Measuring Fiscal Transparency in China
By Zhihan Yu | Department of Economics | NURJ Online 2015-16 | Submitted: Nov. 15, 2015 | Published: May 3, 2016
The purpose of this paper is to introduce and discuss the “2015 Chinese City Government Fiscal Transparency Report” published by a research team, of which I was a part of, at the Center for Public Finance and Governance of Tsinghua University, China. The report of this year encompasses all of 652 Chinese city governments—namely, four province-level, 290 prefecture-level, and 358 county-level Chinese municipal governments. By collecting fiscal information from each city websites, the research team released “2015 Fiscal Transparency Ranking of Prefecture-Level Cities,” and “2015 Fiscal Transparency Ranking of County-Level Cities.” The study finds that although there is improvement in fiscal transparency as a nation compared to the last fiscal year, many Chinese municipal governments still need to improve on disclosing government debt and major fiscal records. Among all city governments, Beijing, Guangzhou, and Shanghai have been among the top three of the “Most Transparent Cities of China” for the past two years, serving as paradigms in improving fiscal transparency practice in China.
The debate about government secrecy and open government is a heated and ongoing issue. While a secretive government may safeguard national security, an open government, in theory, allows for maximum supervision and democracy. There is a general consensus in media and academia that fiscal transparency is beneficial to a government’s well being. Access to information is a central component of fiscal transparency, which is one of many tools necessary to achieve government accountability.
Definition of Fiscal Transparency
The contemporary definition of fiscal transparency has not deviated much from the definition proposed by Kopits and Craig in 1998. They defined fiscal transparency as “openness toward the public at large about government structure and functions, fiscal policy intentions, public sector accounts, and projections”. This form of openness is necessary for accountable and responsible fiscal policies. Transparency of this kind will lead to more credible policies and faster fiscal policy response, ultimately stirring the nation in the direction of better economic performance.
Fiscal transparency can be further broken down into three major dimensions: system and policy transparency, accounting transparency, and index and forecast transparency.
1. System and policy transparency: Transparency in this area includes the overall openness of the roles and responsibilities of government related institutions. Not only so, budgeting methods, budgeting purposes, budget prioritization, performance reports, and financial audits of these government related institutions are nested within this dimension.
2. Accounting transparency: Apart from the detailed financial statements, this part also encompasses governmental funds, social security funds, quasi-financial activities of public enterprises, etc.
3. Index and forecast transparency: Governments are not only obligated to release their financial statements, but should also reveal relevant indices (such as financial sustainability, structural and cyclical fiscal balance, debt service reserve, etc.) and net government debt. Kopits and Craig (1998) suggested that in order to achieve fiscal transparency in the short, medium, and long terms, governments should respect the truth, draw clear distinctions between the initial situation and the situation after enacting policies.
Importance of Fiscal Transparency
The implication of fiscal transparency is extensive. On one hand, fiscal transparency not only informs the public about the government’s involvement in the economic environment, but also points in the direction of future macro settings. On the other hand, fiscal transparency allowed taxpayers to know how tax money is spent. Generally speaking, aftermaths of fiscal transparency can be categorized into its impact on government operation, political competition, public deficit management, and anti-corruption efforts.
Fiscal Transparency and Government Size
Fiscal transparency plays an integral role in determining government interaction with the economy. Ferejohn (1999) proposed a fiscal transparency model, in which the more transparent a government, the bigger the involvement of it in the economy. Under a democratic political system, when a government is proactive in disclosing its fiscal information, there will be an invisible force that pushes politicians to maximize public benefits. As a consequence, the general public is more wiling to allocate resources in welfare departments, resulting in an expansion in government involvement within the economy. One could easily see this phenomenon through an agency model. In this model, the clients, taxpayers, relinquish their resources to the political agent, who will presume the role on reallocating resources and providing public goods in return. Transparency, in this model, is measured by the degree of freedom where clients can adjust to changes made by the agent. Therefore, with complete transparency, the asymmetry of information is curtailed; agents no longer have the means to use such asymmetry to reap benefit for themselves. Also with greater transparency, taxpayers will be able to predict government decisions more accurately and swiftly, leading to increased trust between the two sides. Because of transparency, political policy uncertainty is reduced, trust between public and government is increased, so taxpayers are more willing to invest more in public goods, resulting in greater economic size of governments.
