Student Research: Evaluating Policy Responses to COVID-19

Written By: Jeff Hicks and Max Norton

Assisted By: Joanne Xu and Yi Zhao

Posted: February 23, 2021

By mid-March, 2020, many Canadians had come to recognize the COVID-19 pandemic as a once-in-a-lifetime crisis that could cause permanent changes to their lives. Just as online classes immediately began to transform the experience of legal education, academics also shifted their attention to the enormity of the challenges brought by COVID. The Centre for Asian Legal Studies organized a COVID-19 Roundtable on March 5. In the ensuing months, faculty members and students together pursued multiple strands of research on COVID’s impact on law and governance in Asia.

You can find some examples of student research in this area at the CALS blog: topics ranged from changes in Canadian immigration policy, international competition and coordination in vaccine research, to novel uses of parliamentary power in China during pandemic times. Many of these research projects are still ongoing, and we would be very interested in feedbacks from readers of this newsletter.

One example that illustrates our research on governmental responses to COVID is a working paper jointly authored by Jeff Hicks, Max Norton (both  Ph.D. students at UBC’s Vancouver School of Economics (VSE), and Wei Cui (Allard law and CALS member). The paper, titled “How Well-Targeted Are Payroll Tax Cuts as a Response to COVID-19? Evidence from China,” studies the most substantial piece of economic policy that the Chinese government adopted in response to the COVID shock—a payroll tax holiday made available to almost all firms in the country. Not only is the policy important, a large and unique dataset we used to carry out the study also enabled us to make findings otherwise infeasible.

On February 20, 2020, China’s Ministry of Human Resources and Social Security (MOHRSS) announced that for the period between February and June, all businesses other than the largest (less than 1%) of firms were completely exempted from the obligation to make employer contributions to three components of China’s social insurance (SI) regime: pension, unemployment and injury. The remaining large businesses as well as private, non-business employers received a 50% reduction in contribution obligations for 3 months (February-April). In June, MOHRSS extended the exemption for the first group of firms to the end of 2020, and the 50% reduction for the second group firms to June.  Separately, on February 21, 2020, China’s Nation Healthcare Security Administration announced guidelines for mitigating employer contributions for medical insurance (MI)—the second largest component in China’s SI system after pension insurance. Under these guidelines, local jurisdictions may reduce employer MI contributions by up to 50%, for 5 months (February to June).

These tax holidays represent a response to COVID that is large both in aggregate terms and for each firm beneficiary. The government estimated that the foregone revenue to the nation’s pension systems alone exceeded CNY 576 billion by the end of June. The entire fiscal cost for 2020 could easily surpass CNY 1 trillion (CAD 200 billion)—which would be larger than the projected combined costs of the Canada Emergency Response Benefit and Canada Emergency Wage Subsidy programs. For many employers, the policies brought a tax cut that was more than 20% of the wages paid. At least at first glance, these policies should improve the cash flow and the probability of survival for businesses, support job retention, and even facilitate the hiring of new workers.

A distinctive feature of our study is the use of confidential taxpayer data from one large Chinese province. We use this data to simulate the impact of China’s 2020 payroll tax cuts, and this approach carries a critical advantage. Not only does China have no national SI regime, even China’s provinces do not have their own unified SI systems. Pension insurance is often pooled at the prefectural level, and MI may be pooled at even lower, county levels. This means that when provinces report their SI budgets to the national government, they are aggregating budget reports generated by cities, which in turn are aggregating budgetary reports by counties and other lower units. The more layers there are in this aggregation process, the more information is lost. In contrast, comprehensive firm-level data gives both researchers and policymakers a more detailed, ground-up view of the impact of changes in SI policies.

Our first finding is directly attributable to this data advantage. Our firm-level data covers both firms that participate in SI and those that do not.  We observe that as many as 54% of active firms—representing 24% of aggregate economic activity—do not participate in SI at all. Therefore, they stand to receive no government support from the 2020 tax cuts. Moreover, non-participation is far higher among small firms: only 22% of the smallest decile of firms make SI contributions compared to 78% of the top decile (see Figure 1). This means that the payroll tax cut would be unable to deliver benefits to a vast population of small firms that engage in informal labor practice (in the sense that they do not offer their employees SI benefits.)

Figure 1 SI Participation Is Very Low among Small Firms in China

Despite this fundamental limitation of the policy, we find several forces that push in the other direction and give rise to desirable targeting properties. The first has to do with the fact that small firms tend to be more labor-intensive than large firms: their wage bills represent a larger portion of their total costs. Consequently, a payroll tax cut delivers greater benefits to smaller firms relative to total costs. On average, firms that participate in SI receive benefits equal to 1.3% of annual business expenses. But among the lowest decile of firms that participate in SI, the subsidy rises to 14% of annual expenses. This is approximately 20% of cash holdings the median small firm has on hand.

A second force that improves targeting is the regressive tax structure of China’s SI scheme. When an employer pays SI premia with respect to an employee, the employee’s wage is assumed to be no lower than 60% of the local average wage. This floor on employer premia means that the effective tax rate of the premia is very high for low wage workers. Meanwhile, employers are assumed to pay wages no more than 300% of the local average wage, which means that hiring workers for higher wages generate no additional SI premium expense. By suspending this system, the payroll tax holiday delivers more benefits to firms that hire low-wage workers—which tend to be more affected by the COVID crisis.

These first two forces combine to allow China’s payroll tax cuts to deliver greater benefit (relative to business expenses), as can be seen in Figure 2. In fact, even when non-participating firms that receive no benefits at all are included (as represented by the grey line in Figure 2), the smallest firms receive on average greater benefits as a fraction of their total costs.

Finally, we find that many industries that are most negatively affected by COVID-19 also tend to be more labor-intensive. This pattern is illustrated by the hospitality, education, and culture and entertainment industries, and we verify it partly by drawing on results from a recent study conducted by researchers at Tsinghua University. For this reason, the SI tax cut also delivered a greater benefit (as a proportion of businesses’ operating costs) to industries that are more exposed to the economic downturn (see Figure 3).

Figure 2 Payroll Tax Cuts Deliver Greater Benefits to Small Firms on Average

Figure 3 The Payroll Tax Cut Delivered Greater Benefits to Vulnerable Industries

Students who participated in this research project included not only the two co-authors named above but also research assistants Joanne Xu and Yi Zhao who gathered important data and legal information. Indeed, without the effort of our talented students, many of the research projects would not be feasible. Your feedback on our research will thus not only constitute welcome advice to our faculty members but also especially contribute to our student training.


Optimize Tax Administration, President Xi Says

Written By: Wei Cui

Posted on: February 22, 2021

On December 30, 2020, Chinese President Xi Jinping convened a meeting of one of the most important decision-making bodies currently in the Chinese Communist Party: the Central Committee for Comprehensively Deepening Reforms. Xi gave a strongly ideological speech: in summarizing a report that offered a comprehensive evaluation of the Party’s measures for “deepening comprehensive reforms” since 2013, he claimed “historical” and “revolutionary” accomplishments for his leadership. The meeting also approved a slate of new policy directives, covering many high-salience topics ranging from strengthening Party leadership in state-owned enterprises to building a green, low-carbon economy. Among the new directives approved was a document named “Opinions regarding Further Optimizing Tax Enforcement Methods.” This new edict about tax administration—a topic that normally does not grab media attention—was immediately lauded as the most newsworthy item in Chinese taxation in 2020.

