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Fiscal incentives, competition, and investment in China

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  • Lv, Bingyang
  • Liu, Yongzheng
  • Li, Yan

Abstract

This paper explores how fiscal incentives offered to local governments in China affect investment rates in their jurisdictions. Theoretically, we build a simple fiscal competition model to establish the linkage between local fiscal incentives and expenditure policy and consequently, capital movement. The key prediction of the model, borne out by data from Chinese provinces spanning 2004–2013, is that an increase in the local corporate income tax-sharing ratio, which proxies fiscal incentives offered to local governments, motivates local governments to compete for capital investment through increased public expenditure. Our results contribute to the literature on both fiscal federalism and state capacity by showing that local fiscal incentives significantly shape policy choices and local economic performance. In addition, by exploring fiscal incentives offered to local governments, we offer a novel explanation for the unusually high investment rate in China that has been sustained over a prolonged period.

Suggested Citation

  • Lv, Bingyang & Liu, Yongzheng & Li, Yan, 2020. "Fiscal incentives, competition, and investment in China," China Economic Review, Elsevier, vol. 59(C).
    • Handle: RePEc:eee:chieco:v:59:y:2020:i:c:s1043951x19301324
    DOI: 10.1016/j.chieco.2019.101371
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    More about this item

    Keywords

    Fiscal incentives; Local tax competition; Investment; China;
    All these keywords.

    JEL classification:

    • H72 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Budget and Expenditures
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • R53 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Public Facility Location Analysis; Public Investment and Capital Stock

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