Media Platform: Finance & Trade Economics
Author: Zhang Kezhong et al.
Sales tax and VAT have long been important factors in determining the financial strength of local governments, and are the main cause of regional financial inequality. Since the tax-sharing reform, local governments' financial autonomy has been declining, with business tax gradually becoming the main tax type for local revenue. “Business tax replaced with VAT reform” led to an impact on local financial resources. In response to the pressure of the absence of the major local tax, the VAT sharing ratio between the central and local governments has been adjusted from "75%:25%" to "50%:50%" to maintain the same level of relative financial resources of local governments. In theory, the central government's practice of funding local governments according to their revenue sources alleviates the pressure on local government spending, and mitigates the vertical fiscal imbalance between the central and local levels. However, the regional financial gap may also be widened, leading to horizontal financial imbalances. Numerous studies have examined the impact of tax sharing on vertical fiscal imbalances, but have neglected the divergence of local horizontal fiscal patterns resulting from vertical fiscal adjustment.
Starting from the VAT sharing reform, Professor Zhang Kezhong and his research team have studied the changes in the government's financial power pattern after the sharing reform. Professor Zhang proposed a tax sharing scheme aimed at promoting regional fiscal balance, providing an analytical perspective for understanding fiscal relations between governments in China. The research found: 1. The VAT sharing reform alleviated the vertical fiscal imbalance caused by “Business Tax Replaced with VAT reform”, but exacerbated the horizontal fiscal imbalance and widened the regional financial gap. It has mitigated the impact on the financial resources of local governments. However, it still does not bring the relative financial balance between central and local government back to the situation before the "Business Tax Replaced with VAT reform". 2. The exacerbation of horizontal fiscal imbalance is due to the expansion of regional fiscal capacity differentiation after the reform of VAT sharing. Fiscal capacity divergence is an important cause of the increased horizontal fiscal imbalance following the sharing reform. The financial capacity of the coastal provinces has risen more after the share ratio adjustment and less in the inland provinces. 3. adjusting VAT raising principles and sharing methods can help reduce the degree of regional imbalances. The study found that the introduction of the financial resources principle or a combination of the "consumption + population + financial resources" principle will minimise the fiscal imbalance compared to the current VAT production location principle in China.
The policy implications of the study are threefold: 1. It is necessary to adjust the principle of the place of production for VAT increases. The gradual transition to a place-of-consumption principle or a combination of consumption, population and financial resources, and the reduction of distortions in government behaviour caused by the VAT collection principle are important aspects of VAT reform. 2. It is necessary to improve the local taxation system and establish a balanced sharing mechanism to narrow the vertical fiscal imbalance and horizontal fiscal imbalance of local governments. 3. The reconstruction of the VAT sharing system is conducive to the construction of an intergovernmental fiscal relationship with clear authority and responsibility, financial coordination and regional balance. It is positive for the advancement of financial reform in the new era.