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| Regional Competition, Downward Shift of Expenditure Responsibility,and the Expansion of Local Government Debt |
| JI Yunyang,FU Wenlin ,SHU Lei
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| School of Public Economics and Management, Shanghai University of Finance and Economics |
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Abstract In recent years, the scale of local government debt in China has expanded rapidly. According to the data released by the Ministry of Finance, by the end of 2017, local government debt liable for repayment reached 16.47 trillion yuan. Over-borrowing by local governments has become one of the main uncertainties affecting China's financial stability and sustainable economic development. To guard against systemic risk caused by excessive expansion of local debt, the central government has introduced a number of debt management measures in recent years. However, if the institutional factors causing local government expenditure and debt expansion are not eliminated, the excessive growth of local government debt will be difficult to solve. The most direct factor in the expansion of local government debt is undoubtedly the longstanding gap between revenue and expenditure in local finance. Previous studies on the formation mechanism of local government debt tend to emphasize an increasing “upward shift of financial power and downward shift of administrative affairs” in the intergovernmental fiscal relationship since the reform of the tax distribution system, leading to an increasing imbalance between local financial resources and public service demand. Local governments have had to be passively indebted to fulfill their public service functions. From 2000 to 2013, the proportion of central expenditure decreased from 34.7 to 14.6 percent, while local expenditure increased from 65.8 to 85.7 percent. Does the downward shift in the vertical intergovernmental expenditure responsibility lead to passive liability among local governments？ The literature focuses mainly on qualitative analysis or case studies, and lacks normative theoretical and empirical evidence. Local government debt is expanding, whether in the Eastern, Central, or Western region, and local government debt funds are invested mainly in infrastructure and municipal construction projects rather than in livelihood areas such as education and social security, where expenditure responsibility is fast increasing. This shows that the reform of the tax share system is not enough to explain the expansion of local debt. The competition between local governments to attract investment by preferential means of finance and taxation will usually aggravate the contradiction between local fiscal revenue and expenditure. The strategic interaction of local government debt financing caused by inter-regional “yardstick competition” needs to be empirically examined through the framework of a spatial econometric model.Based on the dual perspectives of downward fiscal expenditure responsibility and inter-government competition, we examine the impact of administrative and economic factors on the expansion of local government debt. The main contributions are as follows. First, by constructing a theoretical model of local government debt-raising behavior, this paper analyses the characteristics of an optimal debt financing strategy in representative areas when the higher government's expenditure responsibility falls and the finance in competitive areas is used for debt financing. Second, by summing up the data on bank loans and urban investment debt of public facilities construction in 279 prefecture-level cities in China, a more reliable dataset of local government debt is constructed. Empirical analysis of spatial econometric model is used to verify that the expansion of local government debt is the result of a downward shift in higher government's fiscal expenditure responsibility and the regional yardstick competition. The expenditure pressure on local government caused by a downward shift in intergovernmental expenditure responsibility is an important reason for the passive debt. The yardstick competition among local governments makes them follow an imitation strategy in debt borrowing. The main cause of the expansion of local government debt is heterogeneous for different regions, and the debt in Eastern China has risen mainly as a result of the fiscal tournament.This study suggests that the resolution of local government debt risk should not only standardize the division of fiscal expenditure responsibility, but also improve the performance appraisal system for local governments and strengthen the accountability mechanism for irregular debts. Future research needs to improve the data measurement of local government debt and the division of governmental powers, and construct a more general theoretical model for local government financial behavior based on the diversified evaluation index system for local government performance to provide a more scientific explanation for the change in the scale of local government debt and to identify the political and economic risks caused by local government debt.
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Received: 10 January 2018
Published: 01 April 2019
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