China's Fiscal Policy

Theoretical and Situation Analysis

Gao Peiyong

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781317480822
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Fiscal policy has always been a primary measure of macroeconomic control. The fiscal revenue and expenditure can influence the operation of the whole economic and social activities by changing the existing GDP distribution pattern, affecting the consumption and investment of enterprises and people, etc.

Within the framework of macroeconomic analysis, this book reviews the evolution of China's fiscal policy, and the main changes China's economy has experienced since 1990s. To begin with, it makes an empirical research of China's national debts, including their relationship with macroeconomic regulation and total social demand. Besides, it examines the economic effect mechanism of national debts issuance. Then it focuses on the taxation issues, elucidating the sources of tax revenue growth and the judgments on tax burden. The issue of tax reduction is also covered, especially its complexity in China. Lastly, it provides insights into China's fiscal tendency, changes of macroeconomic policies, and financial operation in the context of the "New Normal".

Scholars and students in economics, finance and Chinese economic studies will be attracted by this book. Also, it will appeal to readers interested in modern Chinese economic history.

1
National debts management and macroeconomic regulation

In recent years, the increasing issuance and accumulative scale of Chinese national debts have become a topic of common concern. For instance, there are doubts about whether we can bring under control the increasing year-by-year scale of national debts and to what extent China can achieve this at least in the reasonably near future. It is also argued that China will be at high risk if repayments of principal and interest for national debts keep occupying an overly high proportion of the national fiscal expenditure as a result of the expanding scale of national debts. Such arguments are too numerous to mention one by one. However, the relationship between national debts management and macroeconomic regulation has not been discussed as often as the foregoing, and may be in effect a task of top priority and of greater practical importance.

1 Scientific definition of NDM’s connotation and extension

Correctly understanding the connotation and extension of the economic concept of “National Debts Management (NDM)”is a prerequisite for discussing the relationship between NDM and macroeconomic regulation.

At first appearance, NDM may look like something familiar because all economic activities financed by national debts maybe included into items under NDM and because NDM seems a general term of a series of activities carried out by the State government to decide, organize, envisage, direct, supervise and regulate the operation of national debts. Nevertheless, there always exist some ever-elusive intricacies in our mind. In the case of fiscal deficit, for instance, offsetting the deficit by way of borrowing debts should be deemed as a NDM activity; however, the deficit offset policy is usually taken as a part of fiscal policy by the government, so it is obviously inappropriate to treat this deficit offset method that falls within the scope of fiscal policy as a NDM activity. Furthermore, in addition to national debts, the deficit offset methods available also include other fiscal revenue forms such as taxation and fiscal overdraft, which certainly doesn’t exclude national debts as a deficit offset method. However, it is illogical to include the choice among various fiscal revenue forms offsetting fiscal deficit into the scope of NDM activities.

Further studies show that the occurrence of fiscal deficits is always accompanied by borrowing debts but at no time will it lead to the assertion that national debts are borrowed only to offset the fiscal deficit, and that the earnings from taxation and other fiscal revenue forms can’t be used for the same purpose. The reason is very simple: it is hard to make clear whether the fiscal deficit results from one or more items of fiscal expenditure because it is almost impractical to attribute fiscal deficit to certain fiscal revenue forms. In fact, despite different forms, the fiscal revenue itself is unified and undifferentiated in its very nature. It will make no sense if the deficit reduction method is included in the NDM’s scope.

For another example, there are some questions about the borrowing of national debts: how to use the financial funds raised by issuing national debts, in what sectors the funds will be invested, how to assess the returns on such investment, etc. If these questions are covered by NDM, they will mingle with the fiscal expenditure policy that theoretically pertains to the scope of fiscal policy.

One more example: the so-called Open Market Operations (OMO) initiated by the Central Bank to implement monetary policy and regulate money supply is also relevant to national debts. Similarly, if the Central Bank’s OMO business is considered as an activity of NDM, it will be harder to define the boundary between national debts and monetary policy.

