By Mi Jianguo, Yan Kun

I. The Necessity of Establishing a Complete Public Finance and Taxation Supervision System

Since the start of reform and opening up, through continuous study and renovation, a preliminary multi-level public finance and taxation supervision system has been set up in China. It has played an important role in maintaining consistency of administrative decrees of finance and taxation, standardising economic order and guaranteeing the implementation of the budget and the normal operation of the public finance system. Along with the gradual establishment and completion of China’s socialist market economy system, the role of finance and taxation in economic and social development has become more and more important. However, the old public finance and taxation supervision system can no longer meet the new requirements of economic and social development and the reform. In the new environment, it has become necessary and pressing to establish and complete a public finance and taxation supervision system and a scientific operation mechanism that are in line with the socialist market economy system and can meet the needs of economic reform and development.

A. Defects of the Current Public Finance and Taxation Supervision System

The multi-level public finance and taxation supervision system was gradually established on the basis of the planned economy system along with economic development and deepening of reform. It has shown eminent incapability to adapt to the new situation. It restricts the authority and the effectiveness of public finance and taxation supervision and weakens the functions of public finance. The main deficiencies include the following:

1. In terms of tasks and methods, supervision was most conducted in a direct and rushed manner.

Since 1985, public finance and taxation supervision has been characterised by large-scale finance, taxation and price inspections, which were carried out all over China, known as "guerrilla warfare". In spite of certain achievements, such inspections demonstrate apparent after-event and rushed characteristics. They target only on financial accounting results and demonstrate an obvious lack of a restrictive supervision mechanism to supervise and restrain the impact to taxation of new economic actions and transaction methods (such as enterprise restructuring, asset reorganization and e-commerce), as well as to government purchase and transfer payment. The scales and themes of the supervision are not well focused, unscientific and not far-sighted. Therefore, they seriously affect inspection efficiency and results. In addition, many problems have emerged regarding the standard, severity of treatment and of authority of supervision. Since China abolished the "three major inspections" in 1998, many localities (provinces) have adopted new measures and methods to conduct public finance and taxation supervision (e.g., Hubei Province has established the Public Finance Supervision Division to carry out networked and systematic supervision). However, no fundamental improvement has ever been made. The main reason for abolishing the "three major inspections" is that their concentratedness and rushedness can no longer meet the needs of the market economy. The objective of the abolishment is to standardise public finance and taxation supervision, not to weaken its effectiveness. The key to strengthening public finance supervision is to change people’s ideology and set up, as soon as possible, a scientific and standard supervision mechanism to strengthen pre-and mid-event supervision, cover the whole process of finance and taxation activities under supervision, change after-event handling to process control and reduce the number of concentrated and rushed after-event inspections. At present, the pressing issue is how to set up a highly efficient supervision mechanism which covers all processes and links practically based on the particular characteristics of public finance and taxation supervision.

2. Public finance and taxation supervision lacks legal basis.

In certain sense, market economy means economy governed by law. All activities under market economy must be conducted according to law and all competition must be carried out in line with the state stipulations. One of the major tasks of constructing a socialist country with a legal system is to manage public finance and levy taxes according to law. The current situation shows that the laws and regulations governing public finance management and public finance and taxation supervision are extremely incomplete with lots of loopholes. At present, China only has the Budget Law, the Accounting Law and the Tax Collection and Management Law. It does not have the State-owned Asset Management Law, the Public Finance Management Law, the Public Finance and Taxation Supervision Law and the Financial Affairs Management Law. Moreover, the Budget Law has only specified criterions for the government and the public finance departments to follow during budget formulation and implementation process. It did not specify the limits of authority and the responsibilities of the finance departments to guarantee the implementation of the budget. Therefore, according to relevant provisions in the Budget Law, the Public Finance Management Law should be formulated to further define the limits of authority, responsibilities and scale of work of the finance departments. In addition, the Public Finance and Taxation Supervision Law should also be formulated to define the authority, the methods and the extent of public finance and taxation supervision, so as to standardise and legalise public finance and taxation supervision.

