Involved in the matter

Chapter One: The Power and Affairs of Local Governments#

Section One: Characteristics of Government Governance#

China's five-level government management system: central - province - city - county/district - township. This system has evolved from the historical "central - province - prefecture/county" three-level system.

Chapter Two: Finance, Taxation, and Government Behavior#

The financial package system has led to the continuous decline of the "two proportions": the proportion of central fiscal budget revenue in the total national fiscal budget revenue is decreasing, while the total national fiscal budget revenue's proportion of GDP is also decreasing (Figure 2-2). Not only has the central government become poorer, but the overall fiscal situation has also worsened.

The tax-sharing system reform in 1994 divided taxes into three categories: central taxes (such as tariffs), local taxes (such as business taxes), and shared taxes (such as value-added taxes).

The most important tax in the tax-sharing system reform is the value-added tax, which accounts for one-fourth of the national tax revenue.

Before the reform, the value-added tax (i.e., product tax) was the largest local tax, but after the reform, it became a shared tax, with the central government taking 75% and leaving 25% for local governments.

The information and phenomena encountered by the public are mostly the results after negotiation, while students lacking social experience may mistakenly regard the results of negotiation as successful policies behind successful negotiations and compromises.

Corporate income tax is the second largest tax in China, accounting for 23% of national tax revenue in 2018.

The proportion of central government revenue in the national budget jumped from 22% before the reform to 55%, stabilizing at this level for a long time.

The proportion of national budget revenue to GDP gradually increased from 11% before the reform to over 20%. The reform greatly enhanced the central government's macro-control capability.

The tax-sharing system fundamentally changed the model of local governments developing the economy.

Section Two: Land Finance#

The tax-sharing system did not change the local government's task of focusing on economic construction, but it reduced the available fiscal resources at hand.

On the other hand, local governments can increase off-budget revenue, the most important of which is the "land finance" generated around land transfer and development.

Given the tax rate, to increase tax revenue, one must either expand the tax base or strengthen tax collection.

Part of the reason can be attributed to strengthened tax collection efforts, but a more important reason is the expansion of the tax base.

Before the reform, most corporate taxes were paid according to their affiliation; after the reform, they were paid where the business is located, which naturally stimulated local governments to attract investment.

Since the vast majority of tax revenue comes from enterprises and is mostly collected at the production stage, local governments tend to prioritize enterprises over people's livelihoods, focusing on production while relatively neglecting consumption.

To compete for tax revenue and large industrial projects, local governments have relaxed environmental supervision, harming the ecological environment and increasing excess capacity.

In regions with significant fiscal pressure, industrial pollution levels are generally higher.

China implements land public ownership, with urban land owned by the state and rural land owned collectively. To convert agricultural land into construction land, it must first be expropriated and converted into state-owned land before it can be used for industrial or residential development.

Thus, the value of state-owned land far exceeds that of agricultural land.

In 1998, two significant events began to reveal the true value of urban land. The first was the cessation of welfare housing distribution by units, gradually implementing monetary allocation for housing, marking the beginning of the era of commercial housing and real estate.

For example, some developers took advantage of state-owned enterprise reforms to acquire land transferred from enterprises, then obtained development permits from urban planning departments, paying only a small amount of land transfer fees as stipulated by the state, thus engaging in real estate development. This was a lucrative business, and the corruption involved is evident.

Consequently, local governments began to expropriate farmers' land in large quantities and then transfer it for compensation, leading to the expansion of land finance.

By 2010, land finance accounted for 68% of local public budget revenue.

In 2018, "land finance" revenue amounted to 89% of local public budget revenue, making it a veritable "second finance."

The way local governments develop the economy has shifted from "industrialization" to a dual focus on "industrialization and urbanization": on one hand, continuing to supply a large amount of industrial land at low prices to attract investment; on the other hand, restricting the supply of commercial and residential land to profit from the rising land prices.

Thus, although commercial and residential land only occupies half of the transferred land area, it contributes nearly all of the land use rights transfer revenue. Therefore, the essence of "land finance" is "real estate finance."

With the development of industrialization and urbanization, a large influx of new population into economically developed areas has occurred, while the supply of residential land in these areas has been insufficient, causing housing prices to soar, which in turn drives up land prices, leading to exorbitant land auction prices.

The so-called economic development is merely about improving resource utilization efficiency, striving to achieve "maximizing talent and utilizing resources."

In the early stages of economic development, the main resources available are labor and land.

Compared to labor, land is easier to capitalize, turning future returns into today's soaring land prices for local governments to use.

Local governments lower industrial land prices because industry has a strong driving effect on economic transformation and upgrading, can bring value-added tax and other tax revenues, and can create jobs.

Although both industrial and commercial residential land are monopolized by local governments, there are many places where industrial enterprises can settle, making it difficult for local governments to raise land prices in the competition for investment attraction.

Commercial residential land, however, is different; it primarily serves local residents, and the monopoly power of land suppliers is stronger, making it easier to raise land prices.

Some well-known shops can bring greater foot traffic to shopping malls, so the mall can not only waive their entry fees but also reduce profit-sharing or even subsidize them (similar to various subsidies given to enterprises by local governments).

The capitalized operation of land essentially mortgages future returns to borrow money today. If the borrowed money is invested wisely and converted into valuable assets and higher future income, then debt is not a significant issue. However, local officials have limited terms, which inevitably leads to short-sighted behavior, consuming future resources and excessively borrowing to undertake large projects and "face engineering." The achievements remain in the present, while the benefits are left for the next leadership to deal with. As a result, investment quality declines, returns are low, and the debt burden becomes heavier.

However, on a national scale, optimizing land resources and construction land allocation is challenging. Although there is competition between regions, land use indicators cannot flow across provinces to more efficient areas.

Section Three: Vertical and Horizontal Imbalances#

Once grassroots governments run out of money, they will find ways to increase revenue to maintain normal operations.

"The farmers are truly suffering, the countryside is truly poor, and agriculture is truly dangerous." This "three rural issues" has become one of the focal points of policies and reforms in the early 21st century.

By 2011, the central government had allocated a total of 330 billion yuan for rural compulsory education reform, exempting approximately 130 million rural compulsory education students from tuition and textbook fees.

