Social Sciences in China (Chinese Edition)

No.10, 2015

Transfer Payments and Fiscal Competition between Local Governments

(Abstract)

Li Yongyou

Can transfer payments become an important mechanism governing competition between local governments under a system of fiscal decentralization? On the basis of county-level cross-sectional Chinese data, we employed the spatial system estimation method in empirical research on the financing and distribution mechanism of transfer payments and the financial competition between neighboring counties. Our research shows that in general, transfer payments in China do not function to coordinate financial competition between local governments because after controlling for the influence of such factors as location and economic level, the transfer payment mechanism intensifies taxation competition between them overall, whether through its direct effect upon the instruments of fiscal competition or through its indirect effect upon such instruments. General transfer payments, which are an important component of Chinese transfer payments, have a marked weakening effect upon taxation competition between local governments, but they account for a relatively low proportion of the total and cannot redress competition between local governments as a whole. As an important mechanism of decentralized governance in a large country, transfer payments in China need to be innovated so as to recreate a structural incentive for inter-governmental competition.