The central government has called for planning a new round of fiscal and tax reforms, among which the fiscal transfer payment system, whose scale has been increasing year by year and has broken through 10 trillion yuan for two consecutive years, is a focal point of the reform.

Recently, the Institute of Fiscal Science at Renmin University of China and the China Center for Fiscal and Financial Policy Research held an online forum to discuss how to improve the intergovernmental transfer payment system. Controlling the scale of transfer payments and enhancing the efficiency of fund use have become hot topics.

Controlling the Scale

Fiscal transfer payments refer to the funds that higher-level governments allocate to lower-level governments without compensation, including both central government transfers to local governments and transfers from higher-level local governments to lower-level ones. These are mainly used to address regional fiscal imbalances and promote the equalization of basic public services across regions. They are an important policy tool for the government to achieve regulatory goals.

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To accommodate the changes in local financial resources caused by the 1994 tax-sharing reform, the central government began to establish the transfer payment system. The scale of central government transfers to local governments was only a few hundred billion yuan, but in the past two years, this scale has exceeded 10 trillion yuan, with an expected 10.2 trillion yuan for the year 2024.

Professor Liu Yongzheng from the School of Finance at Renmin University of China stated at the aforementioned forum that the increasing scale of central government transfers to local governments has played a very supportive role in the development of less developed areas. Moreover, the structure of transfer payments has been continuously optimized, with the proportion of general transfer payments rising year by year, better equalizing local fiscal resources and continuously enhancing their role in promoting the equalization of basic public services.

Liu Yongzheng believes that the current total scale of central government transfers to local governments is quite large, having already exceeded the central government's general public budget revenue. It has grown more than 150 times in the past 30 years (excluding tax rebates), and it is worth discussing how to control the scale of central government transfers to local governments in the future. For instance, the scale of central government transfers to local governments should be matched with the growth of central fiscal revenue. In terms of structure, increasing the scale of transfer payments related to fiscal equalization and controlling the scale of special transfer payments should be considered.

Wang Zhenyu, Dean of the Local Finance Research Institute at Liaoning University, believes at the meeting that it is necessary to control the scale of central government transfers to local governments, otherwise, it will reduce the efficiency of this system. It is possible to consider establishing some necessary mechanisms for the gradual reduction of transfer payment scales.

Xu Hangmin, Secretary-General of the Guangdong Finance Society, stated at the forum that the higher the efficiency of the fiscal system, the less a region's dependence on transfer payment policies and funds will be. This is because the effectiveness of the transfer payment system can continuously support the maintenance of the fiscal system's efficiency. Under a mechanism where responsibilities and funds are well-matched, more and better effects can be achieved. The amount of transfer payments depends on the effectiveness of one's own work, rather than the intensity of the effort to secure them. Therefore, the enhancement of one's own fiscal strength naturally reduces the dependence on the transfer payment system and inherently weakens the competition for transfer payment funds.

"Under the current transfer payment system, there is a lack of a fiscal system to ensure a good arrangement of responsibilities and funds. Since the focus is on making up for the revenue and expenditure gap, the more the system achieves a match between funds and responsibilities, the less transfer payment funds will be obtained. However, localities continue to expand their revenue and expenditure gaps and strive to secure more funds, which can lead to obtaining more transfer payment funds. Therefore, the existing transfer payment is a reverse incentive; the more funds are given, the larger the revenue and expenditure gap may become," Xu Hangmin said.He stated that if the nature of transfer payments is not followed, shifting from an immediate incentive model to a deferred compensation model, where the higher-level government compensates local governments based on their efforts and results, it will be difficult to reverse the aforementioned reverse incentive mechanism. The internal control of transfer payments will be hard to achieve, and if a forced scale control is implemented, it may lead to many side effects.

In fact, before 2019, the scale of central government transfer payments to local governments was mostly in line with the growth rate of central fiscal revenue. However, in recent years, due to the impact of the pandemic and large-scale tax cuts, grassroots finance has faced difficulties. As a result, the central government has increased the intensity of transfer payments, with the scale breaking through 10 trillion yuan. But maintaining the high growth rate of previous years is clearly unsustainable, and it is estimated that the scale of central government transfer payments to local governments in 2024 will be more than 90 billion yuan less than the executed number in 2023.

Enhancing Efficiency

How to balance the fairness and efficiency of this 10 trillion yuan transfer payment fund has always been the focus of transfer payment reform discussions.