The phenomenon of "cities oppressing counties, cities squeezing counties, and cities consuming counties" is severe, and the urban-rural gap continues to widen.

The "county management of township finances" and "provincial direct management of counties" reforms essentially flattened China's five-level administrative management system (central - province - city - district/county - township) in terms of fiscal management, transforming it into a three-level system (central - province - city/county).

Conclusion#

Thus, the true power of land lies not in "land finance," but in the bank credit and other funds leveraged by land as collateral. Once "land finance" is integrated with the capital market and leveraged, it becomes "land finance," which can snowball and drive rapid economic expansion, while also creating increasing debt for local governments, triggering a series of macroeconomic issues.

Chapter Three: Government Investment, Financing, and Debt#

The boss calmly corrected him: "It's 10 buildings, not 10 apartments. Each building has 7 floors."

Land itself is not valuable; what is valuable is the economic activity on the land.

If land can only be used to grow wheat, its value is limited. However, if it can attract businesses and talent, the potential value will be unlocked, and the cumbersome land will show unparalleled advantages: it does not move or disappear, making it naturally suitable for collateral and various capital transactions, thus its value skyrockets.

Local governments can also capitalize future income related to land to obtain loans and various funds, amplifying the scale of "land finance" into "land finance."

Section One: Urban Investment Companies and Land Finance#

The Chinese government not only owns urban land but also controls the financial system, naturally participating in industrial investment in various ways, making it impossible to remain aloof.

However, industrial investment is not like buying and selling stocks; it cannot be exited at any time, and the investment process is often irreversible: projects that are not completed or do not operate normally may result in total loss of initial investment.

For a long time, the main driver of China's GDP growth has come from investment, and this growth model inevitably involves deep government participation in economic activities. The efficiency of this model depends on the stage of economic development.

The law stipulates that local governments cannot borrow from banks, and before 2015, they were also not allowed to issue bonds, so if the government wants to borrow money for investment, it needs to establish special companies. Most of these companies are state-owned enterprises, generally referred to as "local government financing platforms."

However, these companies are not formally called "financing platforms," but often have terms like "construction investment" or "investment development" in their names, highlighting their investment functions, and are therefore often collectively referred to as "urban investment companies."

Some companies specialize in developing tourist attractions, and their names generally include "tourism development."

Section Two: Local Government Debt#

The government not only relies on land use rights transfer income to support "land finance," but also capitalizes future land revenues, borrowing massive amounts of funds from banks and other channels, using the immense power of "land finance" to drive rapid industrialization and urbanization.

However, once economic growth slows, land prices fall, and land transfer income decreases, accumulated debt can become a heavy burden, potentially overwhelming financing platforms and even local governments.

However, to introduce bank funds into urban construction and development, three technical issues need to be resolved.
First, a company that can borrow is needed, as the government cannot borrow directly from banks.
Second, urban construction projects are complex, including water supply, roads, parks, flood control, etc., some profitable and some unprofitable, but none can be omitted, so they cannot borrow for individual projects; it is best to bundle them together, using profitable projects to drive unprofitable ones.
Third, relying solely on fiscal budget revenue is insufficient to repay debts; it is necessary to utilize land-related revenues.

City commercial banks are mainly controlled by local governments. In 2015, about 70% of city commercial banks' largest shareholders were local governments.

Therefore, local governments often control at least one bank, facilitating loans for financing platform companies and infrastructure construction.

The primary financing method for urban investment companies is bank loans, followed by bond issuance, commonly referred to as urban investment bonds.

However, for urban investment bonds, these two theoretical advantages essentially do not exist.
First, the vast majority of urban investment bonds are issued in the interbank market, with 70-80% held by commercial banks, resulting in poor liquidity and concentrated risk in the banking system.
Second, the market perceives urban investment bonds as having implicit government guarantees, making them very safe.

No one knows the exact amount of local government debt. The clearly defined "explicit liabilities" are easy to calculate, but the trouble mainly lies in various "implicit liabilities," with financing platform company debts accounting for a large portion.

The estimated total local debt between 2015 and 2017 was around 40-50 trillion yuan, accounting for 50-60% of GDP, with 30-40% being implicit liabilities.

However, debt risk cannot be viewed solely from an overall perspective, as it is individuals who owe money, not the collective. If someone owes 100 million yuan, theoretically, it could be repaid by everyone in the country contributing a few cents, but in reality, this debt could crush that individual. The same logic applies to local debt; one cannot obscure local risks with overall figures.

Officials are required to establish a correct view of performance, strictly control the increase in local government debt, and hold them accountable for life, tracing back responsibilities.

Section Three: Local Officials in Investment Attraction#

However, the traditional value of "learning and excelling leads to officialdom" remains, and the government is still the most resourceful and influential department in China, making civil service exams highly competitive every year.

The so-called incentive mechanism can be simply described as "carrots and sticks": What benefits does an individual gain from doing a good job? What are the consequences of messing up?

Local officials have limited terms, and to quickly boost economic growth during their tenure, they often have to increase investment and launch various large projects.

In the first two years of taking office, infrastructure investment, industrial investment, and fiscal expenditure often rise rapidly.

On average, about 30% of prefecture-level cities change mayors or party secretaries each year, leading to a flurry of investment across regions.

Thus, in the first few years of an official's tenure, the number of land transfers generally increases. Most of the newly supplied land is located in suburban areas around cities.

Before 2016, officials were not held accountable for debts incurred after their promotion or transfer, and new officials often ignored old debts, continuing to increase investment, leading to a continuous rise in government debt.

For performance reasons, local officials often focus on "visible" infrastructure projects, such as urban roads, bridges, subways, and green spaces, while relatively neglecting "invisible" projects, such as underground pipelines. Therefore, many cities experience flooding during heavy rains.

Whether in companies or governments, as long as work performance cannot be measured 100% clearly (like the number of packages delivered), the subjective evaluation of superiors becomes important, and personal relationships with superiors become crucial.

Personal relationships rely on key individuals within them, which is highly uncertain; there is "one person ascends, and the whole family rises," as well as "when the tree falls, the monkeys scatter."

Thus, the vast majority of government employees are more concerned about incentives that are not promotions but rather actual income and work benefits, including salaries, bonuses, allowances, subsidies, affordable cafeterias, and comfortable office conditions.

