MODELING CENTRAL-LOCAL FISCAL RELATIONS IN CHINA

This paper discusses the impact of the lack of credibility of the Chinese central government on localities' revenue collections. The model shows that under the Chinese system, the center's pre-announced revenue-sharing methods are time-inconsistent. Without a mechanism that can force the central government to commit to the pre-announced policy, the localities are tempted to reduce their tax collection efforts. The finding of the model suggests that applying a rule that restricts the center's frequent revision of revenue-sharing methods may help solve the time-inconsistency problem.