3. Backward means of public finance and taxation supervision restricts the effectiveness of supervision.

The authority and deterrence of supervision come not only from law but also, to a large extent, from the severity and actual effect of implementation. Over a long time, public finance and taxation supervision has constituted a fixed thinking and a custom of targeting on issues rather than people. Inspections ended mostly with economic punishments, which usually targeted on institutions. The 13-Year Inspection did carry certain authority and deterrence because the inspection was focused on enterprise financial affairs where most breaching acts were in fact problems of financial accounting procedures. Meanwhile, it was quite effective because most punishments took the form of fines, which directly affected the immediate interests of enterprises. In recent years, the focus of public finance and taxation supervision on small coffers and extra-budgetary funds has been shifted to the administrative and public establishments. However, there has been no fundamental change in our thoughts, methods, means and treatment of supervision, which still focus on inspection over financial affairs. In terms of treatment, we still rely largely on account adjustments and fines, regardless of the fact that they are non-profit institutions and have financial sources mainly from fiscal appropriation and management income. In particular, as extra-budgetary income is gradually included into budget or into special accounts, with the implementation of the comprehensive public finance budget management, charging fines is like transferring funds between "the left and right pockets" of public finance. Therefore, the restrictive function can hardly play an effective role by relying on fines alone. On the other hand, in terms of the types of regulation-breaching acts of the administrative and public establishments, there are less cases related to financial accounting procedures than to decision-making and administrative actions of their leadership, which includes unauthorised funds, lavish distribution of bonuses, deliberate treasury mix, unauthorised tax reduction or exemption, unauthorised preferential policies and embezzlement of special funds. Obviously, under such circumstances, economic punishment has but limited effect, and its rationality ought to be questioned.

4. Internal public finance supervision is weak.

Public finance and taxation supervision looks over the whole process of public finance operation. It encompasses supervision not only on other sectors and enterprises (institutions), i.e. the external supervision, but also on itself and on all units directly under the public finance departments. Over a long time, the public finance department has not put enough emphasis on internal supervision, which has always been a weak link of public finance and taxation supervision and has, therefore, given rise to frequent internal malpractices in the public finance sector. The problems mainly have the following characteristics:

(1) Illegal retention of fiscal revenue. Some people in charge of enterprises make authorised commitments, allowing enterprises to put unpermitted expenses into cost expenditures, so as to enable enterprises to pay less income tax. They also permit the payment delay of due taxes so that enterprises may embezzle them into production operations or capital construction. People in charge of incomes coming from punishment fines do not implement the rule of separating revenue from expenditures and intentionally leave the penalty fees that should be handed over to the higher level authorities to law enforcement agencies. Most of the economic entities set up by the public finance departments in the past and the public institutions subordinated to the public finance departments do not pay due taxes in full sums. As public finance offices at the township level collect taxes in cash, some tax collectors do not hand in tax payment to the treasury in time, and some even committed embezzlement or corruption. In order to fulfil tax collection quotas, a few finance offices at the township level even "bought taxes" in areas outside their jurisdiction. They dispatch people to collect taxes outside their jurisdictions, issue more receipts for taxes collected, and share the balance with taxpayers to gain a "win-win" result. Consequently, the finance offices are awarded for over-fulfilling their tasks.

(2) Improper handling of the circulating funds. Since the start of reform and opening up, some business agencies of public finance department have replaced some appropriations by loans and set up public finance operation funds. The purposes are to meet the temporary fund needs of enterprises for their production, help enterprises operate normally and raise their economic efficiency. It is also aimed to support public establishments to create income, reduce dependence on fiscal appropriation and gradually become self-sufficient. The results are varied. Some are effective but many are unsatisfactory. A number of corruption and rebate-taking cases also emerged, contradicting the original purposes of the circulating funds.

(3) Arbitrary use of special funds. The special funds appropriated by the central government to the local governments refers to the earmarked funds not included in the regular expenditure of local governments’ fiscal system within the central and local fiscal budgets, but appropriated by the central finance department to local finance department according to their specific needs. In fact, it constitutes a major inter-government transfer payment. In practice, however, some lower level finance departments do not use the earmarked funds according to their stipulated or designated purposes. Some even conspire together to embezzle the funds or fabricate projects to share the funds. The spending is also arbitrary and not well targeted.

5. The performance assessment of public finance and taxation supervision lacks objective evaluation indicators, and the statistical analysis has obvious defects.

