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Debt authority and intentional overstatement of budgetary deficit: evidence from Chinese Provinces

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Abstract

This paper takes advantage of China’s 2011 “debt decentralization” reform to identify its causal impact on the budgetary deficit of Chinese subnational governments (SNGs) by employing a difference-in-differences approach. We use data on Chinese SNGs from 2009 to 2014 to implement the analysis. We find that debt decentralization can help contain the intentional overstatement of budgetary deficit by SNGs. We argue that our finding carries wider policy implications even beyond China.

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Notes

  1. Generic studies include Plesko (1988), Cassidy et al. (1989), and Larkey and Smith (1989). For specific country (types), the following are relevant: Paleologou (2005) for the U.K.; Campbell (1977) for Japan; Kauder et al. (2017) for Germany; Anessi-Pessina and Sicilia (2015) for Italy; Luechinger and Schaltegger (2013) and Chatagny (2015) for Switzerland; Stijn et al. (2008) for Belgium; Serritzlew (2005) for Denmark; Jochimsen and Lehmann (2017) for OECD countries; and Caiden and Wildavsky (1974) for developing countries. Deng and Peng (2011) provide some preliminary evidence suggesting that the Chinese central government has consistently underestimated revenue growth by a substantial margin.

  2. By SNGs, this paper refers to all provincial-level governments with provincial or semi-provincial status in their administrative authority.

  3. Some other researchers have explored political factors such as ideology, government fragmentation, and electoral motives as possible determinants of the intentional overstatement of budgetary deficit (for example, Larkey and Smith 1989; Stijn et al. 2008; Anessi-Pessina and Sicilia 2015; Jochimsen and Lehmann 2017), but with mixed results. Given the dominant role played by the Chinese Communist Party (CCP) in China, these political factors are also irrelevant, and hence we ignore them in our study.

  4. For example, Oates (1985), Marlow (1988), Zhang and Zou (1998), Jin and Zou (2002), Rodden (2002), Eyraud and Lusinyan (2013), and Liu et al. (2017).

  5. In 2009, the total bond issuance under this policy was 200 billion RMB (then exchange rate between U.S. dollar and Chinese RMB was about 6.8).

  6. These four are Shanghai, Guangdong, Zhejiang, and Shenzhen. The first three are provinces; Shenzhen is a special economic zone with semi-provincial status in administrative authority.

  7. SBC is seminally introduced by Kornai (1979, 1980). The budget constraint of an organization (firm, government, or others) is said to be soft if the organization expects to be bailed out in cases of financial difficulties.

  8. The institutional background knowledge presented earlier suggests that studies should focus on this time period.

  9. In order to finance and implement local infrastructure projects, Chinese SNGs have established many Local Government Financing Vehicles (LGFVs). The quantity and size of LGFVs mushroomed in the 2000 s. The transactions of the LGFVs were not recorded in the (federal, state, etc.) budget, i.e., they are “off-budget”. We focus on the “on-budget” activities of SNGs for several reasons. First, the balance sheet data for the LGFVs are not available. Second, typically, a LGFV is established as a special purpose vehicle (SPV); its expenditure and revenue are “earmarked” in some sense. Third, the LGFVs are not explicitly guaranteed by SNGs. Fourth, the assets held by those LGFVs are in general productive and of good quality. Finally, Jin and Rial (2016) argue that LGFVs were in fact a specific type of unregulated public–private partnerships (PPPs), and the Chinese authorities are effectively promoting a new generation of PPPs with a new regulatory framework, which is a common practice adopted by countries worldwide to develop infrastructure projects.

  10. Difference-in-differences models are necessarily fixed effects models.

  11. For example, see related reports in The Beijing Business Today magazine and The China Securities Journal (available at http://msn.finance.sina.com.cn/gdxw/20111021/0739367631.html and http://www.chinareform.net/index.php?m=content&c=index&a=show&catid=24&id=16787, respectively; both accessed on October 21, 2011).

  12. The Hawthorne effect is a type of reactivity in which individuals modify an aspect of their behavior in response to their awareness of being observed, which can undermine the integrity of research. The term was first coined by Landsberger (1958) when he was analyzing earlier experiments from 1924 to 1932 at the Hawthorne Works, a Western Electric factory outside Chicago.

  13. For example, prior studies show that the findings on the determinants of capital structure in developed countries are mostly exportable to China (for example, Chen 2004; Chen and Strange 2005; Huang and Song 2006; An 2012). This line of literature suggests that after thirty-plus years of market-oriented reforms, businesses in China are following the same basic rules of a market economy and have shown a profit-oriented nature.

  14. See, for example, “The euro zone crisis: Eurobonds: il conto, la cuenta, l’addition, die Rechnung,” The Economist, May 29, 2012.

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Acknowledgements

The authors thank Alan J. Auerbach, Kimberley Scharf (the editor of this journal), Feila Zhang and two anonymous reviewers for helpful comments.

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Authors and Affiliations

  1. Division of Enterprise Risk Management, Fannie Mae, Washington, DC, 20005, USA

    Zhiyong An

  2. Center for Policy Research, The Maxwell School of Citizenship and Public Affairs, Syracuse University, 426 Eggers Hall, Syracuse, NY, 13244-1020, USA

    Yilin Hou

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An, Z., Hou, Y. Debt authority and intentional overstatement of budgetary deficit: evidence from Chinese Provinces. Int Tax Public Finance 27, 461–477 (2020). https://doi.org/10.1007/s10797-019-09561-w

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