Income Inequality and Fiscal Policy Reform in China

When Deng Xiaoping introduced his reform plan in the late 1970s, some Chinese were in a better position to take advantage of the new economic environment than others. This paper argues that while some amount of inequality is natural in developing economies, the degree of income disparities in China today can be considered “artificial” insofar as it has been exacerbated by the government’s fiscal policies. First, China’s tax policies are extremely regressive, forcing the poorest in society to bear the greatest tax burden. Second, China’s decentralized fiscal system provides local officials with an incentive to concentrate scarce resources in prosperous urban areas that promise the highest economic returns at the expense of rural areas. Third, decentralization has left the central and provincial governments with a low capacity to impose equalizing fiscal transfers between regions. The dilemma that the Chinese government now faces is how to reduce income disparities, which is necessary for social stability, while at the same time maintaining high rates of economic growth, which is necessary for political legitimacy.