With the world in turmoil, why is President Xi Jinping thinking about tax administration now? One might have tried to look for an answer in the Party edict itself. But like many other recently issued, top Party leadership decisions that are supposed to represent important policy recommendations—and be the subjects of diligent study by Party members—the December “Opinions” on optimizing tax administration are nowhere to be found. It is unclear that the document will ever come to the public light. Thus, even when senior government officials stress the importance of Xi’s new take on tax administration and elaborate its implications, they cannot reveal what exactly it says. Instead, they merely repeat the official media’s summary of the “Opinions.” According to this summary, Mr. Xi would like tax enforcement to be more “precise,” taxpayer services to be more “attentive,” and tax administration to be more “sincere and collaborative.” Compliance and taxpayer satisfaction should both substantially increase, while compliance and administrative costs “notably reduced.” Tax administration, according to Mr. Xi’s vision, should play a fundamental role in the country’s governance.

What does this all mean? We know that tax administration had in fact been on Xi’s mind for several years already: in March 2019, China’s State Tax Administration (STA) cited “important instructions and comments” from Xi on “optimizing tax enforcement,” in an internal document circulated to tax administrators around the country. Judging from the trajectory of Chinese tax policy in the last few years, two explanations about what motivates Mr. Xi are likely relevant.

First, a signature policy Mr. Xi has pursued is the delivery of big tax cuts to the Chinese economy. The tax cuts announced in the last few years are very wide-reaching—in Xi’s own terms, they are “inclusive”—and are available to both individuals and business taxpayers. Having decided on such an approach of reducing the private sector’s tax burden, it is understandable that China’s political leaders want to see results—in the forms of both economic growth and political popularity. And it is typical for leaders in China’s central government to see local governments and grassroots tax administrators as not completely reliable in implementing such policies. Unlike the central government, China’s local governments directly face budgetary pressures. They are thus perceived as potentially too interested in maximizing revenue to permit taxpayers to access the tax preferences announced by the central government. Tax administrators, in the meantime, naturally take greater pride in raising than in giving up revenue. In other words, Mr. Xi may fear a major principal-agent obstacle in the delivery of tax cuts. Bringing China’s tax administration under his firm discipline may seem to be a critical solution.

But a second explanation points to a different source of anxiety. During his reign so far, Mr. Xi has also championed major social spending programs. A widely-discussed project is the eradication of poverty by 2020. Pension and health insurance regimes that are funded by tax revenues instead of employer and employee contributions have also expanded. These large spending programs are crucial to Mr. Xi’s claim to legitimacy and his vision of a “well-off” society, but they are very costly. Sustaining these spending programs seems to be on a collision course with the goal of keeping tax cuts. The fiscal challenges that many local governments face seem so severe that there is evidence that the government has already begun to censor discussions of the topic. A few years ago, Mr. Xi’s main proposed solution appeared to be cutting waste within the government (most famously through anti-corruption campaigns). A newer solution now seems to be “precision” in tax administration: tax administrators should be able to offer tax cuts where they are required to, but also raise revenue when there is tax to be collected.

Is there room for such optimization in Chinese tax administration to achieve Mr. Xi’s wishes? My research in the last few years on Chinese tax administration—summarized in a book I am completing that will be published by Cambridge University Press—suggests that the prospect is not sanguine. There are several basic reasons for this conclusion. First, taxpayer services in China are already quite strong by international standards, and taxpayer satisfaction (based on official surveys) has been very high for many years. This is substantially the result of the fact that Chinese tax administration resources are distributed in a dense network of grassroots offices located in amazing proximity to taxpayers: one runs into tax offices in China more easily than one can find Canada Post offices in Canada. Consequently, Chinese taxpayers routinely rely on tax administrators to help them with tax compliance, leaving little to be done by accountants and tax return preparers. Chinese tax administrators have also rapidly adopted new technologies, such as smart phone apps, to facilitate taxpayer compliance in recent years.

Low compliance cost is not the only thing that reduces Chinese taxpayer complaints. Tax administrators also rarely impose penalties, removing a major source of antagonism in tax collection. Even when taxpayers are selected for audits, they are often given the chance to “self-inspect” first, and declare previously under-reported tax liabilities with no fines. Thus, at least by international standards, Chinese tax administrators already adopt a very “collaborative” approach to tax collection.

This is especially remarkable given that Chinese taxpayers are generally not perceived, even among themselves, as that compliant. Tax cheats are known to easily get away. Indeed, some scholars have produced evidence that tax incentives announced by the central government often do not perform well, because taxpayers are already successful at reducing taxes through evasion. That is to say, it may not be zealousness in tax collection, but the very tolerant approach taken towards non-compliance, that prevents the recent tax cuts from being more effective. There are thus reasons to think that if Chinese taxpayers complain—if the government believes that greater political popularity can be gained through tax cuts—it is not because taxpayers have been treated badly, but precisely because taxation is one thing that citizens are allowed to complain about.

Finally, precision in tax administration cannot simply be willed into being. A major cost of China’s decentralized tax administration is that it hinders specialization among frontline tax offices. Local tax administrators are asked to serve and monitor assigned taxpayers in comprehensive fashions, which makes it impossible for them to gain expertise on a subset of tasks. The STA has paid lip service to specialization for decades, with little to show for accomplishments. When tax administrators lack expertise, and when taxpayers invest little in compliance and rely instead on local tax administrators, it is unclear how compliance can avoid being a matter of just muddling through. Perhaps the government thinks that a path to precision lies in advances in information technology and more comprehensive databases, but this remains largely speculative.

China’s grassroots tax administrators will likely share these doubts about Xi’s new ideological explorations on tax administration as the foundation of governance. But they of course cannot express them. For the time being, the proposal to optimize tax administration will simply have to be repeated. Just as one can only pretend, without ever being sure, that some of the government officials eulogizing the proposal actually are lucky enough to have read the secret Party document, one is left to pretending that the proposal means something.


New Research on China’s Personal Income Tax and Its Impact on Income Distribution

Posted On: December 07, 2020

Written By: Wei Cui

The tax that citizens in many modern economies are most familiar with is probably the personal income tax (PIT). The salience of the PIT, compared to other major taxes such as the corporate income tax and value added tax, is often, but not always, matched by the PIT’s significance as a source of revenue. In Canada, PIT revenue represented 49% of total federal government revenues in 2017-2018. In many developing countries, however, the PIT is a much less important revenue source. There are two standard explanations for this. First, the PIT, since its adoption in industrialized countries in the early 20th century, tends to generate the most revenue from the taxation of wage income. That is, most PIT revenue comes from employers’ withholding of the tax from paychecks written to employees. In many developing countries, however, the formal employment sector is small, and therefore the tax base of wages of formally employed workers may be too small to sustain the PIT.  Second, it is often believed that the PIT must possess certain features—e.g. there must be progressive tax rates, certain types of deductions must be allowed, etc.—that make the tax administratively complex. Low administrative capacities in developing countries further handicap them in raising revenue through the PIT.

