Central-local government fiscal relations and cyclicality of public spending: evidence from China

In this study, we analyze how fiscal decentralization affects the cyclicality of government spending. We focus on China, which experienced fiscal decentralization during 1979-1993 and then partly centralized its revenue with the 1994 fiscal reform. By employing both time series and province-level panel data, we show that Chinese provincial and total government spending was strongly procyclical during the decentralization period before the reform, but both became significantly less procyclical with respect to nationwide output fluctuations after the reform. We suggest several channels through which the procyclicality of subnational government spending in decentralized fiscal federations could be restrained. We further find that less procyclical provincial government spending is associated with smaller output volatility.