Gao Peiyong* * Gao Peiyong, Professor, Renmin University, Beijing, China. gaopy@263.net.

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1 The Scale of Public Debt in China Gao Peiyong* In measuring the present scale of China s public debt, cess has public debt in China experienced? Thirdly, facing the current situation of public debt in china, what two different types of indexes, stock index and flow index, should be employed separately. The scale of public debt in China, developing from zero in 1979 to what it countermeasures should the government take? is today in a short period of a little over 20 years, results II. Two Different Measuring Indexes from the compound effects of factors such as institutional reform, tax default, non-standardized government Although numerous indexes are used to measure the scale revenue, borrowing new debts to repay old ones, and an of public debt in China, they can be summed up in two expansionary fiscal policy. Under the background of categories: the stock index and the flow index. The stock China s current situation, to prevent the latent risk of public index concerns the accumulated scale of public debt, such debt, we must focus on diminishing the comparatively high as the debt burden rate, which represents the proportion debt dependence degree with mutual effects of multiple of accumulated debts to GDP of the year, and reflects proportional relations between total accumulated public debt factors. and the gross economic scale of the year. The flow index I. Introduction focuses on the issuance scale of public debt, such as the debt dependence degree, which is the proportion of total issuance amount of public debt to the government fiscal There are two contrary judgments for the present scale of public debt in China within academic circles and expenditures of the year, reflecting the level of dependence government departments. One is that the scale is not of government fiscal expenditures on debt revenues. large and there is still expanding space within the acknowledged safety line. The other is that the scale is judging the scale of public debt in China may result in The application of the two different indexes in too large and there are already certain hidden risks and different conclusions. so we should take some measures to control it. Let s first look at the rate of debt burden. By the end The author believes that the scale of public debt in of 2001, the amount of accumulated debts to be repaid China is a special issue that reflects general law as well had hit billion yuan, 1 approximately 19.1 percent as exposes the specific situation of China. To study it, of the GDP of the year (National Bureau of Statistics, we should follow the path of integrating general law 2001; Xiang, 2002). Compared with the safety line of with the situation of China carefully under a background of institutional evolution. is very low, so many people don t think the scale of public 60 percent prescribed by the Maastricht Treaty, this figure Based on the understanding above, this paper discusses issues of three aspects: Firstly, is the scale of considerable expansion space. debt of China is large and believe there is still public debt in China large or not? Secondly, during the As for the index of debt dependence degree, China 23 years from 1979 to 2001, what developmental pro- issued billion yuan 2 of public debts in 2001, which * Gao Peiyong, Professor, Renmin University, Beijing, China. gaopy@263.net. 1 This figure is 270 billion yuan more than the billion yuan announced by authorities. It was due to the public debt of 270 billion yuan issued specially to state owned commercial banks to make up their capital in 1998, which was only an adjustment of accounts on the surface, but still a part of public debts in nature and should be counted in public debt. 2 In which, billion yuan was the debt revenue of central public finance, and 40 billion yuan was issued by central public finance on behalf of local public finance. 3

2 covered 23.9 percent (=500.4 / ) of national fiscal expenditures (including both central public finance and local public finance expenditures) and 64.4 percent (=500.4/ ) of central fiscal expenditures (central fiscal expenditures only) of the year (Xiang, 2002). Whatever figure we use, neither can be said to be low, compared with those of European and American countries, and to some extent they are on the high side. Because of this, many people worry about the rapid expansion of the issuing scale of public debt. The accumulated scale of public debt is not large, but the issuance scale is relatively high. The reason for the co-existence of the two facts lies in the short history of public debts issuance in China, which is about 23 years if we take the starting year as The large accumulated scale of public debts in Western countries, including Europe and the US, results from several hundred years of accumulation. But that is the very problem: If the issuing scale of public debts in China expands similarly, it won t be long before the accumulated scale is out of control (Gao, 1998). Furthermore, the ratio of the issuing amount of public debt to national public fiscal expenditure, and that to central public fiscal