Chapter

6 A Comparative Perspective on Expenditure Assignments

Editor(s):
Ehtisham Ahmad, Vito Tanzi, and Qiang Gao
Published Date:
September 1995
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Author(s)
Ehtisham Ahmad*

Principles

Expenditure assignments influence the effective provision of certain services, as well as macroeconomic policy, but have important distributional implications. They are often based on a benefit principle, that the responsibility for the expenditure should be accorded to the jurisdiction within which the benefits are contained. The “responsibility,” however encompasses (1) policy formulation, (2) financing arrangements, and (3) policy administration or implementation. A number of combinations are possible, given the existing institutional framework. Thus, mandates from higher levels, or given policy parameters, could be effectively combined with local financing and administration. Alternatively, central policies and certain types of financing may be negated by local administrations. This paper focuses on international patterns of expenditure assignment, as well as the possibilities for assigning responsibilities for social protection expenditures between different levels of government in China.

With respect to the nexus between administration and policy, there are three types of government programs. The first covers so-called national public goods that require centralized administration and, by necessity, policy. For example, decentralizing responsibility for macroeconomic stability, redistribution, and national defense would be inefficient. Second are so-called local public goods for which decentralization of administration and policy is feasible and generally considered to be desirable for allocative efficiency and administrative efficiency, for example, municipal services. Finally, there are mixed public goods for which there are advantages to decentralized administration but for which some degree of centralized coordination of policy is needed.

With primary education and preventive health care, there are certain efficiency advantages to local supply, such as possibly better quality through local supervision and some allowance for communities to express their preferences and priorities. Tertiary education and research and development, as well as hospitals, have economies of scale and benefits that would accrue to more than one jurisdiction—in such cases, higher levels of administration or finance may be needed. For distributional reasons, a nation might want a global minimum standard to ensure that regional disparities do not reflect income differences rather than different preferences. When conflicting goals arise, such as in this case, the analysis can become quite complicated and subject to normative biases. Therefore, one would expect different arrangements in different countries to arise, depending upon the global priorities of society and the government. The case of infrastructure investment is discussed by Hofman and Newfarmer (Chapter 7).

One of the primary conclusions that emerges is that administrative efficiency and allocation efficiency call for a large degree of decentralization of administration. In practice, industrial countries have more decentralized administration than developing countries on average. Perhaps of more interest, in the more highly centralized industrial nations, France, Italy, and Spain, significant tendencies toward decentralization of services is in evidence. This is combined with a centralization of revenue functions for efficiency of administration and to ensure a capacity for redistribution from richer to poorer regions. The distributional implications of expenditure decentralization, however, are often undesirable; tension often exists between expenditure assignments and financing arrangements. Grants serve as the coordinating mechanism that allows decentralized expenditures along with centralized tax collection. They can enable a large degree of decentralization, while allowing a country to pursue redistribution targets. Grants may cause a problem in that they decrease transparency and lead to fiscal illusion, and a trade-off emerges between the separation of administration from financing.

Once an administrative system is in place, there has to be an over-powering efficiency or budgetary reason to change it. Certain reforms to policymaking and financing arrangements may be needed, however, for macroeconomic control. In practice, there is considerable leeway in determining expenditure assignments, which are governed by a country’s historical and institutional background. Thus, expenditure assignments in China should display “Chinese characteristics”, given that the international experience is very varied.

The Government’s Role

Before assigning duties between various levels of government, the scope for the public and private sectors must be defined. In principle, production and consumption of private goods should be left primarily to market forces. The government should then confine itself to cases where there are externalities and market failure. However, even when substantial externalities and informational constraints exist, as with large infrastructure projects, it is not evident that production of private goods should be carried out by the state. Private provision could be accompanied by other forms of intervention or regulation, such as the establishment of environmental standards and regulations. The case for state provision is strongest for public goods, and defense and public administration are examples of public goods par excellence.

The Central Government

There is little doubt that macroeconomic stabilization has to be the responsibility of the central government, although the allocational and distributional objectives are more debatable. Indeed, a variety of patterns are found around the world. Stabilization is difficult to achieve, however, without control of overall expenditure levels. Thus, assignment and control mechanisms of different types of expenditures are of considerable importance from the macroeconomic perspective.