No organization, whether a company or a government, can rely solely on external rewards and punishments to motivate employees.

Therefore, a sense of mission, values, vision, and other internal emotional drivers are needed.

The development model of government investment and land finance has a significant drawback: severe corruption. Transactions and investments related to land often involve large sums of money, and power is highly concentrated in a few officials, making it easy to breed corruption.

First, corruption coexists with rapid economic growth.

Second, as reforms deepen, the relationship between government and market continues to change, and forms of corruption also evolve.

The first type is "predatory" corruption, such as extorting private enterprises, soliciting bribes from the public, and misappropriating public funds.

The second type of corruption is "collusion between officials and businessmen for mutual profit." For example, officials use their power to allocate projects to connected enterprises, and the enterprises not only need to complete the projects and contribute to the officials' performance but also provide many benefits to the officials privately.

Thus, corruption can coexist with economic growth for a period.

Conclusion#

The path of reform lies in simplifying administration and delegating power, gradually transforming from a production investment-oriented government to a service-oriented government.

Chapter Four: The Role of Government in Industrialization#

The real world does not have a clear division between "market" and "government," but rather various combinations of intertwined interests.

Chapter Five: Urbanization and Imbalance#

The dilemma faced by most people can be summarized as: the city with the desired job has too high housing prices, while the city with affordable housing does not have the desired job.

Why is housing so expensive? Why is there such a low sense of belonging? Why must one venture alone in a foreign land, unable to be with parents and family?

Housing prices are linked to land prices, land prices are linked to finance, and finance is linked to infrastructure investment, thus forming a complex relationship of "one prospers, all prosper; one suffers, all suffer."

What supports housing and land prices is people's income.

"Left-behind children, left-behind women, left-behind elderly."

Section One: Housing Prices and Resident Debt#

Whether in developed or developing countries, the supply and demand for housing are closely related to population structure, as young people are the main force in home buying.

Although the land area in a region is fixed, the indicators for constructing residential buildings can be adjusted; the floor area ratio and green space can also be adjusted on the same residential development land.

However, in second-tier cities, housing prices have risen faster than per capita income; in first-tier cities, the increase in housing prices far exceeds income growth.

Although housing prices are low in the Midwest, young people are still willing to move to the high-priced East because there are more job opportunities and resources there.

Lending money to the poor to buy houses is much easier, as it can alleviate the dissatisfaction of the poor, give everyone a chance to achieve the "American Dream," and also raise housing prices, increasing the wealth of homeowners, thus stimulating their consumption and creating more jobs, achieving multiple benefits.

Real estate is often referred to as the "mother of economic cycles," rooted in its inherent supply-demand contradictions: on one hand, banks can create almost unlimited new purchasing power through mortgages; on the other hand, the supply of non-renewable urban land is limited.

Housing accounts for nearly 70% of household assets, with 60% being housing and 10% being commercial properties. In contrast, 72% of American residents' wealth is in financial assets, with real estate accounting for less than 28%. The major difference helps to understand some basic policies of the two countries, such as China's emphasis on the housing market and the U.S. focus on the stock market.

Unless housing prices fall significantly below the down payment ratio, residents will not default on mortgages, losing their down payments.

A crisis similar to that in the U.S., where a drop in housing prices triggers massive mortgage defaults and a cascading effect through financial markets globally, is unlikely to occur in China.

The fundamental solution lies in increasing income, especially for low- and middle-income groups, encouraging them to work in places that offer more opportunities and higher incomes.

Section Two: Imbalance and Factor Market Reform#

The main contradiction in Chinese society has transformed into the conflict between the people's growing needs for a better life and unbalanced and inadequate development.

Low-income groups want to increase their income, and the most direct way is to work in economically developed cities, which can provide decent income for low-skilled jobs (such as delivery or domestic work).

In other words, although there are significant differences in scale between states, the per capita GDP differences are small; regardless of which state one lives in, the average living standards are not very different.

Due to high population density and large market demand leading to refined division of labor, these jobs in large cities offer decent income.

As for public services such as education and healthcare, the fundamental solution to relieve pressure is to increase supply, not restrict demand.

By the end of 2019, Shanghai had 5.12 million elderly people aged 60 and above, accounting for 35% of the total registered population.

Urban land is owned by the state and can circulate in the market; rural land is collectively owned and subject to many restrictions on circulation.

The state allows villagers who can legally settle in cities to voluntarily and compensated exit their homesteads, encouraging rural collective economic organizations and their members to activate and utilize idle homesteads and vacant houses.

The significant social issues brought about by "left-behind children, left-behind women, and left-behind elderly."

Section Three: Economic Development and Wealth Gap#

The "tunnel effect" describes the anxiety and impatience of the still lane when two lanes in a tunnel move at different speeds.

Chapter Six: Debt and Risk#

A young couple, both working in Shanghai's financial sector, have decent incomes. After graduating from graduate school a few years ago, their combined monthly income is 50,000 yuan, including year-end bonuses. They are optimistic about the future and have reached the age of discussing marriage, so they decide to buy a house. Their elderly relatives pooled together the down payment, and they took out a mortgage of several million yuan, with monthly repayments of 30,000 yuan. Shanghai's prices and living costs are not low, and the young couple also has entertainment and socializing expenses, leaving little savings after paying the mortgage.

Section One: Debt and Economic Recession#

If housing prices fall, the public will feel poorer and will tighten their belts and cut back on consumption. If goods cannot be sold, corporate revenues will decrease, making it difficult to repay debts; companies with excessive debt burdens will go bankrupt, leading to bad debts in banks, tightening loans, and even good companies will face tighter conditions.

Section Two: Why Debt is High: Lessons from Europe and America#

To understand the growth of debt, one must first understand why banks lend extensively.

The frequency of global banking crises is highly correlated with the scale of international capital flows.

Bank credit secured by land also follows the fluctuations in land value.

Thus, banks rarely provide assistance in times of need but often lend generously during prosperous times, fueling economic overheating, while tightening their pockets during recessions, exacerbating economic downturns.

In the game of passing the parcel, what is passed is not important; as long as someone takes over, it is fine.

To maintain the dollar's status as the international reserve currency, the U.S. may need to maintain a trade deficit for years to provide more dollars to the world.

