China & the World Economy Week 5: Lecture 4 - Fiscal Policy in China

Question 1

What are the key components of fiscal policy in China at the national and local levels?

Answer 1

Fiscal policy in China involves both central and local governments.
Key topics:
Trends in fiscal policy
Role of fiscal stimulus
National vs. local deficits
Sustainability of fiscal deficit
Local governments play a major role in infrastructure and public services.
Local governments use Local Government Finance Vehicles (LGFVs) and Special Purpose Vehicles (SPVs) to bypass borrowing restrictions.

Question 2

Fiscal stance since 2000s

Answer 2

Early 2000s: Sustainable national fiscal policy.
Post-2008: Shift to expansionary fiscal policy due to the Global Financial Crisis.
COVID-19 further increased fiscal spending.
Improvements in taxation and bond market helped sustain national borrowing.
Local governments relied on real estate sales and off-budget borrowing.

Question 3

How does local government funding in China compare to the US?

Answer 3

Both countries: Local governments handle education, infrastructure, and public services.
US:
Funded by property taxes, user fees, income and sales taxes.
China:
Pre-1994: Funded by taxes on non-state firms.
Post-1994: Share of VAT, corporate tax, personal income tax, and land sales.
Chinese local governments have greater control over land and influence over credit allocation.

Question 4

What is the augmented fiscal balance and why is it important in China?

Answer 4

Augmented fiscal balance includes:
Special bonds
Land-use income
Off-budget activities
Provides a more accurate picture of fiscal health than the standard balance.
Local governments use off-budget financing for infrastructure due to borrowing restrictions.
Revenue sources:
General revenue (70%): VAT, corporate tax, non-tax income.
Government-managed funds (30%): Bonds, land sales, infrastructure funds.

Question 5

Real estate crisis and fiscal policy

Answer 5

Local governments heavily relied on land sales for revenue.
Decline in land prices/sales has worsened local deficits.
Increased pressure on off-budget borrowing.
Highlights the need for reform in local government financing.

Question 6

Is China’s fiscal deficit sustainable in the long run?

Answer 6

Sustainability depends on:
Growth rate (g) of the economy
Real interest rate (r) on debt
If g > r, debt-to-GDP ratio declines over time.
China’s high growth rate suggests the deficit is sustainable.
Faster decline if:
Government spending (G) falls as % of GDP
Tax revenue (T) rises as % of GDP