Vertical Fiscal Imbalance, Transfer Payment and Local Government Governance

Abstract Accelerating the construction of modern fiscal and tax system helps not only free local governments from the shackle of the “competition for growth” development model, but also improve the governance capacity of local governments and realize the good governance of the country in the long term. Firstly, based on the typical fact of Chinese-style fiscal decentralization, this paper theoretically interprets the multiple channels and influencing mechanisms among vertical fiscal imbalance, transfer payment and local government governance. Secondly, it constructs a comprehensive index system to measure the governance capacity of local governments. The result shows that local government governance is relatively low in capacity and slow in improvement, and displays obvious regional heterogeneity. Then, the paper chooses structure and scale of transfer payment as mediator to construct the panel simultaneous equation model, and uses the three-stage least squares estimation (3SLS) for empirical investigation. The study finds that first, both the scale and structure of transfer payment may significantly affect local government governance, but the direction of the effects is opposite; second, the intensified vertical fiscal imbalance and the increase of transfer payment in scale can significantly inhibit local government governance, but the optimization of transfer payment in structure can significantly improve the governance; third, vertical fiscal imbalance not only directly inhibits the improvement of local government governance, but indirectly impedes it through the scale and structure of transfer payment.