The Redistribution of Local Resources

Ironically, the same arguments that reformers use to argue for thorough price reform and greater enterprise autonomy are also used by local officials as the justification for their intervention in enterprise activities. Reformers argue that in today's half-reformed economy, unreformed prices do not yet send the proper signals to enterprises, and a number of objective conditions beyond the control of managers—transportation links, energy supply, state pricing decisions, existing state of capital stock—make the link between efficiency and profit tenuous and threaten to exacerbate existing distortions and imbalances. In the terminology of reform, these "objective conditions" (keguan tiaojian ), beyond the control of enterprise managers, make it impossible for such "subjective factors" (zhuguan yinsu ) as good management or hard work to be measured by factory profits. Local officials are highly conscious of this, and they take it as their right, indeed their duty, to protect enterprises under them from the consequences of unequal "objective conditions," ensure the balanced and stable growth of the local economy, and protect the welfare of local citizens.

The first consequence of this situation is a practice popularly referred to as "whipping the fast oxen" (bianda kuai niu )—in effect, tailoring effective taxation rates to rates of profit. As one factory director stated to me in a matter-of-fact fashion, "If our profits increase in future years, there will be supplementary taxes to adjust for changed performance."^[25] This is often said, both in China and abroad, to reflect the desire of local officials to restrict enterprise autonomy and maintain their power. But even if local officials fully supported enterprise autonomy (and I encountered some very critical and outspoken advocates in various bureaus and banks), they would be compelled by circumstances to behave in this fashion.

Every city government will have a set of enterprises, typically producing raw or intermediate materials, whose products are in short supply and badly needed by other local enterprises, but whose price niche ensures that their profitability will be very low. These enterprises, typically producing steel or fabricated metal products, nonferrous metals, industrial chemicals, or simple components for engines or electrical equipment, will at best make profits that are quite small compared with their capitalization, and will frequently operate near the break-even point or below. They will be unable to cover more than a fraction of their badly

[25] Interview 81, August 1984.

needed investments for plant renovation and expansion. Yet these are precisely the industries that need to develop most rapidly.^[26]

At the same time, every local government will have a set of enterprises that are highly profitable and that succeed, not because their products are generally in short supply, but because the quality or specifications of their products are such that they find steady markets. These enterprises typically fabricate finished consumer or producer's goods; various kinds of machinery, electrical equipment, or consumer electronics are common examples. Their profit rates are much higher than those of older, inefficient plants and those producing raw or semifinished materials. Yet these high profits are arguably due to state pricing policies, which keep materials' prices relatively low and finished products' relatively high.

Unless it is to allow current bottleneck industries to stagnate, the city government has no choice but to favor the disadvantaged enterprises across a broad range of financial measures and administrative practices. The first measure it takes is to ration investment by setting its own priorities in local construction and renovation programs (guihua ), allocating investment projects to those enterprises the city wishes to develop fastest, regardless of prevailing profit rates.^[27] Every city and every industrial bureau has five-year investment plans that allocate investment quotas down to each enterprise. Every construction or renovation project must be approved by the industrial bureau, the planning commission, or higher authorities, depending on its size, and put into this plan, even if it is relatively small and funded entirely by the enterprise. Enterprises with the financial wherewithal to substantially fund investment projects are allowed to do so, but only up to the limits established in the plan. Those who have been allocated a place in the plan, but who cannot substantially cover their needed investment, will receive tax cuts or subsidized loans to allow them to complete the construction or renovation plans decided upon by their leading organs.

Effective taxation rates are tailored to the profit rates of each enterprise. The adjustment tax (tiaojie shui ), designed to compensate for unequal competition due to price niches, different capital endowments,

[26] A typical example was a large and important machine-building plant in Dalian, which was considered an excellent firm, based on the high quality and demand for its products, but which suffered from very low profitability. Despite the fact that it received tax breaks allowing it to keep 90 percent of its realized profits, it still could afford to contribute only 4–5 of the 77 million yuan earmarked for its investment in the Seventh Five-Year Plan (interview 125, August 1986).

[27] Another reason for the investment quotas and tight controls over investment is the tendency for enterprises to overinvest, creating an "overheating" of the economy that feeds inflation, creates severe shortages of construction materials, and lowers the productivity of investment. It should be noted, however, that these controls were placed by the central government in order to restrain local governments and enterprises.

and other "objective factors," was instituted with the shift to enterprise taxation and is the best known of these leveling mechanisms.^[28] But in practice it was found that this tax was too small and too inflexible to allow local officials to guide industry effectively (tax regulations specified that this tax rate remain unchanged for a certain number of years).^[29] In fact, on paper the entire tax structure looks quite inflexible, since localities, as it was explained repeatedly to me, do not have the power to change centrally determined rates of taxation.