Wang Zhenyu said that from the perspective of multi-level government relations, especially from the local perspective, the transfer payment system has many shortcomings in terms of scale, structure, projects, and standards. There are issues such as negative incentives, reverse adjustments, diminishing marginal effects, and even a reduction in the efficiency of the entire fiscal system. A systematic reform should be promoted. For example, currently, some grassroots governments, in order to "ensure basic livelihoods, wages, and operations," misappropriate special transfer payment funds from higher levels. This is understandable and appropriate but not compliant with regulations and laws. Fundamental reform of transfer payments is necessary from the local perspective.

He gave an example that in a county, a school misappropriated a special fund to pay wages to the school's chef to improve some of the students' lunch conditions. However, after the misappropriation was discovered, the local disciplinary committee initially wanted to hold a large-scale accountability. Later, everyone felt that the funds did not go into personal pockets and solved some problems that the school needed to address. Therefore, in the end, the big issue was reduced to a small one, and the accountability was symbolic.

Wang Zhenyu believes that the fiscal system should prioritize efficiency before fairness. It is currently necessary to clarify the scope or boundary of the transfer payment system in the secondary distribution of the entire fiscal system to avoid becoming the "unified revenue and expenditure" system of the planned economy period. It is possible to consider moderately reducing the central fiscal concentration and granting local governments the privilege to integrate transfer payments from the bottom up for issues involving "three guarantees," achieving a compatibility between reasonable and legal compliance.

Xu Hangmin believes that the transfer payment has become an important field and tool for the game between higher and lower-level governments. The current operational efficiency of the transfer payment system is not high, mainly because there are misunderstandings and misconceptions about the nature of transfer payments. The essence of transfer payments is that different levels of government resolve the issue of mismatched funds and responsibilities through fiscal systems and arrangements, based on a fiscal system that matches rights and responsibilities and performance, to ensure the flow of resources and funds for the public product and service delivery capabilities of a certain level of government.

Xu Hangmin stated that the construction of the transfer payment system and mechanism must ultimately be realized through operational and management systems. Only by innovating the operational and management mechanisms can the system efficiency of transfer payments be transformed from design to reality, and the many problems of transfer payments can be fundamentally solved.

He believes that to improve the management and operational mechanisms of transfer payments, it is necessary to follow the nature of transfer payments, to match the relevant subjects, relevant fields, how to match matters and money, performance and efficiency, rights and responsibilities, to improve the scientific, open, and fair allocation of funds, and to strengthen fund supervision. This will stimulate the initiative of lower-level governments, avoid the expansion of unreasonable gaps, and truly enhance the central regulatory capacity.Zhang Licheng, a researcher at the Chinese Academy of Fiscal Sciences, stated at the forum that as the volume of transfer payments grows larger and the focus on fairness intensifies, it is crucial to fully consider the dimension of efficiency constraints during the process. The future improvement of the transfer payment system should take into account the enthusiasm of regions where financial resources are relatively concentrated, and strive to reduce the dependency of underdeveloped areas on transfer payments.

Zhang acknowledged that currently, China has a large floating population of about 400 million people, and the allocation of transfer payment funds does not fully follow the people, leading to a situation where the supply of basic public services such as education in some large cities with continuous population inflow cannot keep up, while some counties and cities in the west with continuous population outflow invest transfer payment funds in areas like education and health, creating a divergence. Therefore, in the future allocation of transfer payments, it is necessary to "follow the people," manage the relationships between stock and flow, underdeveloped and developed areas, and rural and urban areas, and optimize the structure of transfer payment distribution.

Lu Ming, the Executive Dean of the China Development Institute at Shanghai Jiao Tong University, said at the aforementioned forum that China is currently accelerating the reform of the household registration system, and the future population agglomeration will further develop, leading to an increasingly obvious differentiation between areas of population outflow and inflow. The future reform faces the long-term trend of population mobility differentiation, and it is necessary to address the spatial mismatch between population and land, including fiscal transfer payments and investment. If this issue is not resolved, it will be a loss to economic growth efficiency and is not conducive to achieving fairness between regions. If resolved, it can achieve a win-win situation for growth and fairness, especially as the process of population mobility helps to narrow the income gap between urban and rural areas and among regions.

In the "State Council Report on the Situation of Fiscal Transfer Payments" made public last year, the State Council clearly stated the next steps to promote the improvement of the legal system for transfer payments, such as studying and formulating regulations on fiscal transfer payments and other supporting regulations in a timely manner. It is necessary to establish and improve a classification management mechanism for transfer payments, implement targeted policies based on the functions and characteristics of various types of transfer payments, continuously improve management measures, and enhance scientificity. It is also important to improve the budget preparation for transfer payments, strengthen the management of the allocation, use, and performance of transfer payments, and further promote the reform of transfer payment systems below the provincial level.