Recent efforts to reform taxation, such as the pilot program in Shanghai that replaces tax on revenue with value-added tax in the service sector, are aimed at relieving the tax burdens faced by businesses and, ultimately, lowering the costs passed on to end consumers.

However, as such programs also aim to do away with overlaps in the tax system, they would lead to a drop in tax revenues. For example, some estimates say if the Shanghai pilot were extended across the country, it would reduce overall annual tax takings by 50 billion yuan ($7.85 billion).

This would squeeze the finances of local governments, which are already under huge pressure from spending deficits, loans, growing requirements to build affordable housing and restrictions on the sale of land.

Under these circumstances, I would argue that local governments should be given a larger share of tax revenues by the central government. At present, it is the latter that takes the lion's share of tax revenues, leaving local governments with relatively little financial capacity to fulfill their responsibilities.

The root of the current situation lies in the tax reform of 1994. Under this, while local governments are responsible for collecting taxes, they are only allowed to retain 30 percent of these takings, with the rest being handed over to the central government. However, on average, local government spending is around 70 percent of the amount they collect in taxes before the central government takes its cut.

Although some of the money the central government takes will be re-allocated to local governments, the central government retains strict controls over how it should be spent. As the central government can hardly have a better knowledge of the local government's real spending needs, these strict controls often lead to inefficient spending.

The shortage in cash caused by this system makes local governments highly dependent on other means of raising money.

One major source is the sale of land. However, as the property market declines, so has the revenue from land sales; while this reliance also makes governments reluctant to enforce real estate market controls or turn land over for use in affordable housing projects.

The funding shortfall also increases the likelihood that local officials will be driven to use nefarious means to generate revenue, such as the illegal conversion of farmland into real estate and charging arbitrary fees to businesses.

A feasible way of tackling local governments' financial problems would be to increase the proportion of taxes that local governments are allowed to retain, while at the same time relaxing central government controls on their spending.

 The central government should also strengthen oversight of how local governments spend the money allocated to them, working more as a watchdog on government spending.

The author is an economics commentator. ygy7906@sina.com

原文发于《时代周报》，《环球时报》英文版译后转载  王斐尔译

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