Localities do, however, have a free hand in deciding how much of a factory's profits shall be exempted from taxation during any given year, and for most products they also have the right to exempt any amount of sales revenues from taxes on products. The only limit on these tax breaks, other than central regulations forbidding sales tax breaks on such products as alcohol and tobacco, is the finance bureau's calculation of the effect they will have on local revenues.

Tax breaks are routinely considered in three kinds of situations. In the first, enterprises that have habitually operated at a loss, yet which continue to turn out badly needed materials or components for other local industries, will receive tax breaks to allow them to continue to operate. On occasion, such enterprises will receive even larger concessions to subsidize large investments if local officials deem it necessary to turn the situation around. In the second situation, a plant that normally operates with a profit may, because of "objective conditions," find itself in financial difficulties. The objective conditions may be any number of things: shortages of raw materials, energy blackouts, price rises for raw materials. A temporary tax break will be negotiated to permit the firm, which is in trouble through circumstances beyond its control, to keep operating. The third situation is when a sizable renovation or construction project is undertaken. Because nominal tax rates are so high, very few can afford to repay investment loans within the customary time period. Every such project has a variable tax subsidy in its "loan repayment contract" (huankuan hetong ).

Although we have no data on the prevalence or magnitude of such tax

[28] In an earlier article, based on the 1984 interviews, I described how the adjustment tax was set initially. One enterprise director (interview 84, August 1984) referred to five criteria, one of which was "how much profit the government thinks the factory should be making." See Andrew G. Walder, "The Informal Dimension of Enterprise Financial Reforms," in The Chinese Economy Toward the Year 2000 , vol. 1, The Four Modernizations , Joint Economic Committee, Congress of the United States (Washington, D.C.: U.S. Government Printing Office, 1986), 630–45.

[29] When that time period was up, which in some areas was three years and fell in the year of my 1986 interviews, the adjustment tax was readjusted only after a long process of "arguing, begging, and compromising" between the factory and the finance bureau (interview 90, May 1986).

breaks, one gains the impression from interviews—particularly in the detailed knowledge that people at all levels have of the subsidies and the conditions under which they may be secured—that favorable tax treatment is common. This means that the upper limit on taxation is the nominal tax rate, with widespread reductions in the effective tax rate through exemptions of varying magnitudes. The actual rate of profit retention appears to average between 20 and 25 percent.^[30]

There is another important redistributive mechanism known as "the concentration of funds" (jizhong zijin , or jizi ). These are administrative levies, usually by industrial bureaus but sometimes by planning commissions, on the retained profits of enterprises. One bureau official explained, "This is like an additional adjustment tax. We take more from those with more money, and less from those with less. All sixteen industrial corporations (bureaus) in Beijing do this."^[31] The administrative agency simply takes away part of the factory's retained profits. At the industrial bureaus that described the practice to me, these levies ranged from 7 to 15 percent.^[32] The bureau deposits the funds in a local bank or an investment and trust corporation and loans or grants them to needy enterprises under its supervision at preferential rates. In other cases, in a practice called "apportionment" (tanpai ) in one city, the city government simply places a levy on the profits of a particularly large and profitable firm in its jurisdiction.^[33] These practices were controversial in 1986, and since the press at that time carried articles critical of them, enterprise officials openly complained to me about such "arbitrary practices."^[34]

[30] A 1985 survey of 429 enterprises in 27 cities found these enterprises to retain an average of 22 percent of their gross profits. See Bruce L. Reynolds, ed., Reform in China: Challenges and Choices (Armonk, N.Y.: M. E. Sharpe, 1987), 89.

[31] Interview 102, June 1986.

[32] Interview 101, June 1986 (10%); interview 102, June 1986 (10–15%); interview 117, July 1986 (7.5%, but only for collectives, since the state firms successfully resisted). In Dalian, one bureau official explained, "We borrow without interest from our well-off plants to finance investment in others. The ones we take from don't like it but there's nothing they can do about it" (interview 122, August 1986).

[33] One large factory claimed that the city put a special levy on its retained profits because the firm was by far the biggest in town and the city was revenue hungry (interview 128, August 1986). In Shenyang, various interviews revealed that in 1986 the city placed a 15 percent "construction" levy on retained profits of a number of enterprises that could bear it in 1986. It was to last for three years. In a large enterprise in a third city, the city kept 33 percent of the retained profits in 1985 and wanted to take 42 percent in 1986. "The proportion is different every year according to our profit level. We get to keep very little of the profits. This is because this is a very profitable line of production. This readjusts the profit earned between sectors. In effect, we are taxed three times" (interview 123, August 1986). Note that levies of this sort are not considered taxation and therefore are not divided with the Center.

[34] "They shouldn't do this, but they do it anyway. There's no policy, they just have the power. They take more from the factories that make more money" (interview 101, June 1986).