Chapter Seven: Domestic and International Imbalances#

Section One: Low Consumption and Overcapacity#

In areas where land supply is limited and housing prices are rising rapidly, residents must save money for down payments and mortgage repayments, leading to increased savings rates and decreased consumption. Although rising housing prices increase the wealth of homeowners, theoretically stimulating consumption and reducing savings, most homeowners only have one house, and their ability to liquidate is limited; thus, consumption levels are primarily constrained by income, and the "wealth effect" of rising housing prices is not significant. Therefore, overall, rising housing prices lower consumption and increase savings.

One important aspect of "inadequacy" refers to the low proportion of income for the public and insufficient "sense of gain."

GDP consists of three main parts: consumption, investment, and net exports (exports minus imports).#

The income generated from these projects far exceeds the costs, resulting in increasing debt. Although GDP rose during road construction, actual resources were wasted. Such examples are not uncommon. While these losses have not yet been accounted for, they will inevitably appear in the accounts in the future.

Domestic and international are two sides of the same coin; domestic imbalances lead to international imbalances, and international imbalances can also lead to domestic imbalances.

It is often said that "diplomacy is an extension of domestic politics." From a macro perspective, the imbalance in foreign trade is also a continuation of internal structural imbalances.

Section Two: Sino-U.S. Trade Conflict#

In other words, as long as the world continues to trust the value of the dollar, the U.S. can continuously exchange dollars for actual products and resources from other countries, which is a real "privilege of extravagance" that other countries do not have.

In contrast, the technological impact and challenge to the U.S. are more tangible, which is also the fundamental reason why the Sino-U.S. trade conflict and U.S. technological containment may become long-term.

Young people are no longer the naive individuals of the past; they have the ability to earn money and are on a strong upward trajectory, making it only a matter of time before they accumulate wealth.

Thus, for late-developing countries, industrial manufacturing is the foundation of technological progress.

Section Three: Rebalancing and Domestic Circulation#

Therefore, local governments are increasing spending on education, healthcare, and other aspects of people's livelihoods, which is an investment in "human capital" that will benefit technological progress and economic development in the long run.

Chapter Eight: Summary: Government and Economic Development#

Thus, there is often a gap between theoretical research in economics and practical application.

The reason why economically backward countries remain backward is that they lack many hardware or software resources of developed countries and lack a complete market mechanism.

Section One: Competition Between Regions#

The core principle of economic development is to optimize resource allocation, improve efficiency, and strive to achieve "maximizing talent and utilizing resources." Achieving this goal relies on competition.

The second type is primarily led by local governments, which, after setting economic development goals, delegate power to local governments, allowing them to take initiative and compete for resources in practical work. This is a bottom-up "block-by-block" competition model.

"Territorial management" is conducive to regional policy experimentation and innovation, as it is ultimately a local experiment; if successful, experiences can be summarized and promoted, and if it fails, the costs and risks can be limited locally without affecting the overall situation.

The core of "industrialization" is to transform farmers into workers. This is not only a change in work but also a complete transformation of thought and lifestyle.

Local governments must compete not only in the market but also in the political arena.

Linking political incentives for officials' promotions to regional economic performance.

First, there is a lack of a genuine elimination mechanism. Local governments, even if they are unambitious, will not collapse like enterprises. Officials with poor performance may have fewer promotion opportunities, but as long as they do not violate laws and regulations, they will not bear personal losses due to investment failures or economic downturns.

Promotions for officials are a "zero-sum game," with limited promotion positions; if one person rises, another cannot. Therefore, local protectionism arises in regional economic competition.

Local officials have limited terms and must achieve performance during their tenure, and new officials often ignore old debts, which stimulates impulsive investment and rapid GDP growth, regardless of long-term risks and debt burdens.

Section Two: Government Development and Transformation#

As the country becomes wealthier, the public's demand for government services will increase, leading to increased government spending on public education, healthcare, pensions, and unemployment insurance.

One common feature of many poor and backward countries today is that the government is too weak to maintain social order, let alone create a stable environment for economic development. Economic prosperity, social stability, and effective government are the three pillars of national prosperity, and none can be lacking.

However, taxation has never been easy, and the capacity for tax collection and inspection requires long-term development.

The largest tax in China is the value-added tax, which accounted for 40% of national tax revenue in 2019; the second largest is corporate income tax, accounting for 24%.

Compared to personal income tax, the difficulty of collecting value-added tax is much lower. First, there are invoices as proof; second, the interests of buyers and sellers are not aligned, allowing for mutual supervision. Theoretically, sellers prefer to declare a lower invoice amount or not to invoice at all to pay less tax; buyers prefer a higher invoice amount to maximize tax deductions. Therefore, two sets of invoices can be compared to reduce the risk of fraud.

The reason why economically backward countries remain backward is that they lack advanced countries' complete markets and efficient resource allocation methods.

The model of "decentralized competition + central coordination" or "politics + market" is a characteristic of China.

The so-called strong government not only has the ability and resources to support enterprise development but also has the ability to refuse assistance to enterprises.

For example, in OECD countries, government spending on education, healthcare, social security, and pensions accounts for 24% of GDP, while in China, it is only 13%.

Urbanization is an irreversible process, and the current land and household registration reforms acknowledge this irreversibility. When facing shocks during development, returning to rural areas may be a temporary measure, but it is not an effective long-term buffer mechanism. It is still necessary to establish buffer mechanisms in cities, increasing spending on education, healthcare, and housing, allowing people to live and work in cities.

The "production investment-oriented government" must transform into a "service-oriented government."

A "service-oriented" government is essentially a government that invests in "people."

The bottleneck for expanding spending on people's livelihoods is the revenue of local governments.

China currently lacks a tax type that belongs to local governments. The previous reliance on "land finance" and "land finance" models is no longer sustainable. Therefore, to expand spending on people's livelihoods, it may be necessary to reform the tax system to tilt tax revenue toward local governments. The hot topic currently under discussion is the introduction of property tax. Although this is certainly a local tax, the reform has been widely debated for many years and has been piloted but has not yet made substantial progress.

Section Three: Development Goals and Development Processes#

However, for developing countries, the core issue is not how a good market mechanism operates but how to gradually establish and improve the market economic system.

For developing countries, the key to increasing productivity is not exploring the unknown and innovating but learning known technologies and management models, organizing and investing more resources into the learning process as quickly as possible to improve learning efficiency.

