The Reform of Intergovernmental Fiscal Relations in China*

This paper looks at the impact of China's fiscal decentralization on the central government's ability to use fiscal policy to achieve macroeconomic objectives. It is argued that, under the fiscal contract system introduced in the early 1980s. the localities effectively controlled the tax rates and tax bases. Due to the lack of fiscal resources and policy instruments, the central government found it increasingly difficult to achieve its goals of macroeconomic stabilization and regional equalization. The adoption of the tax-assignment system in the 1994 fiscal reform was an important step taken by the central government to address these difficulties. Nevertheless, a number of elements in the current tax-assignment system may work to make this system unsustainable in the long run.