Elsevier

China Economic Review

Volume 23, Issue 1, March 2012, Pages 190-203
China Economic Review

Rural tax reform and the extractive capacity of local state in China

https://doi.org/10.1016/j.chieco.2011.10.002Get rights and content

Abstract

China's fiscal arrangement in the 1980s has preserved local governments' incentive but the 1994 fiscal reform recentralized revenues. Since then, farmers' tax burdens have risen steeply and become a major challenge to the state legitimacy. How to account for the huge regional variation? Why were some localities able to tax more heavily than others? Based on a national survey of village governance in China, we examine farmers' burdens empirically and identify political and social factors that explain the local governments' ability to tax farmers. This paper suggests that developments since the 1990s have shown that it overstates local discretionary power and does not pay enough attention to societal forces in understanding local public finance.

Highlights

► We examine China’s rural tax reform. ► The reform has reduced overall tax burdens. ► High fees are still charge in some regions. ► Rural self-governing organizations helped to reduce taxes.

Introduction

Tax is the lifeblood of a modern state. Without sufficient revenues, the state cannot finance its basic functions and win popular support. Excessive taxation, however, dissipates regime legitimacy quickly and results in state failure (Cheibub, 1998, Levi, 1988). Oppressive taxation and peasants' uprisings have been common under the Chinese dynastic rule and many empires crumbled as a result of popular rebellions (Bernhardt, 1997). In the 1990s, excessive taxation reemerged in China's countryside. In addition to formal taxes, local governments charged exorbitant levies and fees on rural households. In some cases, farmers' financial burdens reached as high as 20–30% of their already low incomes (Chen, 2003). Many agricultural regions have developed a vicious cycle: to secure tax collection, local governments recruited more staff members; an enlarged local bureaucracy in turn required more revenues and collections (Chen, 2003, Yep, 2004). Excessive taxation and farmers' burdens have become a major source of grievance in China's vast rural areas. Farmers brought their complaints against their local governments to higher levels of the administration, including the central government, the court, and also the pubic media. In many incidences, frustration with these formal and bureaucratic channels pushed desperate farmers into direct confrontation with local authorities (Bernstein and Lu, 2000, O'Brien and Li, 2005). The central government, fearful of the damage to its legitimacy, responded with a series of tax reform policies starting in 2000. The first step, known as the “tax-for-fee” reform, converted some legitimate local fees into one unified agricultural tax. The new tax rate was raised but local governments were prohibited from levying new fees. In 2004, the central government took a bolder move and started to phase out the century-old agricultural tax on farmers. In the long sweep of Chinese history, this was a rare, if not unprecedented, instance of rescinding any obligation of the farmers to the state. Ultimately, the central leadership aimed to restore its political legitimacy and to reign in local state's excessive extraction of farmers.

Like many policy changes in China, implementation can be a major challenge. Have farmers' burdens fallen as a result? Did tax reforms achieve their intended targets? To answer these questions, we examine local state's extractive capacity. Why is there a regional variation in extraction rate and how can some local governments extract more resources than others? In 2005, we conducted a national survey of rural governance with particular attention to the financial aspect of it. As a result, we have collected systemic data about farmers' monetary burdens. The empirical test confirms some key hypotheses we have developed. Rural tax reforms initiated by the central government have indeed alleviated farmers' overall financial burdens — on average, the burdens were cut by more than half — but the pattern becomes more complicated and also more fascinating when we break them down into two components. In accordance with the central directives, local state did scale down agricultural taxes (i.e. the first component) very significantly. The other component includes various informal extractions, such as irregular fundraisings and fines, which local governments were able to maintain as a source of revenue, despite efforts made by the central government to minimize them. Local governments' extractive capacity in this area, however, was checked by two factors: the ability of farmers to resist and the development of informal organizations in villages.

This paper contributes to the literature on fiscal federalism. Some political economists argue that China's rapid economic development can be explained by local governments' pro-growth policies. China is a unitary state but it adopted a quite unique fiscal system in the 1980s. The central government signed contracts with local governments and specified a fixed amount or a fixed ratio of revenue submissions. Beyond that, local governments could keep the surplus and had full discretion in spending. This financial incentive encouraged local officials to promote economic growth in their jurisdictions and maximize their budgetary incomes. These scholars believe that China has become a de facto fiscal federalism (Blanchard and Shleifer, 2000, Oi, 1992, Montinola et al., 1995, Jin et al., 2005). Instead of sorting and matching emphasized in the traditional fiscal federalism theory, this new analysis brings economic growth to the front and expands the scope of the theory.

