In 1978 China initiated its market-oriented economic reform, bringing about significant impacts not only on macroeconomic system but also on govern- mental finance management. SOEs’ budgets were gradually disconnected from the governmental budget and monetary policy was separated from government budgets. Meanwhile, the principle of budget balance was abandoned at the central government. Furthermore, intergovernmental fiscal relationship was no longer operated in the traditional sense.
Fiscal decentralization between 1978 and 1994 greatly increased the autonomy of local governments. Theoretically, the national budget would consolidate the budgets of all levels of governments, and each provincial government would also consolidate all its lower level government budgets.
However, in the 1980s, provincial government budgets were not fully developed to provide such detailed budgetary information of sub-national governments, which made it difficult to conduct revenue and expenditure forecasts in certain areas (World Bank, 1990, p. 83). The fiscal decentraliza- tion also resulted in the decline of the ratios of budgetary revenue to GDP and the central government revenue to total government budgetary revenue. To arrest the fall of the two ratios, since 1994 a tax sharing system has been implemented, aiming at centralizing a large amount of revenues into the coffer of the central government (Teng, 2003, p. 43).
However, before 1999, the fiscal reform mainly concentrated on the revenue side, including re-constructing taxation system, creating a new revenue sharing system between the central and local governments, and modifying the relationship between the government and SOEs (Wang, 2001). On the expenditure side, only several minor reforms were witnessed.
First, China reformed its public investment system. Before the reform, public investment expenditure (construction investment), which was the largest type of investment, was allocated to SOEs for free. A system of bo gai dai (change appropriation to loan) was first applied in 1979 and then formally established in 1985. Under this system, a certain interest rate was charged for all investment expenditures. Further, in 1989, the central government adopted a national basic construction investment budget system. By doing so, the investment fund was divided into two parts: budgetary appropriation, applied to non-business-like basic construc- tion investments, and a loan system, applied to business-like basic construction investments. In 1993, together with the accounting system reform, an enterprise capital fund was created for all SOEs. Since then, SOEs’ budgets have been disconnected from the governmental budget (Wang, 2001).
Second, China reformed its budgetary management system for public institutions, such as government owned universities, research institutes, theaters, hotels, etc. Before 1996, China applied three different types of funding systems to three kinds of public institutions. For the first group of the institutions, all revenues came from budgetary appropriation. For the second group of the institutions, the government only provided revenues to cover the gap between their expenditures and their own revenues. For the remaining part, the government required that they use their own reve- nues to pay for all of their expenditures. In 1996 the government relinquished this system and implemented a new system, in which the government may provide a certain amount of grants but stipulated that
Modernizing Public Budgeting and Financial Management in China g 695
the government would not provide appropriation for any over-spending (Wang, 2001).
Third, in 1994, China passed the first law on government budgeting, the Budget Law. The main goal of the 1994Budget Lawwas to transform public budgeting from central planning to indirect macroeconomic management and it also set basic rules on budgetary procedures and expenditure management. Under this law, the local budget is to be formulated first and then fed into the central budget. Thus, the state budget can be formulated in a coherent framework. Moreover, local governments are required to run balanced budgets. Local governments are not allowed to finance their deficits with bond issues or bank borrowing. If they cannot maintain balanced budgets with their budgetary revenue, they must use accumula- ted budgetary surpluses or extra-budgetary funds to finance the deficits.
The central government is no longer allowed to borrow from the central bank and has to finance its deficits by issuing bonds (Tseng et al., 1994, p. 35).
Fourth, as early as 1993, several provincial governments started experi- menting with zero-based budgeting (ZBB) in compiling governmental budgets, including Hubei, Anhui, Hainan, Shengzhen, etc. The number of local governments conducting the ZBB experiment has increased in the past decade (MOF, 1997).
However, these reforms are not aimed at establishing a foundation for a new budgeting system. During the period between 1978 and 1999, although the role of the plan as the tool of resource allocation began to decline as a result of the market-oriented economic reform, a new and effective bud- geting system was not developed to fill the vacuum. Consequently, both budgeting compilation and execution were problematic.
25.2.2.1 Budgeting Compilation
Budgeting compilation employed during this period was problematic in the following aspects. First, the budgeting authority was fragmented at all levels of government. The power of allocating fiscal resources formerly controlled by the Plan Committee was gradually grabbed by a variety of functional departments. At provincial level, besides the finance bureau, several other departments also had the authority over certain types of governmental expenditures, including the Development and Reform Committee (the former Plan Committee, mainly in charge of basic construction expenditures), Science and Technology Department (in charge of three science and technology improvement funds), Economy and Trade Commission (in charges of state-owned enterprises technology improve- ment funds), and Health Department (in charge of public healthcare funds) (Ma, 2003).
The fragmentation of budgeting power was exacerbated by the expansion of off-budgeting finance since the 1978 economic reform, in which each department held its own off-budgetary revenues and had the authority of spending them. The fragmentation of budgetary power reduced the allocation efficiency because (1) different organizations tended to adopt different methods of making allocation decisions, reducing the competition among departments and programs in public money; and (2) under which it made it impossible to pool all fiscal revenues together in order to achieve allocation efficiency at the governmental level (Li and Liu, 2003, p. 33; Ma, 2003).