Indeed, other studies show similar aftermaths of fiscal transparency. Utilizing the cross-sectional data between 1972-2002 of American states and an index of fiscal transparency, Alt, Lassen, et al (2005) endorsed Ferejohn’s theory. They showed that there is a significant positive correlation between fiscal transparency and government involvement in the economy. Not only so, cross-country studies suggest a positive relationship between broadly defined transparent budget practices and fiscal discipline. Hence, a positive feedback loop looks like this: fiscal transparency would lead to strong accountability and discipline, which, in turn, may render improvement of fiscal transparency. The cycle perpetuates and the result is higher efficiency in the provisions of public services and goods, as governments are more integrated in both the society and the economy.
Fiscal Transparency and Political Competition
Under a democratic political system, fiscal transparency can lead to healthy political competition. As mentioned in the previous section, fiscal transparency of a government can inspire trust between the government and the public. Hence, under certain political environments, fiscal transparency will promote supportive selection. On the other hand, though, Besley (2005) and Besley and Smart (2003), using a political agency model of adverse selection and moral hazard, showed that transparency could be detrimental to voter welfare. Higher transparency may consolidate politicians in their rent-seeking, making it harder for voter to differentiate between good and bad politicians. As shown by previous studies, the degree of fiscal transparency affects the outcome of its impact on political competition.
Fiscal Transparency and Public Deficit Management
Debt management is a critical component of fiscal transparency. If debt and deficits were left out of the picture, governments would embrace their urges to spend more now by issuing bonds for the future to improve their term performance. This way of spending may not seem harmful in the short term, but in the immediate long run, this can be a serious problem.
Shi and Svemson (2002) showed in a political-governance model that when the public chooses politicians based on their abilities to maximize public service and goods without increasing taxes, politicians are instigated to issue bonds to demonstrate their “capability.” Should fiscal transparency be achieved, electorates would be able to easily observe the politicians’ intentions and curb the act of needless borrowing.
Alt and Lassen (2006) took a revised Shi and Svemson’s model to investigate the effect fiscal policy on public debt accumulation. Using the data from the 19 OECD countries, they found out that greater fiscal transparency results in less public debt accumulation, rightwing parties that favor lower public expenditure have lower fiscal deficit than its leftwing counterparts, and the bigger the political discrepancy, the bigger the scale of public debt.
Fiscal Policy and Fight Against Corruption
Generally speaking, fighting against corruption is based on a righteous sense of responsibility, but this is built on ruled-based law and accountability of government. However, in nation states that are still plagued by corruption, the law and government are not operating to their full efficiencies. A large reason for this ineffectiveness is due to a lack of a reliable legal/ fiscal framework. Fiscal transparency provides such a structure so as a government can minimize discretion and mismanagement by having the public supervision over fiscal actions.
In a case study of Uganda, Reinikka and Svensson (2004) showed that rectitude could be realized if the motivation of a government is to serve its people. In the 1990s, for every dollar the Ugandan government donates to local schools, only 20 cents get delivered into the hands of the school, while 80 cents were soaked away by local governments. To combat this situation, the Ugandan government didn’t just commit to stricter fiscal management policies, but started a top-down movement to impart the amount of money schools actually received on local monthly newspapers. This movement allowed the public to administer the funds. The effect was significant; “government captures” dropped from 80% in 1995 to less than 20% in 2001. Therefore, public supervision is intrinsic to combatting corruption.
Previous Efforts in Measuring Fiscal Transparency
By the end of the 20th century, countries gradually came to realize the importance of fiscal transparency. In 1999, the International Monetary Fund (IMF) released a report that discussed fiscal transparency on an international level. By the turn of the century, many OECD countries began to publish ratings of their domestic fiscal situations. The United States began to publish fiscal transparency indices in the hope to better serve its electorates. Similarly, Japan began to disclose fiscal information to steady, driven by the need for political accountability. The European Union saw fiscal transparency as a necessary condition to stabilize the Euro. China, though not a member of the OECDs, also began to require fiscal transparency from all governmental levels in 2008.