Our discussion of farmers' burdens shows that local governments have acquired some autonomy and a delicate bargaining characterizes the central–local relations. But the fiscal federalism argument may have overstated local discretion in China. In the 1980s, the central government respected local discretion most of the time but things started to change in the 1990s. As a result of fiscal contracting, the central share in government revenues dropped. This resulted in the fiscal recentralization in 1994 which gave the central government a larger share in total revenues, including 75% of VAT. Enterprise income tax and personal income tax were initially assigned to local governments. When they grew unexpectedly fast in the following years, the central government forced local governments to give up half of them in 2002. In the meantime, the central government unloaded a lot of spending responsibilities onto local governments. To finance these unfunded mandates, local governments had to exact levies from farmers in the countryside. The rise of farmers' burdens demonstrates the lack of discretionary power (both revenues and expenditures) on the part of local governments. As will be elaborated toward the end of the paper, our research does not support the other extreme of an omnipotent center either. To ensure efficient provision of local public goods, the central government has left certain bargaining room in a highly centralized state.

The fiscal federalism argument has also understudied a major source of constraint local governments must face in revenue collections. Rules regulating central–local fiscal relations undoubtedly affect local governments' ability of revenue maximization. After the reform, the Chinese society has regained some vitality and started to constrain the hands of the state. In studying rural taxation, we found that local governments' extractive capacity depended on the extent to which local society collaborated with local authorities. In localities where the mass and cadres have developed high tensions, local officials had trouble mobilizing revenues. On the other hand, in places where self-governing organizations have developed a capacity for public service provision, local governments were relieved of certain financial burdens. These findings provide a more nuanced picture of state–society relationship in China and enrich the single-dimensioned (i.e. intergovernmental) focus in fiscal federalism (Hansen, 2008, Tsai, 2007).

The rest of the paper proceeds as follows. The next section analyzes the governance structure in rural taxation and explains the rise of farmers' burdens, especially after the fiscal recentralization in 1994. Section 3 develops three institutional hypotheses to explain local governments' extractive capacity. The data from our national survey and empirically tests are discussed next. The conclusion addresses some implications of this study for rural financial challenges and the overall rural governance.

Section snippets

Fiscal recentralization and the rise of farmers' burdens

Rural taxation has played a crucial role in the construction of the new China (Lin, 1992). The state relied on three taxation tools to extract resources from farmers. The agricultural tax was a tax in kind and the rate was about 10% of grain output in China's first five-year-plan period (1953–1957) but dropped to 5% in the 1960s and 1970s (Yan et al., 1988). The second taxation tool of “price scissors” was implicit but quite powerful. Farmers were mandated to sell their grain products to the

Explaining local taxation on farmers: three hypotheses

Local governments faced a challenging environment in the second half of the 1990s. The center became more fiscally and administratively demanding. Local governments must perform and meet central expectations. More aggressive taxation, however, was met with a rural society that was less inclined to be controlled. The next three sections develop some specific hypotheses to explain regional variations in taxation.

Empirical evidence and discussions

We conducted a large national survey in 2005 to test these hypotheses. We first divided the country into six large regions and randomly picked one province in each: Shaanxi (Northwest), Sichuan (Southwest), Hebei (North), Jilin (Northeast), Jiangsu (East), and Fujian (Southeast). All counties in each province were ranked and categorized into five quintiles in order of their per capita gross value of industrial output. In each quintile one county was randomly selected. Two townships in each

Conclusion

Farmers' burdens in the early 2000s have become a serious challenge threatening local public finance in China. Based on a national survey, we show that the rural tax reform has indeed reduced tax burdens in rural China. However, almost all of the tax reduction can be attributed to the lessening of taxation with central permission. There was very little reduction in the amount of taxation beyond central permission. In some regions local governments even carried out more local fundraising

References (53)

  • J. Cheibub

    Political regimes and the extractive capacity of governments: taxation in democracies and dictatorships

    World Politics

    (1998)
  • X. Chen

    A study on China's county and township public finance and farmers' income growth

    (2003)
  • X.L. Cui

    Rural tax reform: transition from production to market transaction

    Chinese Rural Economy

    (2002)
  • E. Friedman et al.

