abolished to protect farmers' interests. A national land development rights trading market should be established, allowing developed regions to purchase land from less developed areas, which would protect farmland and provide income for the latter.
Only by advancing these reforms together can we integrate issues related to land, household registration, and finance, and ensure that urbanization is people-centered rather than land-centered.
Conclusion
This article highlights that the development model driven by land has reached its limits. In the future, we need to reform policies and systems to align finance and land with the goal of serving people's needs. Reform is challenging, but it is essential to avoid risks and create the growth momentum for the next thirty years.