The central government has significant efficiency advantages over local governments in ensuring income redistribution and the establishment of minimum standards across regions. This is because the ability of localities to provide support for low-income groups is severely limited by mobility of the poor, the rich, and businesses. Redistribution by a given locality in isolation can attract poorer individuals from neighboring localities.1 In general, the greater the extent of mobility, the more difficult and costly it is to redistribute income within a locality. In countries where mobility is limited, such as China, need may be concentrated in regions that have limited ability to provide even minimum services. The establishment of minimal access to education, health, and other human services across regions may be seen as a socially desirable goal of central government. Such a redistributive policy implies at least a financing responsibility for the central government.

Subnational Levels of Government

Beyond the benefit principle, as described above, are few a priori guidelines on the allocation of responsibilities between the center and the provinces, and between the provinces and lower levels of government. Thus, considerable variety may be expected, in infrastructure, social services, and social protection policies. While there are advantages for decentralized administration, for example, in social protection—the needy are easier to define at the local level (i.e., township in China)—the policy and financing functions may not necessarily be the responsibility of the same level of government.

International Patterns of Expenditure Assignment

The systems of intergovernmental finance in many federations have evolved gradually, much like their market and political institutions, reflecting historical circumstances and cultural traits. Among the six major industrial federations (Australia, Austria, Canada, Germany, Switzerland, and the United States), the share of local expenditures in total government expenditures varies from 7 percent in Australia to 26 percent in Switzerland; the states’ or provinces’ share of total expenditures varies from 16 percent in Austria, to 48 percent in Canada.2

The share of local receipts of transfers from higher-level governments varies from 16 percent of total local revenue in Switzerland to 48 percent in Canada; the share of intergovernmental grants in total receipts of states or provinces varies from 16 percent in Germany to 50 percent in Australia. Each country has unique features. In Australia, state governments depend heavily on federal transfers; Switzerland is characterized by strong local governments with relatively little dependence on transfers; the United States has a pass-through transfer system from the federal government to state government to local government. In Canada, however, provincial revenue collection is relatively high (see Bird (1986)).

In India, the constitution specifies expenditure assignments, but developmental and infrastructural concerns are addressed through the extra-constitutional Planning Commission, with the Finance Commissions addressing issues of revenue sharing and financing needs of the states. Expenditure control, given India’s federal structure, is a major policy issue (see Chelliah, Rao, and Sen (1992)). In China also, overall expenditure control and responsibilities are critical elements of economic stabilization. Existing institutions and methods provide a starting point to determine desirable directions of reform.

A difficulty in assigning expenditure responsibilities lies in the fuzzy distinction between levels of administration in some countries. Moreover, as pointed out by Levin (1991), regulation is difficult to measure, and whereas finance and administration can be identified, neither fully represents the full range of activities carried out by the government. The difference between finance and administration lies in intergovernmental grants, financed by the grantor government and administered by the recipient administration in providing goods, transfers, and services. The financing (administration) of expenditures at a particular level is determined inclusive (exclusive) of grants given and net (inclusive) of grants received. Centralization ratios based on the administration of expenditures are likely to underestimate the role of the central government, particularly with respect to redistributional transfers that are generally made by the central authorities. The appropriate classification of extrabudgetary funds, particularly for social security, would also affect the reported degree of centralization.

The result of differences in control, finance, and administration of expenditures at various levels of government is often a vertical imbalance between the expenditures to be incurred by a subnational government and the resources available to it. Some of the resources, such as shared taxes and revenues, conditional grants, and borrowing options, provide a degree of control to higher levels of government. In some cases, the central government mandates certain expenditures, making for control over local expenditures even when these are administered and fully financed by the lower level of administration. At the opposite extreme are expenditures mandated and financed by the central government, such as minimum educational or health standards. Here, the effective control over the level of expenditures rests with the administering lower-level authority (health care in Italy), even though officials of the central administration are represented at the lower level (social expenditures in Pakistan). The reason for the loss of central control in the latter case lies primarily because of the effective underwriting by the central government of deficits or expenditure overruns at lower levels of government. Thus, in most cases, the form of transfers from higher levels of government and the associated incentives for limiting expenditure growth are important in controlling overall expenditures.

