Can fiscal transfers achieve both equity and efficiency: Evidence from Chinese counties

Abstract

Whether fiscal transfers can simultaneously achieve the dual goals of equity and growth has been a key topic of public finance research. This paper examines China's fiscal decentralization system and its intergovernmental transfer practices, proposing two conditions under which equity-oriented transfer systems may promote economic growth: The effectively motivate local officials' enthusiasm for economic development and the receiving regions' high marginal capital returns. We employ unique fiscal data from China's county-level economies for the period 2016–2021 to conduct regression analyses. The results show that provinces with more equitable distribution of transfer payments exhibit better economic growth at the county level. However, at the provincial level, there is a non-significant but noteworthy economic loss. This is attributed to the reverse incentives created by the equalization of fiscal transfers, which encourage growth in smaller counties but hinder growth in larger ones. The main mechanisms driving these reverse incentives include insufficient growth potential, distorted fiscal spending preferences, and an over-reliance on transfer payments. Our study demonstrates that, even within China's unique fiscal system and local development incentives, the allocation of fiscal transfer funds still faces a trade-off between equity and growth. This deepens our understanding of the effectiveness of fiscal transfer systems and the logic of local fiscal operations under a multi-level fiscal governance framework.