Once technology and productivity reach a certain level, if the old model cannot successfully transform into an "exploration and innovation model," it may hinder further economic development, and the "latecomer advantage" may turn into a "latecomer disadvantage."

I personally believe that if there is more than one "organizational learning model," there will naturally be more than one "exploration and innovation model." The Western and European models are not necessarily the optimal models.

This is a question of transforming farmers into workers and citizens.

In China, the feasible policy space and evolutionary path are constrained by three major systems: rural collective ownership, urban land public ownership, and the household registration system.

Urbanization cannot be separated from "land finance" and "land finance."

It is necessary to improve economic efficiency while ensuring that decision-makers or power holders' interests are not significantly harmed; otherwise, policies will be difficult to implement.

Feasible economic policies are the result of various interest compromises.

For example, an important concept in political economy is "elite capture," where local political elites are captured by local interest groups, harming the interests of the public.

Economic development inevitably changes old lifestyles and redistributes interests, so it is bound to be accompanied by contradictions and conflicts.

In the field of finance, we refer to the scope of government-provided public goods as the government's affairs, while the government's fiscal revenue is referred to as the government's financial power. In terms of the relationship between the government and society, we generally discuss the government's affairs and financial power, while in terms of intergovernmental relations within the government, we need to discuss the distribution of affairs and financial power among various levels of government.

Whether the financial power and affairs of the first-level government are commensurate or symmetrical; if affairs > financial power, the government will face a deficit and be unable to provide funding for public goods and services; conversely, if financial power > affairs, the efficiency of the government's provision of public goods and services will be problematic, indicating that the taxes collected by the government far exceed the public goods and services that should be provided, and local residents do not enjoy services corresponding to their tax payments.

Considering the issue of multi-level government, the problem becomes more complex. When certain local governments' affairs exceed their financial power, the higher-level government will supplement local governments' revenue in the form of fiscal subsidies or transfers to maintain the balance between affairs and financial power. In contrast, local governments with financial power greater than their affairs will be required by the higher-level government to remit a portion of their fiscal revenue.

"Redistribution of financial power caused by the distribution of affairs is a major component of the government's fiscal system."

Fiscal Decentralization and Local Economic Development#

"Delegation" and "Decentralization"

Decentralization refers to the fiscal system of fiscal contracting adopted by the central government to stimulate local enthusiasm since the beginning of the reform and opening up.

The theory of fiscal decentralization suggests that under the premise that local resources and production factors can flow freely and residents can "vote with their feet," the central government's fiscal decentralization to local governments can trigger healthy regional competition among local governments, effectively promoting economic growth.

How do local governments achieve economic growth under the fiscal decentralization system?

Industrialization, especially the rise and prosperity of township enterprises.
Characteristics of township enterprises:
They are scattered in rural areas rather than cities, and the labor force is mainly composed of farmers.
The ownership belongs to the township or collective, representing a public ownership structure.
The non-private enterprise ownership structure either has some advantages or just fits the political and economic environment at the time.
Township enterprises mainly produce light industrial products, which have a competitive advantage in an environment where state-owned enterprises focus on heavy industrial products and light industrial products are in short supply.

The role of local governments:
On one hand, the government can obtain fiscal revenue exceeding the contracted amount; on the other hand, it can also gain off-budget revenue through the profits contributed by township enterprises, thus greatly motivating the establishment of township enterprises.

Tax system:
Corporate income tax.
Flow tax, collected based on territorial jurisdiction.
Product tax, established in 1984, levied based on sales revenue without considering the enterprise's costs and profitability.
Value-added tax, which was decided by the state in 1986 to gradually replace the product tax for certain industrial products, with 174 out of the original 260 industrial tax categories included in the value-added tax scope by April 1991, leaving only 86 to continue paying the product tax.

The calculation method for value-added tax is: taxable amount = current output tax - current input tax. Since the tax rate is uniformly 17% nationwide, it essentially results in sales revenue minus the cost of raw materials multiplied by 17%.

Tax authorities are directly managed by higher-level tax authorities, including personnel, salaries, equipment, and business, decoupled from local finances.
This concentrates a large amount of local fiscal revenue at the central level.
This is mainly due to the two taxes (value-added tax and consumption tax) being classified as shared taxes and central taxes.

Changes in local government behavior:
The most obvious change is that local governments' enthusiasm for establishing industrial enterprises will be dampened:

The central government shares value-added tax with local governments but does not bear the risks, thus reducing local governments' interests while increasing risks.
The independence of tax authorities renders various preferential policies established by local governments to protect local enterprises ineffective.
The large-scale restructuring of township enterprises and the shareholding of state-owned enterprises are also driven by the tax-sharing system.

The position of business tax in the local government tax revenue system has risen. Business tax is mainly levied on the construction industry and the tertiary sector, with the construction industry being the largest contributor to business tax revenue.

After the tax-sharing system, local governments began to seek off-budget and non-budget funds as a focus for their fiscal growth.

The main body of off-budget funds is the fees charged by administrative and public institutions.
The main body of non-budget funds includes agricultural retention and coordination, as well as land transfer income related to land development.

Land finance, including huge land use rights transfer income, also includes various tax revenues related to land use and development.

One category is taxes directly related to land, mainly land appreciation tax, urban land use tax, cultivated land occupation tax, and deed tax, with 100% of the revenue going to local governments, accounting for 15% of local public budget revenue (source: 2018 statistics).

Understanding All Tax Types in China#

China has 18 and a half tax types.

The tax system reform in 1994 introduced value-added tax (originating from France, characterized by low tax rates) and business tax.

In the circulation sector: tangible assets, intangible assets.

Services: processing, repair, and maintenance.

Paying value-added tax does not require paying business tax; they are parallel. Value-added tax is managed by the national tax authority, while business tax is managed by local tax authorities. Before 1994, the tax was product tax.

Value-added tax (an indirect tax, chain tax): only taxes the value added in the commodity circulation process (only taxes the profits made, with two tax rates of 13% and 17%). The tax burden is passed on, with all tax burdens borne by consumers. The taxable amount is the sales minus the cost of raw materials.

The assumption of "perpetual operation."

Relevant criminal law regarding value-added tax.

The relationship between consumption tax and value-added tax.

