Poverty in China - Fiscal System and Rural Social Services

Fiscal System and Rural Social Services

Market reform has dramatically increased the return to education, as it indicates that there are good opportunities for skilled people and as it creates a powerful incentive for families to increase the education of their children. However, there needs to be strong public support for education and reasonably fair access to the education system. Otherwise, inequality can become self-perpetuating: if only high-income people can educate their children, then that group remains a privileged, high-income group permanently. China is at some risk of falling into this trap, because it has developed a highly decentralized fiscal system in which local governments rely primarily on local tax collection to provide basic services such as primary education and primary health care. China in fact has one of the most decentralized fiscal systems in the world.

China is much more decentralized than OECD countries and middle-income countries, particularly on the spending side. More than half of all expenditure takes place at the sub-provincial level. In part, the sheer size of the country explains this degree of decentralization, but the structure of government and some unusual expenditure assignments also give rise to this pattern of spending. Functions such as social security, justice, and even the production of national statistics are largely decentralized in China, whereas they are central functions in most other countries.

Fiscal disparities among subnational governments are larger in China than in most OECD countries. These disparities have emerged alongside a growing disparity in economic strength among the provinces. From 1990 to 2003, the ratio of per capita GDP of the richest to poorest province grew from 7.3 to 13. In China, the richest province has more than 8 times the per capita public spending than the poorest province. In the US, the poorest state has about 65 percent of the revenues of the average state, and in Germany, any state falling below 95 percent of the average level gets subsidized through the "Finanzausgleich" (and any receiving more than 110 percent gets taxed). In Brazil, the richest state has 2.3 times the revenues per capita of the poorest state.

Inequalities in spending are even larger at the sub-provincial level. The richest county, the level that is most important for service delivery, has about 48 times the level of per capita spending of the poorest county. These disparities in aggregate spending levels also show up in functional categories such as health and education where variation among counties and among provinces is large.

These differences in public spending translate into differences in social outcomes. Up through 1990, there were only modest differences across provinces in infant survival rate, but by 2000 there had emerged a very sharp difference, closely related to the province’s per capita GDP. So too with the high-school enrollment rate: there used to be small differences across provinces. By 2003, high-school enrollment was nearing 100% in the wealthier provinces while still less than 40% in poor provinces.

There is some redistribution within China’s fiscal system, but not enough. Poor areas have very little tax collection and hence cannot fund decent basic education and health care. Some of their population will relocate over time. But for reasons of both national efficiency and equity, it would make sense for the state to ensure that everyone has good basic education and health care, so that when people move they come with a solid foundation of human capital.

China’s highly decentralized fiscal system results in local government in many locations not having adequate resources to fund basic social services. As a consequence, households are left to fend for themselves to a remarkable extent. The average hospital visit in China is paid 60% out-of-pocket by the patient, compared to 25% in Mexico, 10% in Turkey, and lower amounts in most developed countries. Poor households either forego treatment or face devastating financial consequences. In the 2003 National Health Survey, 30% of poor households identified a large health care expenditure as the reason that they were in poverty.

The situation in education is similar. In a survey of 3037 villages in 2004, average primary school fees were 260 yuan and average middle-school fees, 442 yuan. A family living right at the dollar-a-day poverty line would have about 900 yuan total resources for a child for a year; sending a child to middle-school would take half of that. Not surprisingly, then, enrollment rates are relatively low in poor areas and for poor families.