In China’s current supervision process, the performance assessment indicators of the special public finance and taxation supervision agencies have, for a long time, emphasised on the volume of collections. In other words, the major assessment indicator is the amount of payment collected for the treasury. As a result, the supervision agencies focus their assessment of the supervised agencies on the amount of payment they collected, which is also used as a reference to appropriate funds for inspection operation. The incentive function of this assessment indicator is quite limited. It only allows the supervision agencies to find out problems and charge fines, but cannot solve any fundamental issues. Even the inspected units think it is nothing serious except a mere fine. On the contrary, they much the inspected to balance between the "costs" and "benefits" of regulation breach risks. Therefore, the assessment indicators based only on fines can hardly fulfil the objectives of public finance and taxation supervision to restrain malpractice, standardise public finance management, guarantee the security of fiscal funds and raise the efficiency.

Meanwhile, there is no scientific and objective indicator for statistical analysis and system in public finance and taxation supervision. There is only simple classification and summary. Most of the summaries only analyse statistical data and seldom give though analysis of the problems behind the figuren. There is no scientific, accurate and factual analysis and evaluation of malpractices. In addition, the problems discovered are common phenomena or results reflected in accounting books and there are few in-depth analysis of and study in the management problems of the inspected agencies and their internal and external causes. As a result, the inspection reports written on such basis lack convincing effect, important data and evidence. The conclusions derived are also superficial. The management proposals lack generality and are too specific, superficial and simple and, therefore, have limited effect on improving and strengthening the role of public finance and taxation supervision.

B. Weak Supervision over Public Finance and Taxation and Prominent Problems in Fiscal Revenue and Expenditure

1. Tax base is eroded and tax source is not well supervised. Since the implementation of the new taxation system in 1994, the effort of cracking down on tax evasion has been strengthened and the order of tax collection obviously improved. However, the struggle between tax evasion and anti-tax evasion has never stopped. Some law-breakers are still taking advantage of the incomplete taxation system and backward management to erode the tax base and evade state taxes. The current tax base is too small; there is no effective means to prevent erosion of tax bases of all tax categories; and supervision is ineffective. As a result, in addition to the universal problem of "crowding out taxes by fees", there is another prominent problem of "crowding out taxes by prices" through tied-in sales to evade taxes as well as tax evasion through illegal acts. All this has seriously affected the integrity of the tax base. Meanwhile, the bases of some taxes were badly distorted. Take the main tax category of value-added tax (VAT) for example. In general, the number of taxpayers of this tax should be fairly stable, but due to problems related to the special invoice of VAT and management, the number of general taxpayers fluctuated significantly, even getting smaller and smaller. For example, there used to be over one million VAT payers in Guangdong Province, but after several rounds of adjustment, the current number of taxpayers is only over 80,000. This does not only interrupt the VAT linkage, but also distorts the normal trade relations between the two kinds of VAT payers due to invoice issuance and offset problems, and affects the stability of the tax base as well.

Supervision and control over tax sources is a process of supervision over, forecast for and statistical analysis of the current status and development or changes of tax sources. It is the core of the management system. However, as demonstrated by the operation of the new tax collection and management model over the past few years, it has the following major problems: (1) No enough importance is attached to supervision and control over tax bases, which is the basic task of tax collection management. Taxation agencies at all levels usually entrust the task of tax source analysis to their accounting departments, tend to be content with statistics and lack comprehensive analysis of tax bases and field knowledge. (2) Supervision over tax sources is regarded as the responsibility of the management system only, and the fact is overlooked that supervision over tax sources should be omnipresent in all collection and management links and requires co-ordination and cooperation among the departments involved in tax registration, tax declaration, bill management and taxation inspection. (3) The network of supervision over tax sources is incomplete and computer application still remains at a preliminary stage. During the transition from the old to new model, the role of tax source management is sometimes absent due to ineffective link-up.

2. Ineffective public finance and taxation supervision and serious depletion of state-owned assets

The common forms include the following:

Depletion during interaction with foreign economic entities. The main way is to lower the value of the state-owned assets to set up joint ventures with foreign partners, thus harming the State interests. Based on relevant statistics, in 1992 alone, the 5,000 Sino-foreign joint ventures in China effected a depletion of about RMB 50 billion of state-owned assets.

Depletion during bankruptcy and merger. The establishment of the socialist market economy will inevitably lead to bankruptcy of some enterprises with poor management and insolvency. However, some localities adopted illegal means to bankrupt large enterprises -- the so called "stranding large ships" -- to default bank loans, which lead to depletion of the state-owned assets.