expenditures, are computed separately based on two different indexes of debt dependence degree of national public finance and debt dependence degree of central public finance. The public debt of China is issued as a way of collecting revenue, which means that the revenue is listed in the central government budget and is allocated by the central government. The local government doesn t have the right to issue bonds; there is no debt revenue in local fiscal revenue, so local fiscal expenditure is not related to debt revenue. That is, the issuing amount of public debt as a numerator of debt dependence degree calculation formula is wholly the revenue of the central government (although part of it is issued in the name of local government). So we can see, what can really reflect reality is the latter the debt dependence degree of central public finance. Therefore, if we say there is a hidden risk in the scale of public debt in China, the risk comes from a too large issuance scale (not accumulated scale)of public debt, which is centrally indicated as the high debt dependence degree of central public finance (not national public finance). III. Public Debt in China since Reform and Opening up Previously in China there was a period of having no internal public debt and no external debt either. 3 When the Chinese government re-employed public debt in 1979, there was no accumulated debt. Then comes the question: how did the public debt of China, which started from nothing, evolve to its present scale in a short period of 23 years? What are the major factors we can take as historic clues? 1. Institutional reform In China, the re-issuing of public debt took place almost at the same time as economic system reform. One major feature of economic system reform in China is that each progress has been accomplished at the price of tax reduction and profit relinquishment of public finance (especially that of central public finance). The deficit arising from tax reduction and profit relinquishment was financed at first by both overdrawing (borrowing) from the central bank and issuing new debts. To restrain inflation, overdrawing (borrowing) from the central bank was prohibited completely from 1994, and the fiscal deficit was wholly made up by issuing public debts. Since the means of financing deficits was transferred from double-track to singlelane, the scale of public debt proliferated from several billion yuan in the 1980s and early 1990s to several hundred billion ( billion) yuan in The default of tax The national income distribution system under the traditional planned economic system was built on the unified purchases and sales of agriculture and non-staple products, 3 From 1959 to 1978, the Chinese government did not issue any public debts. 4

3 as well as the unified administration of urban worker s salaries. The fiscal revenue structure at that time was a coexistence of both taxes and profits, with profits being the main part. Moreover, profits submitted by state owned economic entities covered a major portion. 4 Since reform and opening up, the unified purchases and sales of agriculture and non-staple products, along with the unified administration of urban worker s salaries, broke down with the development of a market economy, and old fiscal revenue channels disappeared. However, fiscal revenue from standardized taxes had been confronting challenges of the inertial impact of a long period of an absence of legal taxes. Because economic bodies can t adapt themselves to the new situation, tax-evasion subconsciously and consciously occurs simultaneously. As strict administration and severe penalties were still out of phase, and the social environment of governing taxation by laws not yet established, tax evasion spread like a virus, resulting in a failure to collect taxes due and a great loss of national taxes. After tax system reform in 1994, such conflicts have lessened, but the problem is still far from being resolved. Facing the rigidity of fiscal expenditures, default of tax that is supposed to be the main player in a fiscal revenue system can only lead to an increasing dependence on public debts. Thus the offside of public debts arises. 3. The impact of non-standardized government revenue Over the two decades since reform and opening up, with the compound effects of many factors of institutional transformation, Chinese governments at all levels have formed a coexistent structure of three arrangements budgetary revenue, off-budget revenue and off-system revenue, which can also be said to be the coexistence of standardized and non-standardized government revenue. The sharp decline in the proportion of standardized budget revenue to GDP, and the quick proliferation of nonstandardized government revenue off budget and offsystem revenue took place simultaneously. 5 What we need to see is that the growth of off-budget and off-system revenues is under the precondition of crowding out inner-budget revenues to a large extent. Without a shift of budgetary revenue to off-budget and off-system revenue, non-standardized government revenue could not have expanded to the current scale at such a great speed. The impact of non-standardized government revenue on budgetary revenue has directly caused the drop in the proportion of budgetary revenue to GDP. Furthermore, since the decline of the proportion of government expenditures to GDP does not go hand in hand with the decline of budgetary revenues, the gap between the two proportions can only be made up by issuing more public debts. 