A wide variety of expenditure patterns (and associated grants) can be observed across the world. As Table 1 from Levin (1991) indicates, unclassified grants form a predominant share of transfers in countries such as the United Kingdom, France, and Australia. On the other hand, only 11 percent of grants in the United States and around 20 percent in the Scandinavian countries and Canada could be classified as free of regulations. Among developing countries, very few provide the distinction between different types of grants, although a substantial proportion of total expenditures is financed through grants in countries such as India (27.8 percent) or Indonesia (17.6 percent)—excluding transfers for local expenditures in both cases.

Table 1.Portions of General Government Expenditure Financed by Intergovernmental Grants(Average of latest three years available)
Ending

Year
Total

Expenditures1
EducationHealthSocial

Security

and

Welfare
Percent of

Intergovernmental

Grants

Unclassified
(As percent of general government expenditures)
Argentina2198788.0
Australia198724.530.68.21.460.0
Austria1987
Belgium19876.30.0
Bolivia19860.4
Brazil198714.4
Canada198716.750.222.99.421.8
Chile19872.00.0
Colombia198419.1
Denmark198627.19.16.247.623.5
Finland198716.5
France19856.82.71.01.178.0
Germany198310.310.93.53.552.6
Hungary198810.4
India2198627.8
Indonesia2198817.6
Ireland198716.5
Israel19863.718.10.72.451.2
Kenya19844.321.1
Luxembourg198711.54.923.8
Malawi19846.1
Mexico19843.3
Netherlands198823.5
New Zealand19812.1
Norway198615.216.2
Pakistan19799.7
Paraguay19840.0
Poland198810.6
Romania198510.3
South Africa198614.9
Spain19869.8
Sweden198710.321.2
Switzerland198414.921.97.39.419.4
Thailand19823.99.8
Tunisia198212.1
United Kingdom198713.33.90.06.566.4
United States198714.942.818.713.210.9
Yugoslavia19877.2
Zimbabwe19868.537.69.30.02.3
Source: Levin (1991) based on IMF, Government Finance Statistics Yearbook, Vol.13 (Washington: IMF, 1989).

Includes supranational authorities share of general government expenditures in Belgium (2.2 percent), Denmark (2.2 percent), France (1.4 percent), Germany (1.8 percent), Luxembourg (2.7 percent), and United Kingdom (1.9 percent).

Data for general government do not include local government.

Source: Levin (1991) based on IMF, Government Finance Statistics Yearbook, Vol.13 (Washington: IMF, 1989).

Includes supranational authorities share of general government expenditures in Belgium (2.2 percent), Denmark (2.2 percent), France (1.4 percent), Germany (1.8 percent), Luxembourg (2.7 percent), and United Kingdom (1.9 percent).

Data for general government do not include local government.

When possible to identify, grants allocated for particular functions provide an indication of the extent to which the higher levels of government wish to promote a particular activity. A substantive proportion of the expenditures on education is financed by grants in countries as diverse as Zimbabwe, the United States, and Canada, but very little in the United Kingdom and Germany. In the latter group of countries, however, unconditional grants are of considerably greater importance than in the former—thus indicating that even in a highly “centralized” system as in the United Kingdom, local authorities have some freedom to maneuver in allocating resources for education, despite the establishment of nationwide norms and curriculums.

Fiscal illusion has been observed in several countries for which a reasonably long time series is available (Winer (1983) for Canada, and Gramlich (1979), for a review of U.S. studies). Evidence is consistent with the hypothesis that the separation of decision making caused by substituting own resources with grants increases local expenditure beyond expectation, although the degree of illusion tends to subside over time.3 A recent study of decentralization and government size in Latin America (which controls for a positive correlation between rising income and the size of government) finds that decentralization financed by central government transfers rather than by own revenues is likely to increase government expenditures (Reid and Winkler (1992)). A number of studies point out that the counterpart of fiscal illusion at the federal level is that grants will tend to lead to lower expenditures by higher level governments (see Hewitt (1986) and (1991)). Therefore, the impact of fiscal illusion on general government expenditures is uncertain.

In Italy, revenue centralization since 1973, coupled with the local administration of major expenditure items, such as health and social assistance (see Table 2), has led to a loss of accountability at the local level, leading to an uncontrolled growth of total public expenditure. The absence of own-revenue sources led to a reliance on ad hoc and gap-filling grants. This process has noticeably reduced the transparency of the transfer system and of the central government budget,4 and local administrators are devoid of budgetary responsibility. While a considerable part of grants are driven by need, most allocations are based on past expenditure norms. With centralized norms for wages and some prices, it is impossible to determine whether local deficits are due to centralized decisions or to local mismanagement. Local residents are not aware of the local costs of services, since most are borne through general taxation. Thus, preferences between alternative local uses of resources are not revealed, and the allocative advantages of decentralization cannot be obtained.