Some enterprise leaders illegally embezzled the state-owned assets. For example, in March 1999, General Manager Xie Heting of Guangdong Food Enterprise Group Company embezzled RMB 20 million, and Cai Hangang of Suzhou Branch of Bank of Communications illegally launched RMB 4.1 billion of loans. To a large extent, weak supervision is to blame for such incidents. On the one hand, according to the requirement of establishing a modern enterprise system, the finance department undertook major reforms of the enterprise financial management system and abolished direct control and approval system for major financial activities of enterprises. However, as corresponding financial supervision and management did not follow up in time and enterprise self-restraint was weak, some loopholes appeared in enterprise financial supervision and management. On the other hand, the enterprise financial personnel could not effectively play their supervisory role. Although the Accounting Law has granted accounting personnel the responsibility to act according to law, in the absence of restraint on enterprise legal persons and for want of protection to accounting personnel, the responsibility cannot be effectually fulfilled. As a result, the accounting personnel are controlled by the enterprise leadership and jointly commit law-breaking acts with them.

Depletion of state-owned assets by irregular economic actions of state-owned enterprises and public establishments. Some public establishments occupy the state-owned assets without paying any fees, do not enter their incomes into account books and distribute them entirely as "welfare" without authorisation.

3. Huge depletion of central treasury revenues

The long-term effort to increase the "two proportions" has not achieved due effect and the problem of central treasury revenue depletion remains serious. Currently, the revenues mainly drain from governments at all levels, the economic law enforcement agencies, the tax collection and management departments, the social intermediary agencies as well as various levels of state treasury and taxpayers.

The common forms include the following: ╰abChanging tax category to turn central revenue into local revenue; changing the nature of tax to turn central revenue into funds of tax collection agencies; and changing tax payment channel by the auditing department to save the central revenue collected during auditing or inspection activities in its own transitional savings account, and then hand it over to the same level finance department regardless of the nature of the funds and obtain a proportion for its own;

With local government interference, local taxation department over collecting local taxes to reduce central taxes;

After putting central taxes into a transitional account with tax payment completion certificate, the tax collection agency then puts them into the local treasury with a consolidated tax payment certificate and obtains a proportion of them as its own funds from the local finance department. With interference from the local government, the tax collection agency issues treasury transfer notice before annual settlement to rush the treasury transfer, changes tax categories or budget level, and forces the transfer of central revenue to local revenue;

For the sake of government pressure and enterprise financial difficulty, the tax collection agency does not collect or under-collects central taxes to allow the taxes to remain at enterprises, leading to more decreases in tax exemptions and overdue payments; the tax collection agency establishes an unauthorised transitional tax account to keep central revenue from entering the treasury in order to adjust tax collection tasks; the economic law enforcement agency likewise establishes a transitional account and retains the incomes payable to the central government; and specialised banks handling taxes in the tax collection agency’s tax payment hall retains central revenue, too;

In order to reach the benchmark of the "two taxes" (VAT and consumption tax), an idling method is adopted to falsely increase central revenue and defraud the central government of a fiscal settlement rebate.

4. Public finance department emphasises fund appropriation rather than management, so extra-budgetary funds free of supervision nurture corruption.

The supervision implementation demonstrates numerous problems with the utilisation and management of fiscal funds in recent years, which mainly include embezzlement of special funds, changing budgetary funds into extra-budgetary funds, wasteful spending and blindly pursuing after high-class corporate consumption. With regard to transfer payment, the special expenditure of the Central Government to local governments has a wide scale with numerous items. Due to ambiguity of the duties and responsibilities of both the upper and lower levels of governments, some projects that should be financed by local governments are actually taken care by the Central Government. Since the number of projects and the amount of funds that a local government can get mainly depend on its bargaining power, the special expenditure of the Central Government has almost become fixed appropriations to local governments. Meanwhile, the numerous forms of transfer payments, the absence of supervision in a scientific and effective way and the absence of effective restraint consequently lead to wastes in the spending.

Currently, China’s government purchase system is still in an initial development stage. Government purchase should avoid changing from "scattered rent-seeking acts" into "centralised rent-seeking acts". For lack of transparency, standards and restraints during transaction process, scattered purchases are apt to lead to rent-seeking acts. With the adoption of government purchase, the previous scattered purchase becomes centralised. Therefore, attention should be paid to people seeking rents in the government’s name and to the conduct of centralised rent-seeking. To minimise the possibility of rent-seeking, effort should be made to establish complete systems, standardise all procedures and set up a sound supervision mechanism to make the government purchase process a transparent, standard and fair competition, and place it under strict restraints and supervision.