These standard explanations, however, are pretty much irrelevant for developments in China’s PIT in the last 25 years. China’s PIT revenue rapidly rose from 1994 to 2005 as percentages of total tax revenue and of GDP. But as the following figure from a 2017 paper by Professors Rong Li and Guangrong Ma at Renmin University shows, the PIT languished after 2006, at around 6% of total tax revenue and 1% of GDP. The trend since 2006 clearly bears no relationship to the rising income of the Chinese people or the maturity of Chinese tax administration.

China’s PIT revenue relative to total tax revenue and GDP (from Li and Ma 2017)

Instead, it all has to do with relentless—and highly successful—attacks on the PIT waged by China’s urban affluent class, attacks that China’s senior political leadership not only condoned but even embraced.

An essential strategy in these assaults is the thorough obfuscation of basic facts about the distribution of income in China, such as who is rich enough to be subject to tax. And this strategy is extraordinarily effective, partly because one of its most pernicious consequences is the destruction of the government’s ability to collect information about individual income. Because the PIT generates so little revenue, most tax agencies in China cannot afford to invest in auditing individual taxpayers and compiling databases about them. Therefore, even the government itself has little information about individuals’ income. Researchers studying income inequality in China thus have to rely on infrequent household surveys the government organizes, which in developed countries are generally considered less accurate (and less rich) than tax return data. (Impoverished data also makes it much harder for the painstaking work of researchers to gain academic prominence.)

Against this background, some recent analyses done by Chinese economists on the redistribution effects of China’s PIT are highly informative. The paper by Professors Li and Ma cited above used data from household surveys to simulate the impact of several increases in the monthly exemption amount for wage income that happened in 2006, 2008 and 2011. Another recent paper by researchers at Beijing Normal University (Zhan et al 2019) simulated the impact of the 2011 increase in the monthly exemption amount, as well as the consequences of even more dramatic changes in the PIT brought about by 2018 legislation. A few helpful figures from these two papers convey some basic facts about PIT changes since 2006.

One such fact is what one could almost simply call the demolition of the PIT. The monthly exemption amount for wage income was raised from CNY 800 to CNY 1,600 in 2006, and just two years later, to CNY 2,000. In 2011, this exemption amount was raised to CNY 3,500. That is, within just 5 years, the exemption level was increased by 337%. The following figure from Zhan et al 2019 shows the tax structure of the 2011 PIT on wage income against the background of the distribution of wage income in urban households.

The 2011 PIT and the Urban Wage Income Distribution

The three bell-shaped curves represent the distribution of monthly wage income in 2007, 2013, and 2018, respectively. Note that the data is based on surveys of urban households—the urban population being less than 50% of the total population in 2007 and less than 60% in 2018. That is, we are already looking at the richer half of the Chinese population. In 2007, the median wage income (somewhat to the right of the peak of the solid curve) was below CNY20,000, and most likely below the CNY 19,200 that corresponded to the CNY 1,600 monthly exemption applicable that year. In 2013, the median wage income is clearly to the left of CNY 42,000—the annual amount exempted under the 2011 PIT change—which is indicated by the first vertical bar from the left. In other words, at least half of the urban working population would have paid zero PIT on their wages in 2007 and 2011.

The second to fourth vertical bars from the left in the above figure indicate certain brackets in the 2011 PIT’s progressive rates on wage income. The second bar indicates the end of a 3% rate and the start of a 10% rate. The third bar indicates the start of a 20% rate. And the 4th indicates the start of a 25% rate. (Three higher marginal rates, 30%, 35%, and 45%, are not shown because they apply to income levels outside the range of the horizontal axis, i.e. to proportionally very few people.) It is clear that even in 2018, a vanishing portion of urban employees would have faced a marginal tax rate of 25% under progressive rates set in 2011.

But this was not good enough for the urban affluent in China. In 2018, China raised the monthly exemption further to CNY 5,000, corresponding to an annual amount of CNY 60,000. It also further moved up the rate brackets, so that one has to earn CNY 204,000 a year to face even a 20% marginal tax rate. This is illustrated by the next figure from Zhan et al 2019 (the three vertical bars represent the start of the 3%, 10% and 20% marginal tax rates).

The 2018 PIT and the Urban Wage Income Distribution

What the last two figures clearly illustrate is that, since 2008, China has been very busy cutting the PIT for the highest 10% or 5% of wage earners in the country. This has led to a dramatic reduction in the redistributive effect of the Chinese PIT. That effect was already very small to begin with. In an earlier paper in Chinese, Professors Guangrong Ma and Shi Li (along with a co-author) calculated that in 2007, the Chinese PIT had the most redistributive impact in its history, reducing China’s Gini coefficient by 1.25%. This was far smaller compared to advanced economies: Canada’s PIT, for example, reduces the Gini coefficient by about 4%.  However, had the Chinese PIT been left intact after 2006, an increasing portion of the high urban wage earners would have become subject to the PIT, which would have increased the amount of redistribution in the entire population. The 2011 and 2018 tax cuts trounced this expectation. As the figure below from Zhan et al 2019 shows, the 2018 legislation sets back the PIT enough that its redistributive effect would not recover to 2017 levels even by 2025.

Even this is not the end of the story. On top of the generous exemptions and wide rate brackets, the 2018 PIT legislation introduced “additional special deductions” for high-income households, such as the mortgage interest expense deduction and deductions for children’s education. Indeed, Chinese families can send children to study in Canada and claim a PIT deduction for a portion of the expense. Zhan et al 2019 calculate that these special deductions may further remove 5% of the urban wage-earning population outside of the PIT tax base.

Unfortunately, this is a story currently buried in obscure academic journals. If you ask someone from China, that person is more likely than not to tell you that the PIT is high in China. This is first because the individuals from China one meets in North America are likely to be high-wage earners. It is also because even if that person may actually pay no or very little PIT in China, the Chinese news outlets she reads will have repeated falsehoods about the PIT for years. According to Chinese media targeted at the white-collar class, the low PIT rates in Hong Kong and Singapore are the international norm, and China needs to cuts its top marginal tax rates to 20% to be “internationally competitive.” The government’s lack of information and the white-collar media’s determination to disseminate mis-information generate a vicious circle. The work of inequality scholars is bound to be marginalized.

Improving Taxpayer Return Filing through Email Reminders

Written By: Wei Cui

Posted On: October 02, 2020

My post last week described a recent study of how information-sharing among South African government agencies succeeded to improve taxpayer registration. Such information-sharing involves minimal costs, and when, as in the South African case, no additional action on the part of taxpayers is required, mechanically raises the level of taxpayer registration. This technique for bringing more firms into the “tax net” is well-known and adopted in many countries. Indeed, one might ask why the technique is not used more often. Another interesting—and related—question is whether picking such low-hanging fruits actually gains anything for the government. If it does not (the South African registration success did not raise any significant revenue, at least as far as the corporate income tax is concerned), we have a potential explanation for its non-adoption.

I also reported that even in the late 1990s, when China was still a low (or lower-middle) income country, Chinese tax agencies sought out information from local Industry and Commerce Bureaus (ICBs) about firms that need to be registered for tax purposes. Consequently, in 2000, 97% of the firms newly registered with ICBs also got registered by tax agencies. In fact, the two government agencies that all Chinese businesses had to cope with from the beginning of their operations were tax agencies and ICBs. Since the main task of ICBs was business registration, whereas tax bureaus also engaged in tax collection, it makes sense that the ICB had an advantage in registration, and tax agencies benefitted from information shared by ICBs (and not so much the other way around).

