Central Financing, Sub-Central Redistribution, and Funding Adequacy in Heterogeneous Localities - Evidence from China’s Recent Reform

The funding of basic education is provided via different schemes. In the United States, local sources had long been dominant; equity concerns later pulled in the state for resource equalization under constitutional considerations. Another scheme is the involvement of the central government. In other countries, a mixture of these different schemes is more apparent. The case of China’s reform in the past three decades provides a good window to observe and study the shifting of education finance schemes. The process of the country’s reforms in economy, taxation, and financial administration coincides with, and well illustrates, the quick transition of these schemes. From the 1970s to late 80s, localities (villages and townships) bore the complete financial (tax) burden. In the 90s the burden was up-listed to the county level. Under both of these schemes, disparity between urban and rural areas widened, leading to deterioration in overall equity and human capital accumulation. Since the early 2000, the central government has stepped in (with requirements for provincial share in the funding) as an effort to reduce disparity (improve equity) and to raise the overall quality of elementary and secondary education throughout the vast rural areas. This paper will empirically test the differential effects of the last one of these three schemes on the adequacy of education financing, taking advantage of provincial level data and a valuable (available only most recently) panel data set of all county-level jurisdictions of the whole country (T = 7, years 2000-2006). We will control for local own-source revenue, transfers (total and by type), local economy, demographics, policy shocks, urban-rural divide, and region. Different instrument variables will be used to solve endogeneity problems and missing variable bias. The paper will contribute to the literature in important ways. It will dissect the differential effects from the local, provincial and central levels on the adequacy and equity aspects of education finance, and provides evidence on how policy shocks in a fast growing economy affects education provision in a transitioning system. The paper will also shed light on how elements of fiscal federalism work in a unitary state system