Fundamentally, the effect of NDM on macroeconomic regulation can be identified in the analysis of its similarities to and differences from other means of macroeconomic regulation. Only on this basis will the position of NDM be established in the government’s macroeconomic regulation system and be efficiently applied in practice.

It is thus argued in this paper that all economic activities in relation to national debts are classified into several levels: the first involves whether the government decides to issue national debts (to offset deficit) and how many debts are issued (to control the scale of national debts); the second relates to operations concerning the way, to whom, of what type and conditions new national debts will be issued as well as those already issued; and the third level covers the selling and buying of national debts by the Central Bank to implement the monetary policy. At the first level, national debts are deemed as an alternative fiscal revenue form (or a deficit financing method), so it is more likely a kind of fiscal policy. At the third level, national debts are treated merely as an operational tool of OMO for the Central Bank, so it is more likely a kind of monetary policy. Only at the second level will national debts bear the true sense of NDM.

Specifically, NDM involves: (1) design of debt category; (2) establishment of issuing conditions; (3) organization of issuing process; (4) selection of the sources of national debts acquirers; (5) supervision of the secondary market; (6) principal and interest repayment of national debts; (7) operation of national debts trading; and (8) development of debt-related systems.

NDM in this discussion is based on the above-mentioned definition.

2 NDM’s effect on macroeconomic targets

NDM as a macro-control means it plays its role in economic activities by exerting a liquidity effect and interest rate effect; in other words, although NDM activities are implemented to facilitate steady growth of the national economy, a process of force conduction exists between NDM activities and their effects on national economic growth, where liquidity effect and interest rate effect are two intermediary targets used to measure and supervise how NDM activities exert effects on macroeconomic targets.

First, let’s look at the liquidity effect of NDM.

Liquidity effect of NDM means the effect on the liquidity of the whole society by regulating the degree of national debts liquidity to exert an expansionary or contractionary effect on total social demand. The force conductive process can be described as: changes of liquidity of national debts → changes of social liquidity → changes of total social demand.

Therefore, the strategy aiming to change the maturities of national debts can be selected and operated as follows.

First, determine repayment terms of national debts at the appropriate time. National debts are divided into treasury bonds, treasury notes and treasury bills, depending on their liquidity. Treasury bills are most cashable and thus called “a kind of voucher only next to cash”, treasury bonds are less cashable with least liquidity, and treasury notes stand in the middle. Apparently, the design of repayment terms has generated an expansionary effect or contractionary effect on total social demand. When the government decides to stimulate economic growth, it will take a policy means to increase the issuing scale and proportion of treasury bills in total national debts; on the contrary, when the government decides to tighten economic growth, it will increase the issuing scale and proportion of treasury bonds to slow down the liquidity of national debts in society.

Then, alternate between treasury bonds and bills. Differences in liquidity are not only represented in the design but also in the alternation of maturity terms. Substituting treasury bonds for treasury bills will decrease the liquidity of national debts while replacement of treasury bonds with treasury bills will increase the liquidity of national debts. According to the principle described above, alternation between terms of national debts can also be used as an effective tool for the government to exercise expansionary or contractionary economic policy.

The strategy to regulate debt repaying sources can also be selected and operated in two methods.

First, identify entities that will purchase national debts. Considering its influence on money supply, purchasers of national debts include entities in both the banking system and non-banking system. When the banking system (including commercial bank and Central Bank) purchases or holds national debts, it will increase money supply by expanding the credit scale, thus increasing monetary liquidity in society. When the non-banking system (including individuals, industrial and commercial enterprises and administrative institutions) purchases or holds national debts, it will give rise to transfer of capital use right rather than to the increment of money supply, thus giving little effect on monetary liquidity in society. For this reason, identification of national debts purchasers is also a policy means to exercise expansionary or contractionary influence on the economy. In other words, in the event of economic overheating or inflation, the liquidity of national debts in society will be reduced by borrowing money from the non-banking system and by reducing the proportion of the banking system’s possession of national debts in total quantity issued; on the contrary, in the event of economic depression or deflation, the liquidity of national debts in society will be enhanced by increasing the proportion of the banking system’s possession of national debts and by limiting the non-banking system’s subscription of national debts.