But information sharing is only secondary: some government agency must possess the information in the first place. In China, both tax bureaus and ICBs engaged in ceaseless enforcement. As a result, although “operating without a business license” (无照经营) was a phenomenon widely talked about in the 1980s and early 1990s, it is rarely mentioned nowadays. (Economists seem to be late in coming to recognize that enforcement makes the biggest difference to business registration in developing countries: such conclusion is perfectly consistent with the Chinese experience.)

But it turns out that taxpayer registration is not the only thing that can dramatically improve because of strong enforcement. In an illustrative table from the China Tax Inspection Yearbook that I excerpted in part in the last post, the government also reports the rates at which Chinese taxpayers filed tax returns, relative to the number of taxpayers required by law to file such returns. The table excerpted below is a continuation of the same table I displayed in the last post.  It shows that the average rate of timely return filing was an incredible 95.75% (96.6% for legal entities and 95.4% for sole proprietors) in 2000. This reflect the underlying statistic that out of over 50 million (!) taxpayers required to file tax returns, over 48 million did so.

Some readers may feel skeptical about these numbers. In the South African study, the estimated rate of return filing for taxpayers subjected to “forced registration” was less than 10%, and the average rate of return filing among registered taxpayers was less than 30%. Even in Canada, the rate of timely filing of corporate income tax returns was only 86-87% between 2002 and 2007. Can we really trust these Chinese statistics? (A similar question is certainly being raised about the reported number of COVID cases in China these days, although some rigorous studies already address such skepticism.)

A paper published last year in the American Economic Journal: Economic Policy is relevant to answering this question about the credibility of Chinese return filing statistics. In the paper, Anne Brockmeyer at the World Bank and her co-authors studied the effectiveness of the Costa Rica tax authority’s efforts to improve the rate of return filing by sending email reminders to taxpayers. The study is based on a careful randomized controlled trial and contains many interesting details, but since it has already been summarized in several places (see this and this blog), I will only comment on three aspects of it that are relevant for understanding the Chinese case.

First, Brockmeyer et al 2019 finds a rough correlation between GDP per capita and the rate of return filing. Costa Rica’s GDP per capita is actually a bit higher than both China’s and South Africa’s, but its rates of return filing (for income and sales taxes)—at over 80%— are much higher than South Africa’s and closer to China’s. Among initial non-filers, the email reminders from the Costa Rican tax authority increased the ultimate filing rate to over 30%. So, suppose that all non-filers receive email reminders: the Costa Rican tax filing rate could then become as high as 86%—similar to Canada’s. In other words, starting from an already high level of  voluntary return-filing, simple email remainders substantially increased the rate of filing even further.

This suggests that we are again looking at an instance of low-hanging fruits: it may not be that hard to increase the return filing rate, if tax authorities made the effort. To me, this also gives the Chinese statistics some credibility. As can be seen in the table excerpted above, Chinese provincial tax agencies are actually evaluated according to the return-filing metric, so it would not be surprising that much effort went into raising performance along this dimension.

Second, while email reminders sound very civilized (and proved effective), the Costa Rican tax authority as depicted by Brockmeyer et al 2019 comes across as toughies, and indeed rather heavy-handed. For example, the tax authority subjected a significant share of the taxpayers that did not file returns (including those that did not respond to email reminders) to “follow-up activities:” cases were assigned to individual tax officers for phone calls, audits, enforcement procedure, and even temporary closures. Clearly, greater-than-80% return-filing was not good enough for the government. As another example, to prevent deregistration of active firms, all non-filers that request deregistration have to be visited by a tax official.

Moreover, the “list of taxpayers in arrears is usually published online.” Overall, 9 percent of taxpayers in Costa Rica report having been subject to some kind of “control activity” by the tax authority during a 1-year period. All this comes on top of the fact that state institutions and credit card companies are required to withhold 2-6% from transactional amounts as “advance payments of tax”—whether or not there is any true tax liability. Costa Rican taxpayers are also required to engage in much more third-party information reporting than their counterparts in developed countries. All this raises the question: what is really doing the work here, the kid glove of email reminders or the iron fist behind it?

I find this interesting because in my research on Chinese taxation (which I present in a book to be published by Cambridge University Press), I find Chinese tax administrators also working seemingly much harder at tax collection than I believe the IRS in the US and CRA in Canada do. “Control activity,” a term that I have not previously seen before reading Brockmeyer et al 2019, is a pretty apt term for describing the mentality of Chinese tax administration.

This brings me to the third aspect of the Costa Rican study that struck me as remarkable. According to the authors, the tax-to-GDP ratio in Costa Rica is only 13.3% (in 2016). By contrast, Lediga et al 2020 reports that the South African tax-to-GDP ratio was 29% (in 2015). Which country has the greater state capacity, the one with a 25% rate of timely return filing and 29% gross tax ratio, or the one with an 80% rate of timely return filing but 13% gross tax ratio? Neither study considers this question. But it seems to me to be a really good question for researchers on tax and development to ponder.



Intra-Governmental Data Sharing to Enhance Taxpayer Registration

Written By: Wei Cui

Posted On: September 28, 2020

Earlier this month, in a widely-followed online public finance seminar series, the German economist Nadine Riedel presented a paper titled “What You Do (and What You Don’t) Get When Expanding the Net – Evidence from Forced Taxpayer Registrations in South Africa”. Notwithstanding the specific setting of Professor Riedel’s study, the topic is of wide relevance to low- and middle-income countries: how can the government locate and register more operating businesses for purposes of taxation—and what can the government expect when it succeeds in doing so?

In fact, the context of the study (which I will refer to as Lediga et al 2020, following the citation convention in economics) may bear greater affinity to Asia, where a large portion of countries are middle- or high-income, than to other countries on the African continent. South Africa is an upper-middle-income economy (like China, Indonesia, Malaysia and Thailand); its tax-to-GDP ratio is already high at 29%; and the South African Revenue Service (SARS) has a reputation of competence. Even in such a setting, getting businesses to register for tax purposes, which is a big part of moving firms from the informal sector to the formal sector, seems no easy task—or at least it is so traditionally thought.

Lediga et al 2020 studies two incidents—in 2008 and 2014—in which SARS enhanced tax registration simply by taking firm data from another government authority, South Africa’s Companies and Intellectual Property Commission (CIPC). Any business must register with CIPC to formally attain corporate status. Through this simple intra-governmental data sharing, SARS expanded its roster of taxpayers by 11% in 2008 and 8% in 2014.

Two facts are already notable here. First, around 10% of firms that formally register with one government authority fail to obtain a taxpayer ID as required by law, which seems to be a rather significant level of tax non-compliance. Second, all it takes for SARS to address such non-compliance is to obtain information from CIPC, and send out letters to the firms “registered by force” to remind them to commence tax compliance. The administrative costs for such SARS action are minimal. If tax registration is an important policy objective, then an obvious question is why SARS has not done this more often—and whether there are similar low-hanging fruits in other countries for enhancing taxpayer registration.