4. Borrowing new debts to repay old ones The capital and interest of public debts are bound to be eventually repaid. While fiscal troubles, especially those at the central level, are not always resolved, the pressure of repayment has forced the Chinese government to borrow anew to repay matured public debts. Not only the repayment of the principal, but also payment of the interest of public debts depends on issuing new obligations. Since 1994, the expenditure of such repayments have been listed out of budget, side by side with the current budget and the constructive budget, generating a so-called third budget a debt budget, which is not indicated in the budgetary expenditure. In 1997, for example, billion yuan (77.39 percent) out of the total public debt revenue of billion yuan was used to deal with matured capital and interest of public debt that year. This figure was not included in the national budgetary expenditure of billion yuan. Although the annual repayment peak of hundreds of billion yuan can get through this way, it was at the cost of the size of public debts accumulating. Since 2000, the repayment of capital and interest of public debts has been separated interest expenditure 4 Take the gross revenue of national public finance in 1978 for example; there was 35.8 percent derived from taxes paid by state-owned entities, and 51 percent coming from profits handed in by state owned entities. The total amount of the two parts reached 86.5 percent of the gross revenue of national public finance. 5 Based on the typical investigation by Chen Xiaoping in 2000, if we add the three levels of government revenues together, the ratio of public finance revenue to GDP is percent. In the same year, the ratio announced by the authority was 15 percent. See Chen (2001). 5

4 has been included in the budget as an expenditure item of the current budget. The repayment of the principal is still financed by issuing new debts. This arrangement has avoided the hidden worry of the scale of public debt, but the long-term inertial effect and the thus-increased fiscal deficit following the entry of interest payments to budget still call for more public debts to a sizable extent. 5. The expansion of fiscal expenditure The relative decline of budgetary revenue, especially the drop in current budgetary revenue, has not brought a corresponding drop in the fiscal expenditure of Chinese governments. On the contrary, in the tide of reform and opening up, governments at different levels have an increasing need of spending on many aspects. The employment of public debt has made it possible for the government to break the constraints of current fiscal revenue over fiscal expenditure. Furthermore, the public debt administrative system itself is still far from perfect and lacks effective control over the scale of public debts, so the scale of fiscal expenditure has been kept rising. From 1979 to 2001, national fiscal expenditures (including debt payments) increased from billion yuan to billion yuan (= ) 6. It increased over 16 times during 23 years, which is much more than the rate of increase of fiscal revenue, even that of the GDP of the same period. So we may see a chain reaction like this: expansion of fiscal expenditure increase of fiscal deficit enlargement of the scale of public debt further inflation of fiscal expenditure further enlargement of the scale of public debt. 6. Exerting expansionary fiscal policy In 1998, with the widening of the Asian financial crisis and the slowing down of international economy and trade, the Chinese government decided to carry out a so-called pro-active fiscal policy to stimulate demand. The main content of a pro-active fiscal policy is to stimulate domestic demand and maintain economic growth by issuing more public debts and invest more in government infrastructure construction, the technological improvement of state-owed enterprises and other aspects. From 1998 to 2002, China issued 100 billion yuan, 110 billion yuan, 150 billion yuan, 150 billion yuan and 150 billion yuan of long-term public debts respectively. Total issued public debts with the nature of proactive fiscal policy amounted to 660 billion yuan in five years(xiang, 2002). IV. The Way out: Minimizing Debt Dependence Degree As we can see, continuous debt issuance over the past 20 years has brought a series of positive effects to the development of the Chinese economy and society. However, it has also confronted the public finance of China with certain risks by an annual increase of the issuance scale of public debts and the debt dependence degree of central public finance. The continuity and stability of economic policies and the implementation of an active fiscal policy to the request of the current economic situation mean that the issuance size of public debts will inflate even further. Under the current background, the only correct choice is to base it on the present with an eye to the future. When we go all out to secure the stable growth of macro-economy, we should aim to take minimizing the relatively high degree of debt dependence as an important policy to pursue. 