Then, encourage targeted subscription of national debts at the appropriate time. National debts with different levels of liquidity are intended for specific investors. Commercial banks are the most liquid investors of treasury bills because they usually deal with short-term savings and loans and most of their liabilities may fall due at any time in a day or week. Other investors whose business requires less liquidity are less sensitive to selection between long-term and short-term national debts. As a result, trading of treasury bills on the secondary market will for sure affect the commercial bank’s possession of national debts and the liquidity in society while trading of treasury bonds will not. Such being the case, when the government exercises expansionary economic policy, it may opt to sell the treasury bills (and buy treasury bonds simultaneously) on the secondary market to increase commercial banks’ possession of national debts and increase the basis of credit expansion and the liquidity in society. When the government exercises contractionary economic policy, it may buy treasury bills (and sell treasury bonds simultaneously) on the secondary market to reduce the commercial banks’ possession of national debts and narrow the basis of credit expansion and the liquidity in society.

Now let’s come to the interest effect of NDM.

The interest effect of NDM means the rise and fall of interest rates on the financial market as a result of regulating the issuance of national debts or the level of actual interest rates so that total social demand will be subject to expansionary or contractionary policy. The transmission mechanism can be described as follows: the fluctuation of interest rates of national debts → fluctuation of interest rates on the financial market → fluctuation of total social demand.

First, the government may opt to regulate the interest rate of national debts, which can be achieved by determining the level of the interest rate. In the context of a modern market economy, the interest rate of national debts is a typical rate on the financial market that reflects the government’s macroeconomic policy and may make a direct difference between rise and fall of interest rates on the financial market. With regard to the current situation in China, although the interest rate of national debts is contingent on the savings rate, the enterprization of specialized banks represents an irresistible trend as market orientation reform deepens. Once this requirement is satisfied, no longer will the interest rate of national debts follow the savings rate. Such being the case, the interest rate of national debts will be an effective method for the government to influence the market interest rate and then to implement its macroeconomic policy. For instance, if the expansionary economic policy is necessary, the interest rate of national debts can be lowered to bring down all interest rates on the financial market, thus stimulating consumption and investment to increase the total social demand; if it is necessary to adopt contractionary economic policy, the interest rate of national debts can be raised to improve all interest rates on the financial market, thus suppressing consumption and investment to reduce the total social demand.

Then, the government may opt to control the effective interest rate of national debts by trading national debts on the secondary market to regulate the international effective interest rate (rather than the nominal interest rate) based on the reverse change between debt price and interest rate, which is usually performed by a Central Bank or a national debts administrative department of the financial authority. Trading national debts by a Central Bank or a national debts administrative department on the secondary market may lead to a rise or fall in the prices of national debts, and further to a rise or fall of all interest rates on the financial market. Specifically, when economic growth needs to be stimulated, national debts may be bought in, which means the price of national debts will rise with the increasing demand and the effective interest rate of national debts will fall along with the decreasing market interest rate, thus generating expansionary influence on total social demand; when the economic growth needs to be suppressed, national debts may be sold out, which means the price of national debts will fall with the increasing supply and the effective interest rate of national debts will rise along with the increasing market interest rate, thus generating contractionary influence on total social demand.

If this principle is widely applied, buying and selling of national debts may influence the regulation of the structure of the market interest rate. For instance, buying treasury bills and selling treasury bonds on the secondary market will inevitably lead to inverse changes in supply and demand of these two kinds of national debts. Obviously, as the demand of treasury bills exceeds its supply and the supply of treasury bonds exceeds its demand, the price of treasury bills tends to rise (as its effective interest rate decreases) and the price of treasury bonds tends to fall (as its effective interest rate increases). In addition, the decreasing the interest rate of treasury bills will lead to a synchronically decreasing short-term interest rate while the increasing interest rate of treasury bonds will lead to an increasing long-term interest rate. Similarly, buying treasury bonds and selling treasury bills on the secondary market will lead to an increasing price of the treasury bonds (as its effective interest rate decreases) and a decreasing price of treasury bills (as its effective interest rate increases), and further to a decreasing long-term interest rate and an increasing short-term market rate. In fact, the process of fluctuating effective interest rates of both treasury bills and treasury bonds as well as fluctuating long-term and short-term interest rates indicates that the government’s regulatory role in interest rates on the financial market is transferring from macro to micro control. As a result, both the total interest rate on the financial market and the term structure of the interest rate on the financial market will be subject to influence of NDM, thus leading to the fact that financial activities such as enterprise stock, enterprise debt and bank loans as well as interest rates on the financial market may possibly become objects of direct or indirect operations of NDM. In this case, it is self-evident that the government expands and strengthens its ability to regulate the financial market.