II. Institutional Background
To promote fiscal transparency, the State Council of China (Chinese cabinet) issued “The People’s Republic of China Government Information Exposé Action” on May 1, 2008. This marks the beginning of fiscal openness efforts in China. In 2014, the People’s Congress of China passed “The Budget Act”, which becomes effective this year and requires local governments to release specific financial information. Yet, because of the special political and cultural differences fiscal transparency assessment frameworks from other nations cannot be directly applied to China. This section will discuss the uniqueness of the Chinese political and fiscal situation.
Chinese Political Structure: Party State
The political structure of the People’s Republic of China adopts the form of a Soviet-styled socialist republic state run by the Communist Party. Since the leadership of the Communist Party is stated in the Constitution of the People’s Republic of China, state power is apportioned to the Communist Party, including the central, provincial and local governments. The vicissitude of China’s political system can be summarized by two words: “party state.”
The Communist Party has monopolized power over the past six and a half decades. As the Communist Party is the sole leading political organization casted in the Constitution, the Communist Party controls the State Council, National People’s Congress, People’s Liberation Army, and Chinese People’s Political Consultative Conference. As such, the Party approves most of the policies regarding the nation.
Levels of Administration
The unitary administrative system of the China is another distinctive feature. This structure of China consists of five administrative levels. The secondary level immediately under the central government is made up of 33 provincial level governments, including 23 provinces, 5 autonomous regions for minority peoples, 4 province-level municipal cities, and 2 special administrative regions of Hong Kong and Macau with highest autonomous rights of self-governance.
The tertiary level of administration includes prefecture-level cities and autonomous prefectures for minority peoples. As of January 1, 2015, China has a total of 291prefecture-level cities and 30 autonomous prefectures.
The quaternary level is county-level cities, districts, counties and autonomous counties for minorities. There are 358 county-level cities, over 860 districts under provincial-level cities and prefecture-level cities, more than 1600 counties and autonomous counties. At both prefecture level and county level there are government organizations, Party committee, and People’s Congress and other quasi-public units. Hence, in terms of political structure, secondary- and tertiary-level cities are identical; and they differ only in administrative levels.
The gross-root level of administration is the lowest tier of the Chinese formal administrative structure. It embodies around 40,000 townships and towns. In the Chinese administrative order, villages are merely “mass organizations of self-management at the grass-roots level.”
In the scope of this study, the research team in the Center for Public Finance and Governance at Tsinghua University focused on the fiscal transparency of city governments, including province-level, prefecture-level, and county-level cities, which is an important for and integral in fiscal transparency as a nation. Indeed, city governments at these three levels account for major portion of fiscal activities. In order to establish a prefecture-level city, a city government must be able to receive annual revenue of over 200 million among many other mandatory requirements; a county-level city government needs to have annual revenue of at least 40 million. Apart from having strict governmental revenue requirements, urbanization is a predominant feature of China. 53.73% of China’s population lives in cities. Faced directly to general public, city governments at all levels are the major places to implement policies directly concerning well-being of the citizens.
Since there is no available method applicable for the Chinese city government with unique political and administrative features, the research team proposed an original framework to assess fiscal transparency, which requires city governments to follow three basic principles: namely, all-item-inclusiveness, one-stop-service, and user-friendly-release. The framework consists of three major parts:
1) Budget-received agencies (50 points):
Publicly-funded agencies must release the functions together with its structure. They includes agencies in the Party, the government, the Political Consultative Conference, People's Congress, non-profit institutions, state owned businesses, etc.
2) Four books of budget (380 points):
City government (and its departments) should release all execution of 2014 budgets and planned 2015 budgets of four books which are listed as follows:
a. Public revenue and expenses
b. Government fund revenue and expenses
c. State-owned Capital Revenue, and expenses
d. Social security fund revenue and expenses
3) Other Important Fiscal information (170 points):
City government should also release other important fiscal information not included in the budget books. They are government debt, major public projects, government purchases, three-public-spending (public vehicles, public entertainments, and public overseas visits), and principles of the budget spending.
4) Additional scores (30 points):
To emphasize the importance of three principles to disclose fiscal information online (all-item-inclusiveness, one-stop-service, and user-friendly-release), each principle is given 10 scores to assess whether province- and prefecture-level city governments follow these three principles of fiscal transparency.