At present, most of the corruption problems with common nature, such as off-the-balance-sheet accounts, illicit small coffers, wasteful spending and transactions between money and power, are related to extra-budgetary funds, which are scattered, covert and difficult to supervise and manage.

5. The "four unauthorised charges" is banned but still prevailing with a huge non-tax income.

Since the reform and opening up, non-tax income has increased so rapidly that it is already out of control. This happened as a result of authorisation and the acquiesced or encouraged income creation of local governments, the pursuing after economic interests, competing with other government departments, agencies and localities, unauthorised establishment of income items and increasing standards. Currently, while China’s budgetary financial resource is tight, extra-budgetary income continues to swell. In addition to those charges specified by the Central Government, local governments at all levels have also set forth numerous charging items on their own. Take 1995 for example, the investigation by one ministry shows that local governments established, without authorisation, 925 (capital or additional) funds and 2,569 charging items. In 1995, total value of extra-budgetary incomes and administrative/public affairs charges collected by local finance departments at all levels in China amounted to RMB 384.3 billion, representing 62.11% of the RMB 618.77 billion of the national revenues for the year. With the previous 5% non-tax income into account, the proportion of non-tax income was as large as 67.11%. (He Zhenyi and Zhang Xuelan, on China’s Actual Taxation Scale and Tax Burden – A Study on Tax Expenditures in China’s National Income Distribution, Taxation Research Materials, the 7th Issue, 1997.)

In terms of the overall situation in China, government non-tax income in 1996 exceeded RMB 760 billion, which was RMB 100 billion more than tax income. Evidently, the value of "fees" became greater than that of "taxes". In terms of locality, total value of fees collected by all local governments in Henan Province reached RMB 9.6 billion in 1995, while local tax revenue was only RMB7.08 billion. In terms of individual indicator, per capita payment by farmers as public charges in Anhui Province in 1996 was RMB65, of which per capita agricultural tax was only RMB22, while non-tax charges was RMB43. The value of "fees" was two times over that of "taxes". In terms of the growth rate, total value of administrative/public charges in China was RMB41.5 billion in 1988, RMB60 billion in 1992 and over RMB290 billion in 1996. The growth rate of non-tax income was much faster than that of GDP and tax income. All social personages showed deep concern for the problem of unauthorised charges, while all kinds of malpractice keep to emerge.

II. The Plan to Set up a Complete Public Finance and Taxation Supervision System

A. Overall design for a complete public finance and taxation supervision system

The model of the system to be established is a compound one with the following elements: judicial supervision + administrative supervision + public comment + democratic supervision (see the chart).

(1) To a certain degree, China’s current public finance and taxation supervision system was set up on the basis of experience borrowed from the former USSR and China’s actual economic conditions. Although, along with the deepening of reform and rapid economic development, significant changes have taken place in China’s public finance and taxation supervision, the public finance and taxation supervision model fairly remains a simple administrative type. We have analysed in Part III the characteristics of administrative supervision. In spite of the advantages of timeliness and high efficiency, it also has such problems as lack of authority and standards. In addition, the advantages of timeliness and high efficiency are based on a complete legal system. With regard to the actual conditions in China, they cannot play a full role as its legal construction is generally lagging behind.

(2) The adoption of such a model can achieve mutual complement of advantages of the two systems. According to the analysis in Part III, the advantages of judicial supervision are exactly the disadvantages of administrative supervision, and vice versa. In light of China’s actual conditions, the establishment of a judicial supervision system can better standardise and legalise public finance and taxation supervision, unify thinking and change the disorder or absence of public finance and taxation supervision caused by differences in people’s thinking on public finance and taxation supervision. Moreover, it will be significantly conducive to standardising and fundamentally solving many issues in the current administrative supervision.

(3) It can save system establishment costs and help transit to the new system. To establish a new system, considerations should not only be given to its advantages but also to the disparities between the new and the old systems, so as to minimise system establishment costs and reduce shocks caused by transition. The establishment of a judicial supervision system is to fill up the blank in China’s current supervision system. The combination of judicial supervision system with administrative supervision system will only make supervision more authoritative and more standard and, therefore, more effective. It is not a total denial to the present supervision system, but a way to emphasise its advantages and supplement its apparent insufficiencies.