Lediga et al 2020 focuses on not this question but the consequences of forced tax registration. They remind us that for tax collectors to raise revenue, taxpayer compliance must increase along all of several distinct margins. Registering with the government is only a first step. The taxpayers must also file tax returns in accordance with law; they must report their tax liabilities truthfully on such returns; and they must end up actually paying what they owe. Because of this, even when taxpayers are successfully brought into the government’s registration “net,” no significant increase in revenue may result.

This may seem just commonsense. The theoretically interesting question, which Professor Riedel and her co-authors try to tackle, is how taxpayers’ tendencies to comply along these different stages/margins are correlated. For example, does increased compliance along the registration margin drive down compliance with truthful reporting, or vice versa? Lediga et al 2020 offers some intuitions about this question: if the likelihoods of getting caught for non-compliance in these different margins/stages of compliance are separate, then taxpayers may seek to cheat in the stage where it is easiest to do so. However, the model they construct does not yield determinate results.

As pure factual observations, the authors report that even for corporations voluntarily registering with SARS, only about 27.3% file an income tax return.  By expanding registration through intragovernmental data sharing, SARS probably ended up registering taxpayers that are even less likely to comply in the subsequent stages. Thus, compared to the 27.3% filing rate of firms voluntarily registering, only 8-10% of firms “registered by force” file corporate income tax returns.

The very low return-filing propensities of both voluntarily and forcedly registered South African corporations seem surprising. (During Professor Riedel’s presentation, some asked whether many of these corporations are exempt from filing returns because they owed no tax—the current version of the paper does not contain these institutional details.) But if we accept this fact of very low return-filing propensity, and if, further, we think that (i) increasing the rate of timely filing of tax returns is itself an important policy goal, and (ii) increasing the rate of registration can lower the rate of timely return filing, then we may even think that the rate of taxpayer registration in South Africa was too high: we may want to lower rate of registration if a higher rate of return filing is desirable.

This raises the basic question of how we should value the outcomes of registration, return-filing, timely payment, etc.: if they are not important in themselves, what are the ultimate policy objectives for which they represent merely means? Lediga et al 2020 seems ready to accept that raising tax revenue (in the short term) is the most important objective. Yet the authors mainly examine whether the newly registered firm paid significant amounts of corporate income tax. The answer is, as one might expect, No. The reason that this is an expected outcome is that in perhaps most countries, the median corporate taxpayer in terms of profitability is making either a negative profit (i.e. loss making) or only a small profit. The firms that fail to comply with the most basic legal requirements of tax authorities are likely all to fall below that median.

In any case, whether raising tax revenue in the short term is the most important policy objective is debatable. In a book on Chinese taxation that I am currently writing, I explore the issue of how to evaluate the various compliance outcomes of tax administration, and argue that there are some important but often-neglected institutional objectives. I will sketch some of these arguments in subsequent blog entries. But just to give a hint of the relevance of the Chinese case: Chinese tax administrators have long relied on intra-governmental data sharing for taxpayer registration. Indeed, their performance is evaluated on how many taxpayers already registered with the Industry and Commerce Administration (to which the CIPC sounds like the South African counterpart) are registered for tax purposes. And back in 2000, when China’s GDP per capita was not much higher than the GDP per capita of Sub-Saharan Africa (and comparable to the GDP per capita of Tanzania and Uganda today), the national average rate of taxpayer registration—relative to registration with the Industry and Commerce Administration—was 97%!

This is shown in the first 12 columns of the following table from the Tax Inspection Yearbook 2002:

I will also further comment on this table in subsequent blog entries. But the overall takeaway from the Chinese case is that there is no mystery to getting taxpayers registered: it can be done. The main question is what the benefits and costs are for doing so, and what actually motivate states to do so.


“The Coronavirus and the Chinese Healthcare System”

Posted on: February 10, 2020

Dr. Jiwei Qian, Senior Research Fellow at the East Asian Institute, National University of Singapore, will be visiting CALS in early April to present his research on the Chinese healthcare system. Dr. Qian has written extensively on this topic, which, in the past weeks, has been the center of many heart-wrenching stories coming out of China precipitated by the coronavirus crisis.

Dr. Qian recently published a policy brief, Wuhan Virus: Facts, Government Reaction and Outlook, co-authored with Dr. Gang Chen. Among others, the authors argue:

“The information flow and coordination of government departments prove to be inadequate despite the enactment of a host of laws and regulations after the SARs crisis. The Regulation on Handling Public Health Emergencies in May 2003, the Law on the Prevention and Control of Infectious Diseases in 2004 to clarify the responsibility of local government and health authorities in infectious disease surveillance and reporting, and the regulations on contingency plans during a public crisis for central ministries and local governments in 2006 and 2011 apparently do not measure up.

The authors also allude to systematic flaws in the Chinese healthcare system:

“Wuhan has to build two emergency hospitals, one of which is expected to have 1,000 beds by 3 February. Since 20 January, the 61 hospitals in Wuhan have been providing outpatient service for fever round the clock. Hospital visits were four times higher than before the outbreak of the crisis. On the other hand, resources from primary care clinics have been underutilised due to people’s distrust of services provided. After 24 January 2020, the health authority in Wuhan implemented a referral system to take advantage of the capacity of 205 primary care providers. Rather than visit the hospitals directly, patients will be referred to hospitals from primary care clinics.”

We look forward to being enlightened by Dr. Qian’s research.

中国的影子银”行:规避风险和监管回应。 Shadow Banks in China: Risk Mitigation and Regulatory Response” Written By: Yi Zhao 赵祎

Written By: Yi Zhao 赵祎

Posted On: January 31, 2020


北京大学法学院副院长郭雳教授前日访问Peter A. Allard法学院,并于1月13日在亚洲法学研究中心进行讲座。郭雳教授的研究领域包括经济法、国际经济法、法律与金融、商法和比较法。他向前来的听众们介绍了目前中国的影子银行系统的现状和中国监管系统对此作出的回应。

首先,郭雳教授重新定义了影子银行。他认为,影子银行是在传统银行系统之外的信贷中介。传统的银行作为作为交易的中间环节,自己承担盈利和损失;但现在情况变得复杂,银行仍然进行贷款业务,但不再持有贷款直至到期,而是将贷款作为结构性投资工具,以在证券市场上发行新的切分后的小额证券(new tranches of securities)。而传统的存款方在存款利率的限制下也会转而选择购买货币市场互助基金(MMMF),这一点在中国现代银行的发展中极其显著。

其次,郭雳教授指出在“证券化”的发展中,中美银行业有所不同。在美国,美联储通过Regulation Q来控制存款利率的上限,因此美国银行利用发行货币基金来绕过Regulation Q的监管。相对地,中国的影子银行的三大典型用户则为:

一、    受制于政府借贷规定控制的企业,如近年的房地产商(政府以控制贷款作为控制房地产泡沫的手段,所以房地产不再能从银行借到足够的贷款)。

二、    民营私有企业和合资企业,这些企业同样很难从正规渠道获取贷款,驱使他们转向影子银行。

三、    地方政府融资平台。在中国政治制度下,中央政府对地方政府有更强的控制。中国中央政府长期收入大于支出,导致地方政府在经济上处于不利局面;在银行对地方政府的借贷受到政策控制的情况下,地方政府转而依赖于融资平台来完成相应的贷款。








“Categorical matching may provide insight for South Korea’s gender wage gap” Written By: Doe Lee

Written By:Doe Lee

Posted On: February 3, 2020

South Korea has an extremely high and persistent gender pay gap. This is in some ways puzzling, argued Professor Hyunji Kwon from Seoul National University in a recent seminar on this topic at the Sauder School of Business. The percentage of university enrollment in South Korea has been higher for women than men in recent years. Childcare services usage rates are also extremely high in South Korea compared to other OECD countries, rising to an impressive 62% in 2012 from 5.7% in 1997. Thus systemic disparity in education levels across genders or the lack of institutional structure to support women’s careers cannot explain the lower wages women receive.

