The 1994 Tax-Sharing Reform
From 1 January 1994 China replaced the provincial fiscal contracting of the 1980s with a tax-sharing system. The reform was led by Vice-Premier Zhu Rongji, who negotiated with more than a dozen provinces in the second half of 1993. Under the State Council decision of 15 December 1993, taxes were divided into central, local and shared categories, with value-added tax split 75:25 between center and localities and separate national and local tax bureaus created; tax rebates to localities were calculated from a 1993 base. The reform sharply raised the central share of fiscal revenue but is also seen as having aggravated county and township fiscal distress and as one institutional root of "land finance."
Background: Fiscal Contracting and the Falling "Two Ratios"
In the 1980s China ran a system of fiscal contracting between the center and the provinces — "eating from separate kitchens" — under which each province remitted revenue to the center according to an agreed base and ratio and kept most of any surplus. The system gave localities strong incentives to develop their economies, but it steadily drove down both the ratio of fiscal revenue to GDP and the central government's share of total fiscal revenue. According to Xiang Huaicheng, then Vice-Minister and later Minister of Finance, the central share of national fiscal revenue stood at only about 22 percent in 1993: "the central share of fiscal revenue was too low, seriously weakening the center's capacity for macroeconomic control." After the 14th Party Congress set the goal of a socialist market economy in 1992, fiscal and tax reform moved onto the agenda.
Zhu Rongji's Provincial Negotiations
The reform was led by Vice-Premier Zhu Rongji. From 9 to 16 September 1993 he visited Hainan and Guangdong to negotiate the tax-sharing plan with local leaders. According to People's Daily's account of Zhu Rongji on the Record, he told officials in Guangdong: "Central finances are now in great difficulty and have reached the point of being unsustainable. If we do not appropriately centralize central revenue and strengthen central fiscal capacity, we simply cannot get by." On 18 September, back in Beijing, he wrote to Jiang Zemin, Li Peng and the Politburo Standing Committee reporting on his talks with the two provinces, and on 25 September he spoke in Xinjiang on the reform's implications for the western economy. In the third and fourth quarters of 1993, Zhu led officials from the relevant ministries to more than a dozen provinces, autonomous regions and municipalities.
Central Decisions and Design
On 14 November 1993 the Third Plenum of the 14th Central Committee adopted its "Decision on Issues Concerning the Establishment of a Socialist Market Economic Structure," which called for replacing local fiscal contracting with tax-sharing. On 15 December the State Council issued its "Decision on Implementing the Tax-Sharing Fiscal Management System," setting out principles including "correctly handling the distribution relationship between the center and the localities and mobilizing the initiative of both" and "gradually raising the central share of fiscal revenue and appropriately increasing central fiscal resources." Taxes were divided into central, local and shared revenues: customs duties and consumption tax went to the center; business tax, local enterprise income tax and personal income tax to the localities; the largest tax, value-added tax, was split "75 percent central, 25 percent local," and securities transaction tax 50-50. Separate central and local tax administrations were created to collect central and shared taxes on the one hand and local taxes on the other.
Tax Rebates and Implementation
To reduce local resistance, the decision used 1993 as the base year for central tax rebates to the localities: the revenue transferred upward from the localities in 1993 was rebated in full, guaranteeing existing local resources, and thereafter "tax rebates shall increase year by year from the 1993 base, at a rate set at a coefficient of 1:0.3 of the average national growth rate of VAT and consumption tax." The new system took effect nationwide in all provinces, autonomous regions, municipalities and cities with independent planning status on 1 January 1994, with separate national and local tax bureaus established accordingly.
Impact and Debate
The reform greatly increased fiscal centralization. According to Xiang Huaicheng, the central share of national fiscal revenue rose from 22 percent to 53.28 percent by 2008, and total fiscal revenue as a share of GDP rose from 10.8 percent in 1994 to 20.4 percent in 2008. Researchers have also pointed to side effects. In "A Decade of Tax-Sharing: The System and Its Effects," sociologist Zhou Feizhou argues that it was an "incomplete centralization": the center concentrated revenue powers, but costly responsibilities such as rural basic education, health care and social security remained with local governments, leading to fiscal distress at county and township level, while local governments turned to off-budget sources — above all land requisition — to raise funds, producing a "dual fiscal" structure. The tax-sharing system is therefore often regarded as one of the institutional roots of later "land finance" and local government debt.
Narrative Comparison
| Source | Narrative |
|---|---|
| State Council tax-sharing decision and Xiang Huaicheng, "Sixty Years of Reform of China's Fiscal System" | The official account stresses that tax-sharing was a key supporting reform for building a socialist market economy: it ended the situation under fiscal contracting in which the central share of revenue was too low and the center's capacity for macroeconomic control was seriously weakened. By dividing taxes between center and localities on a standardized basis, it mobilized the initiative of both while gradually raising the central share; using 1993 as the base year to protect existing local resources, it achieved a smooth transition between systems. |
| Christine P. W. Wong (World Bank working paper, 2000) | Wong argues that fiscal decentralization in reform-era China occurred in an ad hoc and uncoordinated way, driven largely by the center shedding burdens onto localities, and that the 1994 Tax-Sharing Reform was the first attempt to put intergovernmental fiscal relations on an objective, rule-based footing. She examines the reform within a framework of public expenditure management, focusing on how spending responsibilities between center and localities were arranged after revenue assignment was reformed. |
| Zhu Rongji (leader of the reform), Guangdong speech of September 1993, from Zhu Rongji on the Record | As the leader of the reform, Zhu Rongji told Guangdong and other provinces bluntly that "central finances are in great difficulty and have reached the point of being unsustainable," and that without appropriately centralizing revenue and strengthening central fiscal capacity "we simply cannot get by"; he also insisted that "fiscal and tax reform must follow international practice and the principles of a market economy." |
Key Milestones
- Zhu Rongji goes to Hainan and Guangdong to negotiate tax-sharing
From 9 to 16 September Zhu negotiates the tax-sharing plan with leaders in Hainan and Guangdong.
- Third Plenum of the 14th Central Committee endorses tax-sharing
The plenum adopts its decision on establishing a socialist market economic structure, calling for an end to local fiscal contracting.
- State Council issues the tax-sharing decision
The "Decision on Implementing the Tax-Sharing Fiscal Management System" sets out the division of central, local and shared taxes and the rebate formula.
- Tax-sharing takes effect nationwide
The new fiscal system takes effect in all provinces, autonomous regions, municipalities and cities with independent planning status; national and local tax bureaus are separated.
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