1. Perfecting the tax system further and collecting as much taxes due as possible Basically speaking, under the restraint of the established scale of fiscal expenditure, the current fiscal revenue represented by tax income has a flux-and-reflux substitution relationship with public debts. Since the offside of public debt results from the default of tax income, putting tax income as the main force of fiscal revenue system in place is certainly a key step towards reducing the degree of debt dependence. We should hold a belief that any increase in national taxes will result in a drop in public debts. A great tax dependence degree will accordingly result in a low debt dependence degree. The government should aim at collecting as much taxes due 6 For more detailed information, see National Bureau of Statistics (2001) and Xiang (2002). 6

5 as possible, consummate the tax system, strengthen the tax collecting administration and close all tax loss loopholes to minimize the loss of national tax revenue. 2. Accelerating the process of turning fees into taxes and normalizing government revenue mechanism Despite having different forms, any government revenue is virtually fiscal funds. Turning fees into taxes means transferring all non-standardized government revenue in every department and region to standardized government revenue under the unified administration of fiscal departments, and expanding total standardized fiscal revenue. On this basis, it is obviously of great fundamental significance to normalizing the mechanism of government revenue as a whole for diminishing the degree of debt dependence. 3. Controlling the accumulated amount of public debt at year-end according to international practice China currently controls the scale of public debt by planning and determining the amount of public debt issuance at the beginning of a year, and then submitting the plan to the People s Congress for approval. This is somewhat different from the international practice of controlling accumulated amounts at the end of a year. Comparatively, in view of the characteristics of public debts as a form of fiscal revenue, the international practice may be more reasonable. If we determine the planned amount of public debt at the beginning of a year and try to issue public debts as planned, the debt revenue will be a fixed amount. Such a fixed amount may be out of phase with the actual situation of fiscal operation of the year, thus public debts may lose flexibility and fall into the same category as current fiscal revenue that is relatively more fixed. Furthermore, debt revenue, without its flexibility, due to partial or overall idleness, has to assume compensations. We have had too many lessons in this aspect. The public debt issued in 1996 was a typical instance. On one hand, changes in foreign exchange rates reduced the expenditures on the repayment of capital and interest of foreign and domestic public debts, so the central budget deficit experienced a relief. On the other hand, since China issued debts as planned and determined at the beginning of the year and failed to conduct proper adjustments in line with actual fiscal operations, public debts that should have been mastered flexibly were rigidified. As a result, the debt balance of 1996 hit 4.31 billion yuan, which had to be transferred to the next year. Therefore, it would be much better if we followed international practice. The specific amount of public debts should not be determined at the beginning of a year. The People s Congress should have control over the accumulated amount of public debts at year-end by way of stipulating a limit to the accumulated amount of public debts. The Ministry of Finance should make decisions regarding debt amounts, varieties and issuing dates according to the actual fiscal conditions of the budgetary year. In fact, this will strengthen rather than undermine the control of the People s Congress over the scale of public debts. 4. Making every effort to cut down fiscal expenditure It is always difficult, but still feasible, to cut down fiscal expenditure. If we could reconsider and define the functions of public finance in view of market economic system and reconsider the distribution of social funds in view of promoting the efficiency of fund utilization, the existing functions of public finance will surely be narrowed. If we could aim at diminishing the degree of debt dependence and bettering fiscal conditions at the price of some partial and individual benefits, we will definitely achieve the goal of substantially cutting down on fiscal expenditures. References Chen, Xiaoping, Research on the Reasonable Scale of Government Public Finance in China. Information Materials of Finance and Economy in China, No. 22. Gao, Peiyong, On the scale of public debt in China. Public Finance Research, No. 4. National Bureau of Statistics, Statistical Almanac of China (2001), the Chinese Statistics Press. Xiang, Huaicheng, Reports on the Implementation of Central and Local Budget in Public Finance of China, No. 8. 7