An MMT Informed Fiscal Reform for China

Employing the Modern Monetary Theory (MMT), this paper examines the current Chinese fiscal system and highlights its three characteristics. First, fiscal revenues are centralized at the central government while expenditures are decentralized at the local governments; second, fiscal spending focuses on public investment but is insufficient in providing social safety net and public services; and third, indirect tax accounts for a great majority of tax revenues, leading to limited progressivity of the tax system. These limitations have constrained the effectiveness of China’s fiscal policies and generated many perverse impacts. With the understanding that the central government has the monetary sovereignty and does not face financing constrained and that taxes are not to raise revenues for fiscal spending but to serve other purposes, the paper calls for fiscal reforms that realign fiscal resources and spending responsibilities between the central and local governments, increase fiscal spending on social security and public services, as well as broaden personal income tax to improve the distributive effect of taxation.