Central Government Transfer Under a Soft Budget Constraint

As discussed in Chapter 1, the Chinese central government has experienced increasing difficulties in balancing its budget over the past decade. Two obvious factors are responsible for this problem. First, the current central-local revenue-sharing methods provide the localities with adverse incentives for revenue collection (see Chapter 2). Second, the central fiscal authority has found it very difficult to control the expenditure expansion. The excessive expenditure expansion has to do with two institutional features of the central government’s budget formation process: first, the decision making of most investment projects financed by the budget is strongly influenced by lobbying of the local governments and, second, the budget constraint is soft (that is, the budget approved by the Congress is not strictly adhered to); additional expenditures (exceeding the officially approved budget) that accommodate regions’ lobbying are common. 1 These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.