The importance of real estate development to local government income can hardly be overstated. Much has been made of the dependence of local governments on land sales to support themselves. The poorer and more remote a city, the higher this degree of dependence. Nationwide, the proportion of land sales in local revenue is about 25%. The most real estate-dependent cities tend to be very high on the scale of land dependency. For example, Ordos County in Inner Mongolia in 2011, when it experienced a real estate bust, saw 69% of local revenue from land sales, according to an Oxford University report. Here is the correlation between government revenue and commercial real estate for Tianjin. (NBS data)
Land sales, though, are only a portion of local government benefit from real estate. Tax revenues from real estate developers, construction companies, and manufacturers of materials for the construction of commercial property have been the highest proportion of taxes for a decade now. In Tianjin, for example, a massive region and massive economy, real estate taxes represented 26% of local tax revenue in 2016, the last year of the statistic. Construction activities generated 12% of local revenue in 2016, down from the peak. This disparity is much more acute in the “new zones” that cities develop in their remote suburbs, where land is (originally) cheap. The Binhai zone of Tianjin, for example, which hosts the mini-city that Binhai officials used to call “Little Manhattan” (until they caught on that international visitors were having a laugh), is almost entirely dependent on construction activities and land sales for its local revenue.
As they run out of land for new development, desperate for GDP growth, some cities have dynamited existing buildings and counted the demolition toward GDP.
Controlled demolition in Zhengzhou, Henan Province August 2017. Photo by China Radio International: chinaplus.cri.cn
It has often been noted that China’s current ills tie directly back to the 1994 tax reform, in which the central government started collecting all taxes and reverting a portion back to local governments. This was part of the overall centralization of government authority under Zhu Rongji that responded to fears of a Soviet-style smash-up post-1989.
An April 2016 paper by the Asian Development Bank shows a direct connection between the central government’s fiscal transfers back to local governments following the 1994 deal.
Earmarked transfers account for around 40% of the total. The paper shows that earmarked transfers have the effect of forcing sharp increases in local government spending on infrastructure. Abstract:
Results showed every 1% increase in earmarked transfers to be associated with a 5% increase in local spending on infrastructure. These fiscal transfers also increased the size of local government spending such that a 1% increase of fiscal transfer would increase the ratio of local fiscal spending to gross domestic
product by 1%.
One of the prevalent ideas about China is that debt woes are due to sneaky local governments that steal money from the people. If only the emperor knew! Actually, it’s more the opposite. The increasing power of the central government has squeezed local governments into a fiscal straitjacket. Not only must local governments fulfill the GDP growth targets set by the center, on which they are increasingly dependent, but they are responsible for providing basically all services–schools, medical services, pension, roads, water, electricity–and they have no ability to levy their own taxes and make their own budgets. Selling land and borrowing for centrally approved infrastructure projects are the only strategies that provide local governments with resources to meet the needs of their people.