Nor does South Korea’s Confucian culture provide an adequate explanation: Korea’s gender wage disparity is not mirrored in other arguably “Confucian” countries such as Japan or China. In fact, decomposition analyses from different sources have showed estimations that only 63%-73% of the wage gap can be explained by compositional differences in education, tenure, age, marital status, industries, and occupations. The natural question is, then, what is uniquely contributing to the wage gap in South Korea? Professor Kwon’s studies provide a new angle on this question: firm practices and existing organizational mechanisms.

Professor Kwon pointed first to the pervasive division of jobs as “standard” vs “non-standard” jobs in the Korean economy. Standard employment refers to jobs with an open-ended contract between an employee and an employer. Non-standard employment entails everything else, including part-time work, contract workers, and especially “direct hire temporary employment”, where firms directly hire employees for a fixed term. This last practice is especially favored by the large firms that dominate Korea, and therefore is used for a substantial proportion of jobs in South Korea. Non-standard job workers earn lower income compared to standard-job workers, receive less benefits, and do not receive seniority pay.

Women are disproportionately represented in non-standard work while men take up the majority of standard work employment, contributing to the gender wage gap. Professor Kwon explains in her co-authored paper that “categorical matching” may explain this systemic discrimination. The term refers to a functional category that is not associated with a social category on its face (such as organizational structures) being attached to a social category (such as gender). By matching more standard jobs (a functional category) to male workers (a social category) within an organization, the disproportionate representation of female workers among non-standard workers is perpetuated.

Three mechanisms facilitate internal categorical matching: “opportunity hoarding”, which refers to a distinct group hoarding profitable jobs; exploitation, which refers to rewarding certain employees at the expense of other employees; and claims-making, which refers to the process of using organizational structures to successfully make claims, with stronger bargaining power leading to a higher success rate. Categorical matching strengthens and creates inter-organizational inequality through these mechanisms. Hence, the paper hypothesized that it is more difficult for women to successfully make claims in wage determination in firms where their bargaining power has been diminished to the extent of their concentration in inferior positions.

Different firms participate in categorical matching to varying degrees. Using large-scale employer-employee matched data, Professor Kwon’s study finds that the degree of female to non-standard job categorical matching within a firm, measured by a disparity index, is correlated with variables related to disempowerment, including the proportions of women who have non-standard jobs, are within the top 20% wage group, or hold a union membership. Further, a higher degree of categorical matching is correlated with a higher residual wage gap. Importantly, this correlation held for both standard and non-standard jobs, supporting the hypothesis on the relationship between wage and bargaining power of women in general.

Professor Kwon also discussed the practice of seniority wage, a system of promoting employees in the order of their proximity to retirement. Many Korean firms engage in this practice, but it is not universal. It has been used to stabilize core employee relations, prominent in large Chabol companies that are family-operated. Seniority wage only applies to standard workers—illustrating the mechanisms of opportunity hoarding and exploitation–effectively making hiring standard workers more expensive in the long run. Thus, firms that practice seniority wage system hire more non-standard workers. As the wage discrepancy between standard and non-standard workers widens with seniority, the magnitude of the gender wage gap increases.

In summary, direct hire temporary work provides a mechanism for categorical matching, and seniority wage widens the gender wage gap with career progression, both perpetuating the gender wage gap in South Korea.

“From “Structural Tax Reduction” to “Inclusive” Tax Cuts” Written By: Wei Cui

Written By: Wei Cui

Posted On: January 30, 2020

In an earlier blog, I commented on a recent American Economic Journal article that studied China’s VAT reform in 2009. That study (Liu and Mao 2019) showed that China’s decision to remove a 17% tax on fixed asset purchases stimulated Chinese firms’ investment and productivity. A natural question to raise about the study is: What is the general significance of a finding about the success of China’s tax policy 10 years ago?

Consider the following critique. In the absence of extraordinary circumstances, it really does not make sense for any government to impose a very large tax on firm’s investments in equipment, etc. That China did it renders it an international outlier. Even if other countries wanted to stimulate firm investment and productivity growth, they would not have the policy option China had in 2009—because, most likely, they would never have had such an irrational tax in place to be eliminated.

To underscore this critique, one could note that a recent paper by Professor Juan Carlos Suarez Serrato from Duke University confirmed that the Chinese reform was “one of the largest tax incentives for investment in recent history”—across the world. (By the way, Professor Suarez may present his paper at the Tax Law and Policy Workshop at Allard Law in February.) According to Professor Suarez’s analysis, the 2009 tax cut in China offered a far larger investment stimulus, for any given firm to which it applied, than even the 2017 adoption of the Tax Cut and Jobs Act (TCJA) in the United States. (The TCJA had been perceived to be a veritable earthquake for corporate tax systems around the world.) To find an equivalent stimulus, Professor Suarez and co-authors considered a 17% investment tax credit: so generous a tax credit has not been made available to most U.S. businesses for decades.

I noted the apparent uniqueness of China’s 2009 VAT reform in a 2012 book chapter comparing China’s and European countries’ responses to the global financial crisis: “VAT reform constituted the most important tax policy action China took during the [GFC]. If China had had a more typical tax structure, this specific policy instrument…would not have been available. Conversely, because of the idiosyncrasies of China’s current tax structure, some of the policy measures commonly deployed in other countries also cannot be used.”

Indeed, there is another dimension to the uniqueness of the Chinese experience. Also in 2012, I was invited to talk about the need for tax reform on Radio China in Beijing, and I tried to explain how further VAT reform would enhance the efficiency of the economy. A fellow guest on the show, Professor Lin Shuanglin from PKU, asked me: “How fast do you want China to grow?” I didn’t have an answer, as the question clearly points to a puzzle: How could China have experienced such a high level of economic growth before 2009, under some very distortionary taxes? Which other country can grow for 30 years at breakneck speed, and then say, “OK, we’ve really been handicapping ourselves with high taxes, so let’s cut taxes a bit so that we can keep on growing”?

To be clear, from a pure research perspective, it is possible to give some answers to the question about the “external validity” of the Liu and Mao study. For example, in most U.S. states, and in Canadian provinces like British Columbia, sales taxes still apply to many business purchases and thus distort firms’ investment decisions. That is the most important argument for abolishing the Provincial Sales Tax and adopt the Harmonized Sales Tax, which functions like the VAT. Any such reform may have the same kind of stimulus effect as China’s VAT reform in 2009, even though the magnitude of the stimulus would be smaller. From another perspective, China continued to carry out further VAT reform between 2012 and 2016, converting the “business tax” to the VAT. That reform still reverberates through the Chinese economy. The policy outcomes of the 2009 reform certainly could help us to understand this later round of reform. If the concern about “external validity” arises only because Chinese taxation seems rather different from taxation systems in other countries, this concern should apply to much public economic research, e.g. many studies done on the U.S. tax system.