In sum, the maximum points for province- and prefecture-level city governments are 630; and county-level city governments are 600. The time window of assessment for city governments is from January of 2015 to June of 2015. All fiscal information is obtained from the official websites of city governments.
IV. Empirical Results
Fiscal Transparency of prefecture- and province-level city governments
This is the fourth consecutive year that the research team published its report on fiscal transparency of city governments in China. Compared to the year of 2014, there is a notable improvement in fiscal transparency for city governments of this level. For example, province-/ prefecture-level cities have significantly increased the release of both number of fiscal items and information contents.
Figure 1 shows the average of the total score (in percentage). Most prefecture-level city governments are distributed evenly between 20%-50%; 59 of the governments scored between the 20%-30% range; 58 governments in the 30%-40% range; 54 in the 40%-50% range; 83 are above the 50% scores; and only 6 city governments are in the top rank, between 80%-90%: They are Beijing, Guangzhou, Shanghai, Tianjin, Zhuhai, and Wuhan.
Specific parts of fiscal transparency
1) Budget-funded agencies
Most of the province-/ prefecture-level city governments in China reveal information regarding agencies that are financed by public budget.
2) Four books of budgets
Disclosure of these fiscal books is still far from satisfactory. Figure 2 depicts the score percentage distribution of all 294 province-/ prefecture-level cities.
Out of 294 cities, 268 released certain information of four major fiscal books, and the average score is 33.93% of the total. Only 55 cities scored higher than 60%. This is the lowest scored part compared to other parts of the assessment framework for fiscal transparency, indicating that disclosure of their four fiscal books at prefecture-level cities is behind requirements.
3) Other financial information
In this part, prefecture-level cities excelled in disclosing information abut government purchases, Three-Public-spending, and major project funding. Yet, apart from Beijing, Guangzhou, Shanghai, Tianjin, Ningbo, and Xiamen, other cities did not mention any thing about governmental debt.
Last year’s top-scorers, Beijing, Guangzhou, Shanghai, maintained their spots in the top three positions this year, continuing to set examples for its counterparts. Qualitatively, cities in the top-ten list, such as Tianjin, Zhuhai, Wuhan, Nanning, Jiaxing, Jinan, and Ningbo were also satisfactory in terms of fiscal transparency. It should be noted that many of the city governments among the top ten are located on the east coast of China. This indicates that while the east coast cities leading economic development, local governments are also turning their attention to improve public governance. On the other hand, the city governments that ranked in the bottom ten are clustered in cities located in the west and middle-land of China. Many cities in these areas still take GDP growth as foremost dominating target, ignoring improvement of governance such as fiscal transparency.
Fiscal Transparency of county-level city governments
This is the first year that the research team study fiscal transparency of 358 county-level city governments. Unlike the assessment for prefecture-level and province-level governments, the first-year study of county-level city governments does not include the holistic assessment.
According to the results, the fiscal transparency of county-level city governments is generally worse than those of prefecture-level counterparts. The top three city governments at this level are from Jiangshan (Zhejiang Province), Jianyang (Sichuan Province) and Guanghan (Sichuan Province), scoring 382, 372, and 359 respectively. The last three city governments scored 0, disclosing nothing about fiscal information.
From Figure 3, it is clear that the distribution of the scores is skewed to the left, with the majority of the county-level city governments falling in the 20%-30% category. In fact, less than one third of them scored above 30%; only the top two city governments scored above 60%.
Among the top ten of county-level city governments, three are from Zhejiang Province, two from Sichuan Province, and one each from Hainan Province, Hebei Province, Guangdong Province, Yunnan Province, and Shanxi Province, respectively.
Again, a significant number of the bottom 19 cities are in western provinces.
Specific parts of fiscal transparency
1) Budget-Funded Agencies
The average score of this part for 358 county-level city governments is 29.55; only 43 cities received full scores.
2) Four Books of Budgeting
The average is only 70.92 (18.66%); and only 22 cities scored higher than 200 points. Figure 3 reflects the distribution of scores regarding the four financial books of budgeting. The distribution is heavily skewed to the left: almost half of the city governments have scores in the single digit, while only 9 cities scored over 60% in this section. Hence, it is safe to generalize that county-level city governments in China badly need to improve disclose of fiscal information.
