1 China’s Fiscal Decentralization and Provincial-level Fiscal Disparities: Decomposing the Inequity Measures

Abstract Since China’s 1994 fiscal reforms, there have been increasing concerns about the distribution of fiscal capacities across the country. In this study we trace the evolution of intergovernmental relations in China since 1978, examine the fluctuation of provincial-level fiscal distribution during the period 1978-2006, and apply two approaches of factor decomposition to analyze the underlying factors of fiscal inequality. Gini indices over time show that that provincial-level fiscal dispersion in China remains high during the post-1994 period, as the equalization effects of central transfers became diminished. Caution should be noted in interpreting these results, however, because the fiscal dispersion is in part driven by high per capita local expenditures in remote provinces such as Tibet and Qinghai, probably due to higher cost of public service delivery. With regression-based inequality decomposition, we find that the fiscal dispersion can be primarily explained and attributed to the Prime Ratio, population density, and per capita GDP. The underlying reasons may include economic activity, cost of service delivery, and political considerations of equalization and national unity