Nonetheless, for me, there is indeed something special about China’s 2009 VAT reform that does not revolve around its lacking counterparts in other countries. Instead, reading Liu and Mao 2019, I had the feeling of reading about a bygone era.

In 2009, the Chinese government’s tax policy slogan was “structural tax reduction”. This phrase connoted two ideas. First, in the government view (and the view of international public finance experts), the overall level of taxation in China at that time was not high. There was indeed room for further raising revenue, in order to fund more public goods and services. Second, at the same time, inefficient features of the existing tax system can be reformed, and often this can be implemented through cutting or eliminating outdated taxes.

This technocratic view of tax policy is generally shared by tax policymakers in Western democracies. In Canada, the United States, and many other countries, the phrase “tax reform” embodied the same orientation—improving tax systems but all the while sustaining welfare states that looked after the well-being of all citizens. In 2009, in other words, China was moving in the direction of the Western world.

In the past decade, however, the Chinese government has gradually surrendered the assumption of the legitimacy of taxation. More and more, taxes are portrayed from two perspectives. One is that taxes are a burden on workers and firms, and the burden needs to be reduced. The other is that the government should gain legitimacy by cutting taxes. In early 2019, the State Council introduced the idea of “inclusive” tax cuts, embracing the idea that the more people get tax cuts, the better.

This is an extraordinary transformation. It should also look very surprising. While China is surely a lot richer today than a decade ago, the amount of public goods and services delivered by the government is still nothing compared to most advanced economies. The general level of taxation also has not risen. How is it that the Chinese people have lost interest in public goods, and are only interested in keeping more cash in their own pockets?

This question, of course, is beyond the scope of standard tax policy research. To my knowledge, it has also been completely ignored by Western China observers. While the frenzy of tax cuts in China generates much opportunity for empirical economic research, the underlying political forces seem to me to deserve much greater attention than they have received so far.


How to promote rule of law in China:

Comments on the Regulations on the Principal Officials in Charge of the Party and the Government to Fulfill the Responsibility to Promote Rule of Law

Written by: Jiang Wan, translated by Yan Wang

Posted On: July 21, 2020

(The following is a translation of a shorten version of Professor Wan’s longer blog entry in Chinese.)

In December 2016, the General Office of the Central Committee of the Communist Party of China and the General Office of the State Council jointly issued the Regulations on the Principal Officials in Charge of the Party and the Government to Fulfill the Responsibility to Promote Rule of Law (hereinafter referred to as the Regulations). The Regulations set out the main responsibilities of the principal officials in charge of the party committee and the government in promoting rule of law, and require that the principal officials should include their performance in promoting rule of law in their year-end reports. The higher-level party committee should consider lower officials’ performance during evaluation. If a principal official fails to fulfill their duties, they shall be held accountable in accordance with the relevant Party regulations such as the CCP Accountability Regulations, as well as national laws and regulations.

Performance evaluation and administration by law are generally considered distinctive governance methods. Rule of law is a profound revolution in China’s national governance. Why did the central leadership promote rule of law through performance evaluation?

I. Inherent discrepancy between performance evaluation and rule of law

For a long time, the central leadership has mainly used promotion as an incentive for local party and government leaders. It has also imposed constraints on local leaders through position adjustments. These personnel approaches served as a strong incentive and supervision mechanism for local party and government leaders. In order to get the promotion that they want, local leaders have no choice but to actively implement the policies issued the central leadership. Although performance evaluation can solve some problems in the principal-agent relationship between central and local leaderships, it may still fail to function as intended or to reflect the real situation. This is because local leaderships have the full control over their governance capabilities, governance behaviors and feedbacks on its performances. It is possible that local leaderships may conceal, exaggerate, or distort information. Moreover, overusing the mechanism of performance evaluation would lead to an emphasis on results rather than procedures, as well as a governance logic centered around evaluation.

When the central leadership cannot effectively control local leaderships through its personnel approaches, it is increasingly important to administer the local governments and control the behaviors of local leaderships by law. Contrary to performance evaluation, which focuses on results but neglects procedures, the primary function of regulating local leaderships by law is to ensure that the governance procedures themselves are regulated and legal, and to make sure that local governments are under an institutionalized supervision mechanism. The goal is to ensure smooth pass down of government orders and to maintain the authority of the central leadership. Moreover, administration by law can also provide fundamental insurance that the administrative bodies and their officials would truly serve the people’s interests, which will consequently consolidate the Party’s ruling position and realize long-term stability in the country.

Promoting administration by law can ensure that administrative procedures are regulated and in accordance to the law, but regulated procedures alone may not guarantee effectiveness. Not violating the law is only a minimum requirement. It does not reflect the ability or level of governance of local leaderships. In addition, China is still in the process of economic, social and political transformation, and policies rather than laws actually play a more important role within the government. For areas such as energy conservation, emission reduction, prevention of overcapacity, and real estate regulations, the legal basis for the implementation of policies is still extremely abstract, or even absent, and it is simply not feasible to control local leaderships by holding the local leaders legally accountable. In addition, China’s current political system has its distinctive characteristics. For example, each level of leadership is accountable only to the next level above, and the party committees of various levels have the leading power over the government bodies of the same levels. Although local party committees play a decisive role in local development, they usually do not replace local governments and do not directly perform administrative tasks. It is not feasible to control local party committees by holding them legally accountable.

II. Promoting rule of law through performance evaluation

The substance of promoting rule of law in governance is to regulate local administrative actions and to check arbitrary exercise of power. It will inevitably receive passive resistance from the local governments. In order to promote administration by law, the State Council issued the Outline for Comprehensively Promoting Administration by Law in 2004. The outline proposed that the executive heads of various local governments and departments are the primary responsible persons for the promotion of administration by law. In 2005, the State Council began to propose evaluations on the administration of local governments by law. In 2008, the Decision by the State Council on Strengthening Rule of Law in the Administration of the City and County Governments clearly put forward the requirement to establish a system for evaluating administration by law. The system listed several evaluation items: whether decisions are made in accordance with the law, whether regulatory documents are issued in accordance with the law, whether administrative management are implemented in accordance with the law, whether administrative review cases are accepted and dealt with in accordance with the law, and whether administrative responsibilities are performed in accordance with the law. These evaluation items are included in the performance evaluation of city and county governments and their officials. The evaluation results will affect rewards and penalties, as well as appointments, removals and promotions of officials. The decision also proposed that the principal persons in charge of the city and county governments should effectively assume the responsibilities of the primary person responsible for administration of governments by law. In 2010, the State Council’s Opinions on Strengthening the Construction of the Government under Rule of Law further proposed the establishment of a law-based administrative leadership coordination mechanism led by the principal leaders of various administrative agencies, where the evaluation results will serve as an important part of the comprehensive assessment of the government leaderships.

The Fourth Plenary Session of the 18th CCP Central Committee further stated that it is necessary to “take the implementation of rule of law as an important item in evaluating the actual performance of the leaderships at all levels, and incorporate it into the performance evaluation system.” It also proposed that the principal official in charge of the party and government should perform the duties of the primary person responsible for promoting rule of law. In December 2015, the CCP Central Committee and the State Council jointly issued the Outline for Promoting Rule of Law in the Administration of Governments (2015-2020), which expressly required that the principal officials of the party and the government shall perform the duties of the primary responsible person for promoting rule of law.