Table 2.Italy: Arrangements for Financing, Legislating for, and Administrating Major Expenditure Items
FinancingLegislationAdministration
Center
HealthXX
EducationXXX
Social welfare1XXX
Regions
HealthXFor own earmarked revenues
Education
Social welfare
Provinces
Health
EducationSupport personnel, buildings and furniture, for specific schools in secondary educationFor functions specified under financing
Social welfare
Municipalities
HealthX
EducationSupport personnel, buildings, and furniture in elementary educationFor functions specified under financing
Social welfareCash and in-kind benefits to people on the municipal poor listFor functions specified under financing

Pensions and family allowances.

Pensions and family allowances.

Furthermore, the technical capabilities of local administrators are often inadequate to meet the budget preparation needs of the multiannual budgets, instituted to improve fiscal coordination and to facilitate central control of subnational expenditures. Thus, measures to adjust grants at the margin, and to require more stringent budgeting procedures, have not per se had much of an impact on controlling overall expenditures in Italy. This points to the need to assess expenditure policy and financing sources together with the allocation of expenditure assignments.

There is considerable diversity of experience relating to the share of expenditures on items such as education, health, and social security administered at each level of government, as seen in Table 3 (from Levin (1991). Thus, among industrial countries, education is primarily provided at the central government level, whereas in the United Kingdom and the United States, it is provided by local governments, and by state governments in Australia and Germany. Among developing countries, education and health are primarily provided by the central government in Indonesia, but by the state governments in India (data on local governments are not available in either country). In other countries, such as Brazil, information is not available for the breakdown of functional expenditures at subnational levels of government, despite the importance of such a classification for overall policymaking.

Table 3.Magnitude of General Government Expenditures and Portion Administered by Each Level of Government1(Average of latest three years available)
Social Security and WelfareTotal ExpendituresEducationHealthSocial Security and Welfare
Ending YearTotalEducationHealthCent. govt.State govt.Local govt.Cent. govt.State govt.Local govt.Cent. govt.State govt.Local govt.Cent. govt.State govt.Local govt.
(As percent of GDP)
(As percent of general government)
Australia198739.15.55.59.652.940.46.88.591.30.243.555.60.992.86.21.0
Austria198751.870.413.716.9
Belgium2198756.785.911.9
Canada198746.05.86.012.341.340.318.44.834.560.72.689.57.965.831.32.9
Denmark2198657.67.15.223.144.952.946.853.27.192.926.173.9
Finland198743.054.745.3
France2198549.34.68.320.982.216.575.324.797.03.091.88.2
Germany2198350.24.28.021.258.721.517.91.073.825.274.411.214.479.010.910.1
Ireland198755.872.527.5
Luxembourg2198739.14.40.721.381.315.974.125.992.08.097.42.6
Netherlands198859.270.129.9
New Zealand198143.286.913.1
Norway198647.266.433.6
Spain198638.278.89.911.3
Sweden198761.659.840.2
Switzerland198437.45.35.913.947.528.324.26.257.536.345.532.122.488.55.65.9
United Kingdom2198744.85.15.114.370.927.212.787.3100.00.084.016.0
United States198737.15.14.39.060.317.322.44.224.571.350.533.815.778.014.67.4
Hungary198864.55.74.218.177.822.220.080.039.260.895.74.3
Poland198848.171.128.9
Romania198532.32.12.18.977.023.028.072.010.389.799.30.7
Yugoslavia198725.33.24.27.823.231.445.40.00.0100.00.00.0100.07.375.916.8
India 3198622.63.40.92.347.552.59.090.130.269.80.0100.0
Indonesia 3198822.83.10.50.488.711.365.334.772.827.20.0100.0
Israel198662.95.32.010.090.89.267.232.897.03.094.95.1
Pakistan197926.168.228.33.5
Thailand198221.24.11.11.292.37.794.85.293.56.597.42.6
Argentina 3198733.24.01.19.160.339.733.366.724.475.689.410.6
Bolivia198611.185.910.63.4
Brazil198734.165.824.59.6
Chile198732.34.91.98.893.86.281.718.398.11.9100.0
Colombia198418.05.51.33.267.423.98.755.539.25.349.040.210.890.07.82.2
Mexico198430.290.17.62.3
Paraguay198411.395.14.9
Kenya198429.35.22.11.494.35.794.06.091.98.175.924.1
Malawi198429.13.72.20.693.76.398.71.382.917.1100.00.0
South Africa198633.374.812.512.7
Tunisia198234.05.12.54.794.65.4100.0100.0100.00.0
Zimbabwe198645.08.32.63.075.824.260.239.886.613.4100.00.0
Source: Levin (1991) based on IMF, Government Finance Statistics Yearbook, Vol.13 (Washington: IMF, 1989).