Disadvantages of value-added tax: the tax rate on tobacco products has sharply decreased, significantly increasing profits. France has three tiers of value-added tax, while China has not introduced a high tax rate but has created a consumption tax.

Not all items subject to value-added tax are subject to consumption tax. However, all items subject to consumption tax must also be subject to value-added tax.

Land appreciation tax - adjusts business tax.

Urban construction tax and education surcharge.

In 2016, "comprehensive VAT reform" saw business tax exit the historical stage, and in 2017, national and local taxes were merged. In 2018, local tax bureaus exited the historical stage.

Eighteen and a half tax types, with local education surcharges counted as half a tax.
Chain taxes: value-added tax, consumption tax, tariffs, resource taxes.

Expense taxes: deed tax, vehicle purchase tax.

Capital taxes: stamp tax, property tax, and environmental tax.

Corporate income tax and personal income tax.

Four Fiscal Accounts#

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Tax Management#

Tax management is divided into "tax-specific management" and "general tax management." Tax-specific management is characterized by managing tax types as the object of management division, where tax officers implement specialized management of the tax types they oversee, and the same taxpayer interacts with multiple tax officers. This division method has the advantage of strong specialization, with tax officers managing a single content. The disadvantage is that each tax officer lacks a comprehensive understanding of the taxpayer's tax obligations, leading to disjointed and uncoordinated management. General tax management is characterized by managing taxpayers as the object of management division, where tax officers implement unified management of various taxes owed by the taxpayer, and the taxpayer has a single, fixed contact with the tax officer. This division method has the advantage of allowing tax officers to comprehensively understand and manage the taxpayer's obligations. The disadvantage is that the management content is complex, and attention is dispersed, making it difficult to improve management quality.

There is no longer a need to continue implementing "tax-specific management," which has been replaced by the "one officer per household, general tax management" model, where collection, management, and inspection are all handled by one person. After the reform and opening up, China implemented a two-step "profit-to-tax" reform in the 1980s, leading to a more complex tax structure, but the tax management system has continued.

The tax management system has been able to operate for a long time due to its unique historical background and should not be denied by today's standards. As Qian Mu (2005) said, "One cannot replace historical opinions with contemporary opinions." The implementation of the tax management system was primarily influenced by the technical and economic backgrounds. In terms of technical background, the tax system was simple, and computer networking technology had not yet become widespread, so tax management relied mainly on tax officers manually completing tasks, which was suitable for the fewer taxpayers and simpler tax system at the time. In terms of economic background, the economic structure was simple; before the reform and opening up, China's economy was predominantly state-owned, with 99% of GDP generated by state-owned enterprises. The tax system was relatively simple, and there were no significant conflicts of interest among taxpayers. Accordingly, tax officers' work aimed to ensure "tax compliance," allowing for "one officer per household, general tax management" to be implemented, combining "collection, management, and inspection" into one, serving both as judge and executor, facilitating centralized execution of tax decisions.

Thus, in a specific historical context, the close connection between finance and banking is an inevitable phenomenon in modern economies. In the past, we often attributed this close relationship to the planned economy system, but experiences since the reform and opening up, as well as understanding of Western market economies, show that its existence has a crucial foundation: regardless of the type of economic system, the contemporary monetary supply formation mechanism and monetary movement laws share common characteristics that transcend systemic differences.

The "crotch pants" relationship between finance and banking is objectively present, but with economic development, this relationship manifests in different "joining" methods in different historical periods, and how this relationship is handled and utilized reflects different historical characteristics and specific time imprints.

The Relationship Between Finance and Banking in the Planned Economy#

In 1954, the People's Construction Bank of China was established under the Ministry of Finance to handle basic construction funding. With the expansion of infrastructure scale and changes in management systems, the finance ministry began to entrust the construction bank to directly participate in the allocation of basic construction funds and also transferred the authority to approve the financial settlement of construction units to the construction bank, thus giving the construction bank dual responsibilities, not only handling the allocation of national basic construction investment but also having the authority to inspect the use of construction investment, such as economic accounting and financial management, and being responsible for the calculation of construction investment.

(3) The relationship between finance and banking during the "Great Leap Forward" period.
Starting in 1956, China entered a comprehensive socialist construction phase. During this period, due to the advocacy of abolishing commodities and currency, the banking business system and principles were severely disrupted.

In December 1958, the State Council decided to change the supply of working capital for state-owned enterprises from "dual supply" by finance and banking to unified management by the People's Bank of China, with all working capital for enterprises converted to bank credit. This not only increased the burden on banks but also transferred all the contradictions regarding working capital supply and use to the banking sector, which became overwhelming. At the same time, the credit system implemented "decentralized lending, planned contracting, differential management, and unified scheduling," causing significant chaos in the supply and management of working capital, creating new contradictions between finance and banking (Zhao Menghan, 2002, pp. 291-292). The "Great Leap Forward" led to blind power delegation by banks, resulting in uncontrolled credit issuance and excessive cash circulation. During this period, the annual growth rate of deposits in state banks was 25%, while loans increased by 20%. Additionally, during the peak of decentralization, many banking institutions were streamlined, merged, or abolished, such as the construction bank being abolished in 1958.

(4) The relationship between finance and banking during the "Cultural Revolution."
During this period, the state and society were highly unified, and all financial operations were controlled by the state, with finance and finance mixed in institutions and functions, making it impossible to carry out normal business activities and achieve specialization. The banking system was abolished, its functions weakened, and many institutions were merged and personnel were significantly reduced. The finance and banking departments were merged into one department in the fall of 1969, and in April 1970, the construction bank was merged into the People's Bank of China. The financial and banking departments managed business with only one "financial business group" and one "banking business group," with work in a semi-suspended state. The number of personnel engaged in financial business was less than a hundred at its lowest point, and the president was merely a deputy minister of the Ministry of Finance. The bank operated under the direct supervision of the finance ministry, with the allocation of funds determined by the finance ministry, which decided which enterprises to allocate funds to, effectively reducing the bank's functions and creating a clear dependency on the finance ministry. It was only after 1972 that some departments and bureaus were gradually restored, but the finance and banking departments remained merged.

