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Fiscal incentives, competition, and investment in China

Bingyang Lv, Yongzheng Liu, Yan Li and Siying Ding

No 20/2018, BOFIT Discussion Papers from Bank of Finland, Institute for Economies in Transition

Abstract: This paper explores how fiscal incentives offered to local governments in China affect investment rates in their jurisdictions. Theoretically, we build a simple fiscal competition model to establish the linkage between local fiscal incentives and expenditure policy and consequently, capital movement. The key prediction of the model, borne out by data from Chinese provinces spanning 2004–2013, is that an increase in the local corporate income tax-sharing ratio, which proxies fiscal incentives offered to local governments, motivates local governments to compete for capital investment through increased public expenditures. Our results contribute to the fiscal federalism literature by showing that local fiscal incentives significantly shape policy choices and local economic performance. In addition, by exploring fiscal incentives offered to local governments, we offer a novel explanation for the unusually high investment rate in China that has been sustained over a prolonged period of time.

JEL-codes: H72 H77 O16 R53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cna, nep-tra and nep-ure
Date: 2018-11-20
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