Excluding intergovernmental grants.

includes supranational authorities’ share of general government expenditures in Belgium (2.2 percent), Denmark (2.2 percent), France (1.4 percent), Germany (1.8 percent), Luxembourg (2.7 percent), and United Kingdom (1.9 percent).

Data for general government do not include local government.

Source: Levin (1991) based on IMF, Government Finance Statistics Yearbook, Vol.13 (Washington: IMF, 1989).

Excluding intergovernmental grants.

includes supranational authorities’ share of general government expenditures in Belgium (2.2 percent), Denmark (2.2 percent), France (1.4 percent), Germany (1.8 percent), Luxembourg (2.7 percent), and United Kingdom (1.9 percent).

Data for general government do not include local government.

Social Security and the Social Safety Net in China

Social protection mechanisms in many different types of society embody elements of insurance, together with redistribution. This is true in the industrial societies, where formal social insurance instruments cater for old age, and other forms of loss of income, including unemployment, together with family allowances that limit the risk of poverty due to childbearing, and measures to provide for social assistance. Informal arrangements that mimic the above arrangements are also occasionally to be found in traditional societies in developing countries, but these suffer from a number of difficulties that mirror the level at which the service is provided (see Ahmad and others (1991)).

A major element in the provision of cover for life-cycle and employment contingencies is the pooling of risk. Thus, enterprise-level provision for the aged or the disabled, as was the case in the former centrally planned economies (e.g., China or the former Soviet Union), imposed major costs on older enterprises that were inconsistent with the efficient functioning of a market economy. In India, the absence of an effective mechanism to cater for the unemployed forces the continuation of subsidies to keep inefficient public sector enterprises afloat. And while community-based provision for the disabled and aged tends to be very effective in identifying the appropriate recipients, given the lower costs of local information, such methods are particularly vulnerable to covariate risks, where the whole community is affected, say, by drought or other shocks. Thus, by their nature, social insurance mechanisms should not be based on local pooling of risks, and the net should be spread as far as administratively possible.

In very large countries, such as China or the former Soviet Union, where there are vastly different demographic and income levels, the national pooling of risks may lead to a transfer of resources from poor to richer regions.5 In such cases, it has been argued that provincial or republican level funds may be an alternative (some provinces in China and India have larger populations than most countries of the world). However, the requirement that there should be national standards for pensions and unemployment benefits, together with the need to minimize tax competition across regions, suggests that serious consideration should be given to centralized policy in this connection, with an appropriate pooling of risks. The principal issue relates to interpersonal comparisons, with protection of the aged and unemployed, regardless of where they reside. Interregional transfers should be handled within the horizontal equalization nexus, with an appropriate design of grants.

It is clear, however, that the informational advantages of local provision predominate when there is a need for fine targeting, as with most forms of social assistance. The link with local levels of resources (at the margin) is also clear, with the roots of assistance based on charitable provisions by the church, and the more formalized local provisions based on individual wealth in many Middle Eastern and African countries (see Ahmad (1991)). With financing from higher levels of government at the margin, there is lower incentive to pay, together with a reduced incentive to target the neediest.

The devolution of certain social expenditure responsibilities, for example, for consumer and enterprise subsidies in China, has contributed to an intractable problem associated with expenditure and revenue bargaining at lower levels of government. This has degenerated into a loss of control over such expenditures, together with an increase in the associated overall deficit. An attempt to introduce a degree of control, by moving to matching earmarked grants, has had a regressive impact. This is because the system of price subsidies is more heavily concentrated in more urbanized areas and enterprise subsidies in the older industrial centers. Moreover, the matching ratios for central grants can be as high as two, and poor provinces are unable to comply with the high cofinancing requirements and have to forgo the grants.