    Revolution, resistance and reform in village China

    (2007)
  • China deconstructs

  • X.L. Guo

    Land expropriation and rural conflicts in China

    China Quarterly

    (2001)
  • M.H. Hansen

    Organising the old: Senior authority and the political significance of a rural Chinese ‘non-governmental organisation’

    Modern Asian Studies

    (2008)
  • Y.S. Huang

    Inflation and investment control in China

    (1996)
  • M. Levi

    Of rule and revenue

    (1988)
  • S. Levitsky et al.

    Informal institutions and comparative politics: A research agenda

    Perspectives on Politics

    (2004)
  • J.Y. Lin

    Rural reform and agricultural growth

    The American Economic Review

    (1992)
  • G. Montinola et al.

    Federalism, Chinese style: The political basis for economic success in China

    World Politics

    (1995)
  • B. Naughton

    The Chinese miracle: Transitions and growth

    (2007)
  • B. Naughton et al.

    Holding China together

    (2004)
  • K.J. O’Brien et al.

    Popular contention and its impact in rural China

    Comparative Political Studies

    (2005)
  • K.J. O'Brien et al.

    Rightful resistance: Contentious politics in Rural China

    (2006)
  • Cited by (28)

    • Impacts of agricultural incentive policies on land rental prices: New evidence from China

      2021, Food Policy
      Citation Excerpt :

      Total amount of agriculturally related taxes accounted for nearly 25% of annual government revenue in 1950s, but with the rising government fiscal revenues from industrial and service sectors, it fell to about 14% in 1960s, 8% in 1970s, and remained at about 4% in 1980s and 1990s (Ministry of Finance, 2006). In this paper, we focus on agricultural tax that includes the tax and fees levied on crop production (Liu et al., 2012) but was collected based on crop land held by rural households. In 2000, the rising concerns on farmers’ burdens and income led China’s leaders to make decisions to reduce and finally eliminate the taxes and fees imposed on farmers in agricultural production.

    • Factor reallocation and structural transformation implications of grain subsidies in China

      2020, Journal of Asian Economics
      Citation Excerpt :

      A considerable amount of literature has investigated economic impacts of the Chinese rural reforms implemented between 1978 and 2003 (e.g., Brümmer, Glauben, & Lu, 2006; Fan, Zhang, & Zhang, 2002; Lambert & Parker, 1998; Lin, 1992, 1995; Oi, 1999; Zhang & Brümmer, 2011). In addition, several studies have discussed the impacts of some major policy changes since 2004, for instance, abolishing agricultural taxes, and agricultural subsidy programs (e.g., Huang, Wang, Zhi, Huang, & Rozelle, 2011; Liu, Xu, Su, & Tao, 2012; Lopez, He, & De Falcis, 2017; Wang & Shen, 2014; Yu & Jensen, 2010). However, none of them systematically investigates the effects of agricultural subsidy policy on production factor reallocation, economic growth, as well as agricultural and non-agricultural production.

    • Understanding recent challenges and new food policy in China

      2017, Global Food Security
      Citation Excerpt :

      For example, in the past 13 years (2004–2016), the Number One Document, the first and most important national policy document each year released by the Central Committee of the Communist Party of China, has exclusively focused on these three issues. In the literature, while several papers discuss some major policy changes in the recent decade, such as eliminating agricultural tax (Tao and Qin, 2007; Liu et al., 2012), increasing agricultural subsidies (Huang et al., 2011, 2013; Yi et al., 2015), enhancing agricultural research and development expenditure (Huang and Rozelle, 2014; Babu et al., 2016), and raising agricultural price and income support for farmers (OECD, 2013), none of them systematically examines the evolution of recent policies and motivations for policy changes. Understanding the evolution of recent policy changes is interesting not only for China's own development in the coming years, but also for the rest of world.

    View all citing articles on Scopus

    The authors would like also to recognize the China National Science Foundation (project 70633002 and project 70703032), The Ford Foundation, the Fundamental Research Funds for the Central Universities and the Research Funds of Renmin University of China and the Vassar College for support of related fieldwork.

    View full text