Fiscal Decentralization, Flat Administrative Structure, and Local Government Size: Evidence and Lessons from China

This paper examines the effects of fiscal decentralization and flat administrative structure on local budget size and program outlays. We test three related theoretical hypotheses in China's adoption of province-over-county scheme of financial administration. We provide evidence that both decentralization of expenditure and decentralization of revenue increase the size of local budgets; that the impact of the former far outweighs that of the latter with local budgets on a rising trajectory; and that discretion grants localities more means to increase their budget. These results show that as China's reform deepens the proportion of local outlay on administration declines because of more local discretion from eliminating the prefecture bypass between the province and counties. But neither decentralization nor increased local discretion has allocated more local resources for education, and both contribute to increasing outlay on economic development. The paper formulates tentative policy recommendations that carry potential application for other countries.