Pensions

The present practice provides for a pooling of pensions, generally at the local level. The experience with pooling at higher than county or township level varies by province. The result is a considerable variation in contribution rates across localities, adding to the potential for “tax competition” that is already a major problem in China. Thus enterprises in Shanghai bear a considerably greater contribution burden because of the relatively unfavorable demographic patterns of the province (the highest proportion of the aged relative to the working population, among all Chinese provinces). Furthermore, lax investment guidelines and auditing procedures appear to have permitted the “diversion” of pension funds to other uses in some cases. Such an arrangement would result in uneven benefits and coverage in due course.

An alternative is a two-tier system. The first tier would be a basic state pension that could provide for a basic level of benefits, determined within a predetermined band (to account for regional variations in the cost of living) for all workers, financed by a relatively low standard rate of contribution. The contribution rates would be set on a pay-as-you-go basis, with a moderate level of reserves necessary to ensure payments on a timely basis. A flat rate for contributions and benefits would facilitate administration. This could facilitate an early extension of coverage to the rural areas, and the sections of the population that are not at present covered.

Pooling could be at the national level for a basic pension arrangement, to minimize the differences in overall tax burdens across provinces, and to ensure that a “level playing field” for new investment is created. However, an interim measure could be pooling at the provincial or regional levels. As an additional part of this scheme, a “second” tier of voluntary “defined contributions” could be funded localy. Here, pension fund safeguards would have to be instituted. Additional work would be needed to specify the sorts of investment instruments the private pension funds might be allowed to use. For both tiers, administration may, however, continue as at present.

Unemployment Benefits

China has a system of unemployment benefits, but pooling is organized at the local, and sometimes the city, level. It is very important to pool risks from the perspective of unemployment insurance, since enterprise restructuring may have significant regional implications. With a uniform contribution rate, as at present in China, some localities would have inadequate funds to permit a needed restructuring of enterprises, whereas other localities may have cash reserves together with a problem of maintaining the value of such reserves. Thus, a national pool would be needed to ensure a uniform basis for unemployment benefits.

The level and duration of benefits that might be financed under the unemployment insurance system would need to be carefully circumscribed, in order to avoid the financing problems that have occurred elsewhere (e.g., in Poland). Consequently, there needs to be a reliance, at a secondary level, on benefits provided by provinces and local governments, such as through the wu bao system and targeted public works that are used as a social safety net. There is already considerable experience in the use of public works as a social protection device in rural China (see below).

Social Assistance

The urban ration networks proved to be an effective safety net during the period that food price reform was being phased in. Now that food price reform is virtually complete, there needs to be less in the way of central government mandates or policy requirements (involving financial support) in this connection. The infrastructure associated with administration of the urban rations could, however, be used by local authorities to provide more targeted support on a categorical basis, such as to orphans, widows, or the disabled, provided that the local authority feels there is justification for such support. Such interventions would normally be financed through local own revenues.

An important element in the safety net in China relates to targeted public works, through the “yigong-daizhen” (or the offer of job opportunities, instead of sheer relief, see Zhu and Zhongyi (1993)). These are applicable in the designated poor regions, with community-identified projects and participants. While such public works have been considered useful in the designated poor areas, it is possible to think of a somewhat modified form of public works forming a more general safety net. The latter social safety net would be seen as a supplement to unemployment insurance, which has to be quite restrictive in terms of the level and duration of benefits provided.

The alternative, social safety net type of public works, essentially offers social assistance through the targeting mechanisms of a low wage and the work test. Under such a scheme, the creation of positive investment would be a bonus but is not essential. One could think of such social safety net public works as being related to operations and maintenance-type activities (roads, irrigation canals, or environmental cleanup) that are primarily labor intensive. Such mechanisms have been an important substitute for unemployment insurance (e.g., in Chile during the 1970s and early 1980s, where unemployment insurance did not exist, and major restructuring occurred, see Ahmad (1991)). In China, such an instrument would be an adjunct to the formal social security instruments and would primarily be financed by local own resources.