Characteristics of the Relationship Between Finance and Banking in the Planned Economy#

(1) "Big Finance, Small Banking."
From the founding of New China until the reform and opening up, the state finance played a leading role in the allocation of social resources, controlling all aspects of the social reproduction process through unified planning. Finance was the main body of social investment, encompassing various social undertakings and extending its functions into various financial roles. The fiscal expenditure mechanism was large and broad: not only were massive economic construction investments directly allocated by finance, but the fixed working capital of state-owned enterprises was also allocated free of charge by finance. Additionally, finance had to bear expenditures for national defense, foreign affairs, administration, science and technology, education, culture, and health.

Meanwhile, the People's Bank served as an auxiliary department of finance, "the center and hub of capital activities in the national economy, the national accountant, and the national cashier" (Editorial, 1965). Thus, banks were positioned merely as accountants and cashiers, rather than as profit-oriented economic organizations or institutions implementing national financial macro-control measures.

(2) "Finance squeezes banks, banks issue receipts."
According to the relationship between finance and banking at that time and the requirements for comprehensive balance, fiscal balance could increase fiscal deposits to enhance credit income; the state had the ability to increase credit funds to balance credit revenue. However, from the founding of New China until the planned economy period, finance not only bore administrative management and social management responsibilities but also undertook significant economic construction expenditures. During this period, the fiscal capacity was weak, and fiscal revenue often struggled to meet various expenditure needs. In times of fiscal difficulty, especially during periods of large-scale infrastructure and investment, finance typically resorted to using past surpluses or overdrawing from banks, leading to the phenomenon of "finance squeezing banks and banks issuing receipts."

(3) Frequent changes in the division of finance and banking.
Due to a lack of basic experience in economic construction, China underwent multiple attempts at reforming the finance and banking system, mainly focusing on the financial management system for basic construction and the working capital supply system for state-owned enterprises.

In terms of basic construction financial management, China established the People's Construction Bank of China under the Ministry of Finance in 1954, specifically to handle basic construction funding; in 1958, the fiscal contracting system was piloted, and the construction bank was abolished that same year; in 1962, the construction bank was restored; in April 1970, the construction bank was merged into the People's Bank of China.

In terms of working capital supply for state-owned enterprises, the fixed working capital of state-owned enterprises was mainly allocated free of charge by finance, but the methods of funding supply underwent several adjustments. From 1951 to 1954, fixed working capital was supplied by both finance and banking; from 1955 to 1957, all working capital was supplied by finance; in 1958, the method of supplying fixed working capital by finance and banking was restored; from 1959 to the second half of 1961, all working capital was supplied by banks, i.e., "full credit"; from 1962 to 1965, fixed working capital was entirely supplied by finance; from 1966 to 1971, within the approved working capital usage, both finance and banking supplied; from 1972 to 1978, the method of finance supplying was restored.

(4) The formation of comprehensive balance theory in financial and credit management.
During the recovery period of the national economy and the first five-year plan, there was a gradual realization of the need to correctly handle the relationship between finance and banking, recognizing the importance of comprehensive balance between finance and credit.

In the early period of New China, unifying finance, stabilizing prices, and stabilizing the economy made people deeply aware of the importance of fiscal balance for economic stability. After experiencing the "small advance" in 1953 and the "great advance" in 1956, people gradually recognized the significance of comprehensive balance between finance and credit for economic stability. In handling the relationship between finance and banking, given the reality that banks could not meet loan demands solely through self-absorbed deposits, the national finance began to consciously and systematically support bank credit. Starting in 1954, the national budget began to allocate a certain amount of "increased bank credit funds" each year. Based on the practices of this period, Chen Yun formally proposed the "three balances" in his 1957 report "The Scale of Construction Should Match National Strength," establishing fiscal balance, credit balance, and material supply-demand balance as guiding theories for economic construction to ensure their unity.

The Reasons for the Formation of the "Crotch Pants" Relationship Between Finance and Banking#

The close relationship between finance and banking stems from the fact that finance and banking inherently have a close connection, and the political and economic environment in the early years of New China further strengthened the finance-led integration of finance and banking.

(1) The influence of the Soviet economic model.
During the transition from New Democracy to socialism, the influence of the Soviet model was significant. Theoretically, it was believed that emulating the Soviet Union to abolish market systems and establish a planned economy characterized by highly centralized administrative coordination was a natural thing to do. Until the 1980s, the Soviet Union implemented a highly centralized single banking system compatible with the planned economy system, centered around the state bank, including the construction bank, foreign trade bank, and labor savings bureau, with a large and single structure encompassing the entire financial and credit business. The state bank had a broad range of functions, including those similar to central banks in Western countries, as well as those similar to commercial banks; it was responsible for monetary policy, currency issuance, and banking deposit and loan operations, leading to an unclear definition of the central bank's functions. The construction bank primarily managed investment loans for industrial basic construction; the foreign trade bank handled foreign trade settlements and non-trade foreign exchange transactions; the savings bureau's savings offices mainly absorbed residents' cash for national economic construction. These specialized banks only played a supporting role in certain aspects of banking operations and could not conduct independent accounting. Thus, the entire banking system was not sound and primarily served as an auxiliary to finance, fulfilling the function of a settlement center, with little role in fund allocation. In the planned economy system at that time, Soviet financial institutions represented the state in managing financial operations as administrative units, and the finance ministry had to allocate funds to enterprises, with no profit objectives or tasks, and interest rates remained unchanged for years, leading to insufficient autonomy and self-restraint in banks, lacking a solid credit foundation (Chen Liuqin, 2007). The finance-banking relationship in the Soviet Union served as a model for China.

(2) The planned economy system was the fundamental reason for the formation of the "crotch pants" relationship.
In the early 1950s, the socialist economic foundation in China gradually took shape, and the nature of the socialist economy was determined to be a planned economy based on public ownership. From 1949 to 1952, the state first implemented planned management of the financial sector and foreign trade, and implemented unified purchasing and marketing for a few important products.

From 1953 to 1956, planned management basically covered the product market. In 1958, the government directly controlled the operation of the rural economy, completing the formation of the planned economy.

During the socialist planned economy period, a significant feature of national economic life was planning. Planning governed everything, from production and distribution to circulation and consumption, with planning at work everywhere.

Finance, as the main tool for the state to raise and utilize funds, implement national economic and social development plans, and allocate resources, naturally bears the imprint of the planned economy system. Finance is the department responsible for the distribution of production results across society.

