China on path to modern fiscal system

China's Politburo approved reform plans in three major areas on June 30, with the biggest impact likely to be a planned overhaul of the fiscal system.

As we know, China is currently facing the major task of transforming its economic growth model. The key for the transformation is the role of government evolving from an investment-oriented approach to a service-oriented system. The key for the transformation of the role of government is fiscal reform.

China's old economic growth model was to use government power to mobilize funds to invest in infrastructure and provide important products and services. In the early stage of urbanization, the model was extremely efficient in building infrastructure, improving basic living standards, and reducing poverty. It was very effective in mobilizing China's land, resources and labor in order to utilize developed countries' techniques and to provide standardized products and services.

In the later stages of urbanization, however, the old model suffers from lack of competitiveness and is unsustainable.

Only a free market, rather than a government-led market, can stimulate creativity, meet a variety of consumption needs, and reduce waste. The role of government is not to participate in market competition, but to provide a fair environment for the free market, such as the protection of property rights and the construction of fair legal system. This means China needs to transform the role of government from investment oriented to service oriented.

The best way to transform the role of government is to redefine its way of collecting and spending money. Public finance is therefore about the role of the government in the economy.

We may conclude that fiscal reform is the key for China's economic success and the main goal of fiscal reform is to transform the role of government from an investment-oriented approach to a modern fiscal system, specifically a service-oriented government.

According to the plan, the fiscal reform will focus on budget control, tax reform and changing the expenditure share between central and local government.

The plan goes to the core of the modern financial system, but the specifics have not yet been determined.

The budget system is the foundation of the entire fiscal system and also the core of fiscal reform. The main problem with China's government budget is its lack of transparency and professional supervision.

It is good to see a plan to increase transparency, but it is easier to say than to do. After all, that promise has been made many times. The budget needs to show expenditures for specific projects, not the vague outlines which are shown now.

Since National People's Congress (NPC) deputies are mostly part-time and they only spend a few days each year to listen to government reports, the NPC itself may lack the professionalism it needs to finish its job, too.

In fact, there is still another tough problem. A big part of the government's income and expenditure is outside the budget system because there are many local financing methods and important income from selling land and charging administrative fees. How the state deals with State-owned enterprises will show the courage of the government to transform its role.

Another important part of fiscal evolution is reform of the tax system.

The plan aims to improve fairness and structure. For example, personal income tax may be based on the income of a family and there will be more taxes on property holding, capital gains and inheritance.

This is good news, but lack of related information is a big problem and it seems that the inheritance tax will not be levied in the short run.

In fact, tax legislation and enforcement may need reform. The lack of tax legislative processes and abuse of tax incentives do not get enough attention.

As to the share of expenditure between central and local governments, a more important task is to define what the government should do.

The Third Plenary Session of the 18th Central Committee has set the market system as the core of tool of the allocation of resources. This actually means that while the market needs a negative list to show what it cannot do, the government needs a positive list to show what it can do.

The traditional role of government as a controller rather than service provider has been a tradition in China's culture. The transformation of the role of government can be regarded as a revolution of the soul of government, or a social democracy movement without bloodshed.

The June 30 plan set a clear timetable for the reform: the basic tasks will be finished before 2016 and a modern financial system will be established before 2020.

The reform of China fiscal system will, of course, not easy, but at least it is on the way.