Going Green with Inadequately Supervised Playgrounds for Local Governments

In this study, we examine whether and how the responses of local governments to the central government’s environmental policies impact the cost-effectiveness of those policies when local governments are endowed with inadequately supervised fiscal flexibility. We find that a strengthening of environmental policy decreased on-budget tax revenue and encouraged Chinese local governments to increase the issuance of more flexible but less transparent off-budget debts to offset GDP decline. However, the opaqueness of these debts increased long-term economic risk. On the contrary, other less risky off-budget tools remained largely unaffected. Further analysis indicates that the social costs of this additional flexibility under the Action Plan were closely related to the urgency local officials felt to receive a promotion and the historical reliance on debt. The Chinese experience is also instructive for implementing environmental policies in other developing countries that typically display flexible fiscal policy