ABSTRACT
The 1994 tax reform brought about momentous changes to the Chinese tax system. Instead of individually negotiated tax contracts with the central government, local governments were forced to share lucrative categories of taxes, including valueadded tax (VAT) and resource tax, with the central government. In the case of the VAT, the four layers of local government – provincial, prefectural/city, county, and township – together share only 25 percent of VAT intake (Brean 1998; Wong et al. 1995). To compensate for the sudden decrease in local income, the central government introduced a complicated transfer payment system. Whereas the prereform fiscal system only contained two main categories of transfer payments – fixed subsidies and earmarked subsidies – the 1994 reform saw the introduction of at least four new categories of subsidies.