So far, the document provides the most comprehensive requirements in this regard. Article 8 of the outline incorporated the principal party and government officials’ responsibilities for promoting rule of law in the administration of governments into the performance evaluation system, which adjusted the behavioral incentives of the local party and government officials. The strong political motivations as a result of the incentives would transform the promotion of rule of law in administration of governments into real actions, rather than merely political slogans.

III. Operation of the dual governance model

The current governance mechanism for local governments in China consists of both traditional evaluation-based method and law-based method. The latter has been strengthened during the recent years. The two methods have gradually formed a dual governance model for local governments in China.

  1. Several types of relations between performance evaluation and rule of law

(a) A complementary relationship

Both performance evaluation and rule of law can regulate local government activities. Performance evaluation can make up for the incentives, which administration by law lacks, while administration by law can strengthen the procedural legitimacy of performance evaluation.

First, performance evaluation can be incorporated into existing laws. Performance evaluation is considered a political approach, and excessive use of the approach is considered to affect the legitimacy of governments’ administrative actions. Incorporating performance evaluation into the modern rule of law system not only provides performance evaluation with legal basis, but it also strengthens the binding force of performance evaluation on local governments and ministries. As early as in 1982, Articles 89 and 107 of the Constitution have expressly set out that the State Council and the people’s governments at and above the county level have the right to appoint, remove, evaluate, reward and penalize administrative officials in accordance with the law. More than ten laws, including the Air Pollution Prevention and Control Law, the Sand Prevention and Control Law, the Employment Promotion Law, the Food Safety Law, and the Environmental Protection Law, have stipulated that the local governments must be evaluated on their performance in completing the relevant matters. Performance evaluation is by no means a purely political governance approach outside the current laws, but it has become a legalized governance method.

Second, performance evaluation can promote rule of law. When there is a conflict between rule of law and evaluation items such as political performance and financial indicators, local governments lack incentives to implement rule of law in their administrative actions. For key legal matters closely related to the legitimacy of governance, the central leadership has adopted an approach to advance these matters through performance evaluation. This is due to the high-incentive nature of evaluation performance. When illegal acts give rise to social problems within a particular region, the central leadership will turn to performance evaluation, where it would apply a one-vote veto for those issues that are likely to cause antagonism in the public, and put more weight on those issues that are likely to receive public approval. This is to prevent local governments from failing to comply with the law or failing to enforce the law completely. Some of the exemplary provisions can be found in the Food Safety Law and the Environmental Protection Law. When the central government finally decides to vigorously promote administration by law and set qualifiable evaluation indicators, the local governments have no choice but to obey the decision.

(b) Rule of law weakened by performance evaluation

Promoting rule of law in the administration of government is a low-incentive governance method, while performance evaluation is high-incentive. Once the central leadership adopts the two methods simultaneously, local governments would lean towards performance evaluation rather than administration by law, which will eventually lead to the result where the latter is shelved, alienated, or weakened.

First, it is difficult to quantitively evaluate administration by law. In the lack of full participation of members in the society, change of the central leadership’s governance concept alone will result in local administrative actions being merely an evaluation-driven response. The issued documents, the legal system development goals, and the activities to promote administration by law would all become formalistic.

Second, performance evaluation puts more weight on the excellence of results rather than regulated procedures. Government actions that are useful for evaluation purposes but contrary to the rule of law principles may be treated with lax standards. Particularly, during the time where the economic situation deteriorates and the employment problem is serious, the central leadership would have no choice but to tolerate violations by local governments and adopt an “one eye open and one eye closed” attitude to let go of some activities that are contrary to the law. Those activities will be exempted from penalties, as long as it complies to the governance philosophy of the central leadership.

(c) Performance evaluation replaced by rule of law

Because of the high-incentive nature of performance evaluation, it is easy to cause substitution effects. Therefore, the central leadership would sometimes adjust its governance strategy according to the current situation. For example, when law enforcement is too strong and unregulated, the central leadership will abolish performance evaluation and focus on administration by law. As early as in the last century, the Ministry of Public Security issued a document prohibiting evaluations based on administrative fines, so as not to induce government agencies to conduct phishing law enforcement and use fines to generate income.

  1. Empirical analysis of the dual governance model

Figure 1: Frequencies of two approaches in official documents

Note: upper pair of panels portray State Council documents, lower pair portrays ministry documents; blue line indicates use of rule of law measure, red line indicates use of performance metrics.

Between 1979 and the end of 2015, 244 documents issued by the State Council and 3,753 regulations and documents issued by the ministries required the implementation of policies through administration by law. On the other hand, the State Council promoted policy implementation through performance evaluation in 567 documents, while the ministries promoted policy implementation through performance evaluation in 5,090 regulations and documents (see Figure 1).

In terms of historical trends, both administration by law and performance evaluation have played an increasingly important role in the implementation of documents issued by the central leadership, and the two have demonstrated a complementary rather than a substitute relationship.

Figure 2 compares different ministries by showing the difference between the proportion of documents using the rule of law approach with a similar proportion using performance metrics. Various ministries have used the dual governance model differently. The industry and commerce ministries have always put more weight on administration by law. The State-owned Assets Supervision and Administration Commission (SASAC) and the environmental ministries have paid more attention to performance evaluation. In general, those that focus more on administration by law include the ministries in charge of food and drugs, human resources, commerce and justice. Those that focus more on performance evaluation include the ministries in charge of finance, taxation, temporary working groups and work safety supervision.

Figure 2 Differential use of rule of law and performance metrics across ministries

IV. Controversy and assessment of the dual governance model

The reasons why the central leadership kept the previously adopted performance evaluation method in promoting rule of law are two-fold. Besides inertial thinking, the more important reason is that law is a strong and stable mechanism to check and balance administrative power. Effective rule of law means a new and independent authority system, as well as relatively more stable and impersonalized implementation of legal provisions. This, however, will weaken the authority of the central leadership and limit its mobilization capacity. In modern China, any modifications of governance methods must be implemented on the basis of ensuring central authority. Therefore, the Regulations emphasize that the principal officials in charge of the party and government must adhere to the leadership of the party. The Regulations require that local party committees serve the core leading role in promoting rule of law in the regions. The Regulations stipulate that the upper level party committees should conduct regular inspections on and provide special supervision to the principal officials of their subordinate party committees with regard to this issue. In 2019, the General Office of the CCP Central Committee and the General Office of the State Council jointly issued the Regulations on the Inspecting Responsibilities in Promoting Rule of Law in the Administration of Government, which discussed the inspections in more details.

Of course, there is a logical conflict in the operation of the dual governance model. It is possible that the authority of the law may be weakened by means of promoting rule of law through performance evaluation. Under the premise of democratic centralism, however, it is not realistic for the CCP to abandon the dual governance model and fully rely on rule of law. It is an arbitrary idea to simply separate and contrast performance evaluation and rule of law. Such an idea does not help to understand China’s governance logic. It also obscures the possibility of building the foundational system for China’s economic and social development. It would fail to provide a possible path to further improve the country’s governance model.