Second, the budget report itself was too coarse to provide detailed information for fiscal control either by the finance bureau or by the legis- lature. During this period, despite a decline of the planned economy system, its budget format was comfortably inherited. As a result, governmental expenditures continued to be compiled in terms of the functions that expenditure items play in the economy rather than on the departmental basis. This budget method failed to provide sufficient budgetary informa- tion based on activities of each spending department. Actually, it was the finance bureau rather than spending departments that were responsible for compiling budgets. Moreover, the budget contained only very sketchy information of revenues and expenditures due to the simple classification of revenues and expenditures and the existence of off-budget finance not being included in the governmental budget (Li and Liu, 2003, p.12).
Therefore, it was almost impossible for the finance bureau and the People’s Congresses at all levels to effectively examine and supervise governmental budgets (Xiang, 2001, pp. 90–91).
Third, during this period, within the finance bureau, the process of examining budget requests was decentralized, in which each specialized division within the finance bureau allocated certain types of expenditures to various spending departments, while each spending department went to almost all divisions of the finance bureau to ask for money in terms of the types of expenditures. One of the problems under this system was that there was not any division able to have a complete budget for each spending department. From the perspective of the spending departments, efficiency was lost with the increase of transaction costs since they had to negotiate with various divisions for budget requests.
Fourth, for many years, budgeting decisions had been made upon previous budget appropriation plus an increase (ji shu jia zeng zhang), similar to the so-called incremental budgeting. However, under China’s incremental budgeting, the budgetary base was decided very arbitrarily.
For example, at the provincial level, a variety ofprevious central laws and policies, provincial policies, and spending needs of powerful politicians were three major factors to shape budgeting decisions. In many cases,
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although certain central and provincial policies were no longer solid and reasonable for revenue and expenditure forecasting, they continued to be used to justify budgetary requests. Besides the influence of those policies, powerful politicians, mainly the Standing Committee members of Chinese Communist Party (CCP) governors or vice governors, hadinformalpower to ask the finance bureau to allocate money to certain departments or programs that they favored.3 Consequently, the departments tended to bypass the finance bureau and directly lobbied key politicians for budgetary appro- priation at any time during one budgetary year. If the politician thought that a department’s request was reasonable from his/her personal judgement, he/she would write a note to endorse this budgetary request, called aspi tiao zi(writing a note) in Chinese budgeting practice. With this note in hand, the department could get budget appropriation easily, barely refuted by the finance bureau (Ma, 2003).
China’s incremental budgeting also resulted in an unequal budgetary appropriation among spending departments and failed to reflect the changes in both the economic environment and department demands (PPRCSUFE, 2003). It created a stable allotment among departments, thus leading to an inefficient allocation of public resources because it encouraged some departments to overspend (Wang, 2001) and made re-allocation almost impossible. As a result, budget allocation became less efficient.
25.2.2.2 Budgetary Execution
Budgetary execution under pre-reform budgeting system was also pro- blematic, largely because of the decentralized treasury management developed during the planned economy period. First, in the process of budgeting execution, spending departments never took the budget seri- ously. They frequently went to the finance bureau whenever they ran out of expenditures allocated to them, or they wanted to increase revenues for existing programs or carry out a new program. Therefore, supplemental appropriation and budget adjustments were very prevalent in China’s budgeting system. Moreover, the policy-making and budgetary process were separated. Key political figures (members of the Standing Committee of the CCP, governors, and vice governors) could make policies at any time during budget execution,4demanding additional funds to support these policies. In this situation, the current budget had to be adjusted or reserved fund had to be put into use.
Second, revenue management was low in efficiency. The departments that had authority to collect revenues did not directly submit the collected revenues to the governmental treasury. Instead, they opened a variety of transitional accounts in commercial banks where those departments
deposited the revenues before they were submitted to the treasury. And the management of transitional accounts was beyond the supervision of the finance bureau. These practices not only decreased revenue collection efficiency but also increased the risk of corruption (Wang, 2002).
Third, expenditure management was underdeveloped. There was no single account system. Besides the accounts under the finance bureau, spending departments also opened their expenditure accounts in commer- cial banks, and almost all spending departments opened several accounts in one or more banks. After budgetary appropriations were approved, they were transferred to the spending departments’ accounts and spent at the discretion of spending departments with no intervention of the finance bureau. Therefore, there was not such a system of the fiscal direct payment as that in Western countries, in which the treasury directly pays providers of products and services from a single account. Instead, before the payment finally reached the receivers, the payment always involved multiple-levels of accounts. This system reduced the efficiency of cash management and fund using, and increased the risk of misuse, misappropriation, and cor- ruption (Wang, 2002; Xiang, 2001, pp. 136–137).
Meanwhile, procurement was decentralized in nature, in which each spending department procured its own products and services and paid for them. This system was problematic in the following aspects: (1) the procurement was beyond the control of the finance bureau, (2) it did not take the price advantage on large-scale purchases to save governmental expenditures, and (3) it lacked competition and transparency (Xiang, 2001, p. 145).