3 Coordination between NDM and other macroeconomic regulation means

Now that NDM an important means for macroeconomic regulation, its coordination with other means needs to be highly considered, especially with fiscal policy and monetary policy, two levers of economic regulation commonly employed by the state government under modern economic conditions. It is therefore necessary to define the relationship between NDM and both fiscal and monetary policy.

First, the relationship between NDM and fiscal policy:

This issue was already mentioned in foregoing paragraphs. In general, fiscal policy involves tax policy, expenditure policy and deficit-covering policy. When it comes to the basic conditions for implementation of fiscal policy, adjustment of tax policy (tax increase or decrease) and application of expenditure policy (expenditure increase or decrease) are closely related to fiscal balance. In case of fiscal deficit, there will be an issue concerning how to cover it or how to raise necessary funds. Despite several direct methods of covering fiscal deficit such as exercising fiscal overdraft, enlarging the scope of taxation and increasing tax rate, the borrowing of national debts may be the best one in terms of social and economic benefits. From a global perspective, fiscal deficits are typically cut down through issuance of national debts. In other words, national debts, as an ideal or basic method to cover fiscal deficit, can be an essential condition for the implementation of fiscal policies.

Then, the relationship between NDM and monetary policy:

As known to all, monetary policy involves the application of Open Market Operations (OMO), adjustment to discount rate and change of required reserve ratio by the Central Bank to influence the formation of the market interest rate and regulate money supply. OMO is the most powerful weapon in the hands of the Central Bank to implement monetary policy for national debts, aiming to control financial markets by trading national debts on the open market (financial market). When the Central Bank implements an expansionary monetary policy to increase money supply and ease credit creation, it will gobble up national debts on the open market and pump money into circulation; on the contrary, when the Central Bank implements a contractionary monetary policy to cut money supply and tighten credit creation, it will dump national debts and withdraw money from circulation. It is thus clear that the Central Bank’s trading in national debts on OMO to regulate money supply is based largely on existence of large-scale national debts. “Huge quantity of national debts has provided the ‘Federal Bank’ (i.e. American Federal Reserve Bank) with opportunities to engage in large scale OMO operations… the existence of broad national debts market has made it possible a widespread and steady OMO market, which has therefore enhanced results of the monetary policy” (Samuelson, 1979). In this sense, NDM plays the role of a “transmission device” when the Central Bank applies monetary policy in...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of figures
• List of tables
• Foreword to the Chinese edition
• Acknowledgments
• 1 National debts management and macroeconomic regulation
• 2 Empirical analysis of China’s national debts since reform of the economic system in 1978
• 3 Empirical analysis of the influence of China’s national debts on total social demand
• 4 On the relationship between tax and price in the market economy
• 5 Study of the economic effect mechanism of national debts issuance
• 6 Several opinions about the scale of China’s national debts
• 7 Macro views on taxation: analysis of several current major taxation issues
• 8 Four basic judgments on tax cuts
• 9 Finance and taxation situations, policies and reforms: a review of several major finance and taxation issues in the face of the “Eleventh Five-Year Plan” period
• 10 On China’s current fiscal tendency
• 11 Analysis of current major taxation issues
• 12 Several major changes in China’s macroeconomic policy pattern
• 13 Tax reduction: complexity in China
• 14 Chinese finance under the “new normal”: several tendency changes
• Index