3) Other Fiscal Information
The average score for the five categories in this section is 40.53; only 6 cities scored higher than 100 points. Of the five different categories, disclosure of government debt is the worst, averaging 0.61 (mere 1.54%). The disclosure of three-public-spending is also low, averaging 9.40 (23.51%).
The low scores in the section of Other Fiscal Information, especially in government debt and three-public-spending of county-level city governments are primarily due to the following reasons. First, a majority of local governments control many State Owned Enterprises (SOEs), which take on the role of issuing bonds for the government. However, local governments did not disclose debts of these SOEs in their books of State-owned Capital Revenue and expenses. Secondly, county-level governments in China could have relatively high debts and many of them play the role as debt guarantors, so the disclosure incentive is minimalized. Thirdly, three-public-spending does not officially standalone in the accountant books, as the amount can be disguised under other categories. As a result, governments may choose to artificially reduce the amount they label as “three-public-spending” to show their “fiscal rectitude.” Despite of the current situation, improving regulation of local government debts and the guidelines for three-public-spending is not only vital in rebuilding a accountable government, but also key in rectifying the political system from corruption.
Summary of Results
Although the overall performance of provincial- and prefecture- level city governments have improved by a large degree compared to that of last year, there still exists a gap between the reality and the desired. For example, the disclosure of governmental debt still remains as a mystery, the lack of data for the four major fiscal books of many cities stands as an obstacle, and the indistinct guidelines to three-public-spending still presents itself problematic.
Compared to prefecture- and provincial-level counterparts, county-level city governments are not as good in fiscal disclosure. While the average score for prefecture and provincial-level city governments is 251.72 out of 630 (39.96%), county-level ones only scored on average 141.00 out of 600 (23.50%).
In the process of collecting data, the research team came across websites of many city governments that didn’t release basic fiscal information. In fact, some governments even disclose little information. Because of this, there exists a large spread in the levels of fiscal transparency among city governments in China: while many city governments improved quality of released fiscal information, majority of them still struggled to disclose the basic information. Yet, the general trend is slowly heading toward a direction to reveal more fiscal information to the society.
Fiscal transparency is the first step to building a responsible and credible government. Rights of knowledge and rights of speech are two basic entitlements to citizens of contemporary democratic societies; transparency of public spending will, therefore, bestow taxpayers with the necessary conditions to the same rights of knowledge, rights of speech, and rights to participate. To the government, finance transparency lays the foundation for a legal society and through which increases its own credibility towards both domestic and international users. Not only so, increasing fiscal transparency will inhibit corruption within the government. Agency problem always arises when there is a conflict of interest between the agent and the client. Minimizing mismatch of information is a key to solving this problem. With better fiscal transparency, the government is more accountable and credible. But most importantly, transparency in public finance enables the government to be better involved in the financial market, benefitting both infrastructural construction and economic growth. The aftermath of having a transparent public finance framework, city governments of all levels can benefit both economically and politically by reconstructing more credible profiles.
In the recent decade or so, China’s ascend in economic power and political influence has out sped the expectation of many people. Because of this, the Chinese government needs to be ever more accountable for its action on both domestic and international platforms. Striving for fiscal transparency is one way to achieve the accountability that is necessitated by all. For the past four years, the Center for Public Economics, Finance and Governance at Tsinghua University have closely studied fiscal transparency of Chinese city governments. This year’s reports include assessment of 652 city level governments, including 4 province-level, 290 prefecture-level, and 358 county-level governments. The investigation employed big data method to surf on websites of all city government. Only 55 city governments at the province-/ prefecture- level scored higher than 60%; the average for county-level cities is a mere 18.66%. By all means, Chinese governments at all levels should make big endeavor to enhance fiscal transparency.
Author’s note: Zhihan wrote this paper independent of any NU scholars. The data was obtained from his summer work with the Center for Economics and Financial Management Center of Tsinghua University.
Zhihan Yu is a junior in the Integrated Sciences Program (ISP), majoring in Math and minoring in Economics. He worked as a research assistant for the research team of fiscal transparency in the Center for Public Finance and Governance at Tsinghua University in the summer of 2015, and would like to express thanks for the research team permit him to quote the statistics of the report.