Proactive should be less cautious

Finance Minister Xie Xuren will deliver the 2012 budget to the National People's Congress early this week. We already know the approach as the government announced at the end of last year that the fiscal policy in 2012 will be "proactive". However, even so, the government may still remain cautious. Apart from 2005 to 2008, when the fiscal policy was officially "prudent", the government has described its fiscal policy as proactive every year since 2000. Over the past decade, the budget deficit has fallen in proactive years more often than it has risen. The finance ministry likes to err on the side of caution, so it sets itself easy targets that it can beat. For example, budgeted revenue increased by nearly a quarter last year, three times the growth rate that had been built into the 2011 budget's assumptions. This cautious stance may look wise at a time when elevated government debt levels are causing severe financial and economic strain elsewhere in the world. But China's approach has its costs, too. The ministry's tendency to underestimate how much the government will receive from households and firms makes life difficult for those arms of the government responsible for spending the proceeds. That may affect the quality of services the government provides. What's more, the amount that the government spends is almost certainly lower than it would be if it had a better sense of how rapidly revenues would grow. The finance ministry's figures show a budget deficit that is unusually small for a country with China's needs and growth potential. This point deserves more attention. Many inside and outside of government have agonised for years over what policy changes are needed to boost domestic demand. The budget will point to a straightforward answer: the government should simply spend more itself. When Xie talks about government revenue this week, he'll cover the range of taxes levied on firms and individuals. But other forms of government revenue loom almost as large, and many are not factored into the finance ministry's budget at all. These run from the charges companies pay for registration and certification to lottery proceeds, various fines, and the fees families pay for secondary education. The largest source of "off-budget" funding comes from the sale of land use rights by local governments, which brings in more each year than value-added tax, China's largest single tax. Why is this a problem? There are at least three reasons. First, many of the fines and fees have sprung up to enable local governments to meet spending commitments without much thought being given to how they fit with broader government priorities. They are not coordinated across different layers of government, they differ from place to place and they may seem arbitrary or unfair. They may also undermine other policy goals. For example, school fees can amount to half the average income in rural areas, making them a big disincentive to keeping children in education. The second problem is that uncertainty over the true scale of the central government's revenues raises questions over the state of the government's finances. Recent figures suggest that the off-budget items have improved the government's overall fiscal position. They are used to fund various programs but in general some cash is left over. However this could change, forcing officials either to come up with new money-raising schemes, to borrow more or cut back on spending. A more transparent government budget would increase confidence in the system. Most important though, the lack of clarity blunts the effectiveness of fiscal policy as a tool for countering swings in the pace of economic growth. If growth slowed abruptly, the finance ministry would in principle have space to stimulate the economy. Altogether, government revenues amount to over a third of GDP. But taxes account for only a little over half of revenues and the finance ministry has little room to influence directly or even monitor the rest. Given this, it is no wonder that when the government last faced a downturn in 2008 and 2009 it turned to the banks to stimulate spending rather than the Ministry of Finance. Looking ahead, the presumption of many is that if another stimulus is needed if the eurozone crisis sucks in the rest of the world, say, or if risks in China's property market increased the government would be unwilling to follow the same path for fear of undermining banking sector stability. In practice, the government's fiscal options may be more constrained than many think. The author is chief Asia Economist at Capital Economics, a London-based independent macroeconomic research consultancy.