On the other hand, traditional fiscal theory holds that socialist finance is productive finance, a key component of social reproduction. Enterprises lack investment rights and the ability to expand reproduction, so state finance replaces enterprises as the main body of social investment.

The planned economy requires the elimination of capitalist components in all sectors of the national economy, thus rendering private banks, joint-stock banks, and other financial institutions unnecessary for serving the market economy. Meanwhile, the development of monetary value relations based on commodity circulation will be significantly restricted. Banks, as institutions managing currency and credit, naturally occupy a secondary position in the utilization of state financial resources. Moreover, due to the practice of unified collection and expenditure, enterprises' activities are managed under the national budget, with required funds allocated free of charge by finance, leaving banks to operate merely as auxiliary entities, engaging in limited business activities and supervising and controlling enterprises' finances, effectively serving as the state's "cashier."

The requirements of macroeconomic regulation.
From the founding of New China until the reform and opening up, the strong desire to build a prosperous nation prompted China to consolidate various state resources through planned means for various construction projects, thus establishing a highly centralized and unified macroeconomic regulation system that included material unified allocation, fiscal unified collection and expenditure, and banking unified deposit and loan, aiming for comprehensive balance in fiscal and credit management.

First, the state conducts planned regulation of the national economy from both the perspective of use value and value. The state first controls the production, supply, and sale of materials. State-owned commerce and material systems control the production, supply, and sale of industrial products, while rural supply and marketing cooperatives manage the purchase and sale of agricultural products and the return of industrial goods. On the other hand, "money follows goods," with the state using value means for distribution to achieve circulation and consumption. This macro-regulation method is based on the economic foundation of underdeveloped productive forces, material scarcity, and supply shortages, with the entire society in a seller's market. After the founding of New China, due to many twists and turns in national economic development, the state implemented planned adjustments to material supply and demand, with social capital collection and allocation primarily managed by finance through unified collection and expenditure, which was both necessary and feasible (Zheng Yanchao, 1986).

Second, finance is a means for the state to achieve its plans. Once the national plan is formulated, the specific implementation relies mainly on finance. Finance executes the national budget, participates in the value distribution of national income, and gradually forms various funds, such as depreciation funds for simple reproduction, consumption funds for maintaining labor reproduction, and accumulation funds for additional investment, thus creating monetary purchasing power for units and individuals, achieving the unity of use value and value in the circulation field. This process of unification is also the process of realizing the national plan (Niu Zehou, 1995).

Third, comprehensively coordinating fund arrangements to promote healthy economic development and coordinating the relationship between finance and banking is key. "During the planned economy period, the term 'macroeconomic regulation' did not exist, but macroeconomic regulation was indeed practiced, referred to as 'comprehensive balance.'" "The relationship between finance and banking was also coordinated under the guidance of comprehensive balance" (Wang Bingqian, 2009, pp. 737-738). Finance and banking are two channels for the state's centralized allocation of funds, and the purchasing power formed by finance and credit is an important component of total social demand. Balancing fiscal revenue and expenditure and credit revenue and expenditure is an important condition for achieving balance in material supply and demand.

The "Crotch Pants" Relationship Between Finance and Banking#

The close relationship between finance and banking is an inevitable phenomenon in modern economies. In the past, we often attributed this close relationship to the planned economy system, but experiences since the reform and opening up, as well as understanding of Western market economies, show that its existence has a crucial foundation: regardless of the type of economic system, the contemporary monetary supply formation mechanism and monetary movement laws share common characteristics that transcend systemic differences.

The Relationship Between Finance and Banking in the Planned Economy#

Characteristics of the Relationship Between Finance and Banking in the Planned Economy#

The Reasons for the Formation of the "Crotch Pants" Relationship Between Finance and Banking#

The requirements of macroeconomic regulation.
From the founding of New China until the reform and opening up, the strong desire to build a prosperous nation prompted China to consolidate various state resources through planned means for various construction projects, thus establishing a highly centralized and unified macroeconomic regulation system that included material unified allocation, fiscal unified collection and expenditure, and banking unified deposit and loan, aiming for comprehensive balance in fiscal and credit management.

First, the state conducts planned regulation of the national economy from both the perspective of use value and value. The state first controls the production, supply, and sale of materials. State-owned commerce and material systems control the production, supply, and sale of industrial products, while rural supply and marketing cooperatives manage the purchase and sale of agricultural products and the return of industrial goods. On the other hand, "money follows goods," with the state using value means for distribution to achieve circulation and consumption. This macro-regulation method is based on the economic foundation of underdeveloped productive forces, material scarcity, and supply shortages, with the entire society in a seller's market. After the founding of New China, due to many twists and turns in national economic development, the state implemented planned adjustments to material supply and demand, with social capital collection and allocation primarily managed by finance through unified collection and expenditure, which was both necessary and feasible (Zheng Yanchao, 1986).

Second, finance is a means for the state to achieve its plans. Once the national plan is formulated, the specific implementation relies mainly on finance. Finance executes the national budget, participates in the value distribution of national income, and gradually forms various funds, such as depreciation funds for simple reproduction, consumption funds for maintaining labor reproduction, and accumulation funds for additional investment, thus creating monetary purchasing power for units and individuals, achieving the unity of use value and value in the circulation field. This process of unification is also the process of realizing the national plan (Niu Zehou, 1995).

Third, comprehensively coordinating fund arrangements to promote healthy economic development and coordinating the relationship between finance and banking is key. "During the planned economy period, the term 'macroeconomic regulation' did not exist, but macroeconomic regulation was indeed practiced, referred to as 'comprehensive balance.'" "The relationship between finance and banking was also coordinated under the guidance of comprehensive balance" (Wang Bingqian, 2009, pp. 737-738). Finance and banking are two channels for the state's centralized allocation of funds, and the purchasing power formed by finance and credit is an important component of total social demand. Balancing fiscal revenue and expenditure and credit revenue and expenditure is an important condition for achieving balance in material supply and demand.

The "Crotch Pants" Relationship Between Finance and Banking#

The Relationship Between Finance and Banking in the Planned Economy#

In December 1958, the State Council decided to change the supply of working capital for state-owned enterprises from "dual supply" by finance and banking to unified management by the People's