A final element in China, the wu bao, or five guarantees, provided to the destitute without family or kin support through local targeting and information must necessarily continue as a local function. It appears to be well targeted in the sense that there are few nondeserving recipients of wu bao relief, although there are questions as to whether the stigma and identification criteria involved exclude some of the deserving.

Options for China

The main social security instruments would provide an important element in reducing “need” in China, and it is suggested that these be provided in a uniform manner that does not encourage tax competition across regions. National pooling is an option for both a first-tier pension and unemployment insurance. However, additional measures may be needed locally to cater for those who fall through the “national safety net.” In China, such measures would include local public works of various sorts, as well as the more traditional social assistance mechanisms that are locally administered, with local determination of benefits, and local financing.

Concluding Remarks

The actual assignment of expenditure responsibilities across different levels of government involves three aspects—administration, policy, and financing. There is considerable variation in international experience, and it is seldom possible to get a definitive assignment of responsibilities in this field. In many industrial countries, including those with sophisticated intergovernmental arrangements, such as Australia, the expenditure responsibilities continue to evolve. The eventual framework, including the revenue assignments and transfer systems, thus should be flexible enough to accommodate changes in expenditure responsibilities over time.

In China, it is unlikely that expenditure responsibilities will be clearly determined before the process of enterprise reform is completed—since many state-owned enterprises still perform several public functions, including schooling, health care, and housing. As discussed in the section on social security and the social safety net in China, the unemployment insurance system is not yet developed to an extent that would allow the employment guarantees provided by the state-owned enterprises to be relaxed to any appreciable extent. Nonetheless, it should be possible to design a system of transfers between different levels of government that defines an appropriate set of “provincial and subprovincial” activities, regardless of which level of government actually carries out the functions.

Control of overall expenditure levels is an important element in a successful macroeconomic strategy. This control is not contingent on the actual administration of various expenditure categories by the central government, rather than on the adoption of appropriate policies that are consistent with the macroeconomic goals, as well as financing mechanisms that provide appropriate incentives for control. Indeed, countries with centralized administration of certain expenditure items are as prone to loss of macroeconomic control as those where the administration is decentralized. However, it is also the case that decentralized administration, with poorly defined policy goals and lax financing mechanisms, almost invariably leads to a loss of macroeconomic control.

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International Monetary Fund. This paper is based on Ahmad, Hewitt, and Ruggiero (1994).

At the same time, if taxes are imposed on local factors of production to finance the redistribution, this can lead to a flight of capital and richer individuals, leading to a shrinkage in the resource base. Fixed factors, such as land, vary considerably across regions, and some localities may have very little scope for attaining minimum standards. Although intraregional redistribution remains a possibility, there are administrative advantages in the local identification of target groups and in mobilizing support for such groups.

Figures in this section come from International Monetary Fund, Government Finance Statistics Yearbook, unless otherwise noted.

Brosio, Nyman, and Santagata (1980) tried to capture the effects of the separation of the ability to raise own revenue from expenditure assignments due to the 1970s fiscal reform, and they found that per capita expenditure was indeed positively affected. This increase was immediate, although it tends to decline with time owing to the financial problems soon encountered by the subnational governments, and caused by the central government limiting the amount of transfers granted to them. See also Brosio (1985). Rizzo (1985) also finds a positive impact of decentralization on government size in Italy, when coupled with a decline in fiscal responsibility of local administrators.

For example, the 1990 budget appropriated grants for Lit 4.2 billion (3.2 percent of total grants disbursed that year) to pay for the deficits of local transport companies. That same year, the central government agreed on salary increases with employees of transport firms. This increased the wage bill of local transport firms and the central government had to disburse grants to share the financial burden. Lit 0.2 billion and Lit 0.9 billion were disbursed in 1990 and 1991, respectively. To pay for the remaining Lit 0.4 billion the local authorities were authorized to get 15-year loans. The repayment of these loans would be the responsibility of the central government.

See Ahmad (1993) for a discussion of the former Soviet Union, where the establishment of social insurance in 1990 opened up the possibility of transfer flows from the demographically young, but poorer, Central Asian regions to the European countries with aging, but higher-income, populations. A similar situation exists in China, with regions such as Shanghai, with a high proportion of aged, but higher per capita incomes, in relation to provinces with lower incomes, but a younger demographic profile.

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