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China’s State Council kicks off reform to better align spending at local and state levels

China has launched its long overdue shake-up of fiscal reforms in a push to rebalance central and local government funding as fiscal income dwindles.

The State Council signalled the start of the overhaul by unveiling a policy paper laying out principles for public financing to improve the governments’ ability to provide public goods and social services, according to a statement released through Xinhua late on Wednesday.

Economists said the road map was a crucial step not only for China’s economic transformation but also for better ­governance.

Zhuang Jian, a senior economics officer with the Asian Development Bank’s PRC Resident Mission in Beijing, said: “It is one of the most critical and timely reforms in the people’s republic’s fiscal sector as it’s related to the readjustment of government functions and the relocation of public resources.”

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The reform would clarify public spending responsibilities for central and local governments, and reduce overlaps in those duties, the statement said. It would also mean a moderate increase in central government outlays to ensure public security and equality.

In addition, lower-level ­governments would be given greater authority to manage some public services to better meet ­local needs, it said.

Established in 1994, China’s existing fiscal and tax system channels the lion’s share of revenue to the central government, but local authorities have greater responsibility to provide public goods and services, particularly social welfare services.

Without a fiscal tool to redistribute wealth, China has developed one of the highest levels of income inequality in the world.

These fiscal distortions have long been blamed for the local government reliance on shadow banking to fund local development, and the resulting mountain of debt by those authorities.

Alicia Garcia Herrero, chief economist for Asia-Pacific at Natixis in Hong Kong, said the problem was that most of the stable revenue was centralised, and the central government needed to reassume more responsibility for spending to avoid continued growth in local government debt.

“I think this is what is really behind this long overdue reform but this news can only be the beginning of a process,” Herrero said, adding that she believed it would take years to implement.

Hao Hong, chief strategist with Bocom International, said one of the reasons China’s public finances were deteriorating rapidly was that most fiscal expenditure was conducted by local governments. He cited an estimate in 2008 by Finance Minister Lou Jiwei that local governments were responsible for about 73 per cent of expenditure.

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Setting a timetable for the changes, the statement said reform would start with national defence and foreign affairs this year, then move on to education, health care and environmental protection in 2017-2018. It aimed to cover all major areas by the end of 2020.

Zhuang said the road map and timetable reflected the government’s determination and realism about the reform. But coordinating the changes and fine-tuning links between the various ministries and government agencies would be a challenge.