Test for Budget Law

Lack of funds should not be the reason for allowing local governments to issue debt bonds if they are not subject to effective supervision by lawmakers and the public.

This should be the rationale for the Budget Law revision, which has raised a controversy on local government debts across the country.

According to the second draft amendment to the law, being reviewed by the National People's Congress Standing Committee, local governments should not issue debt bonds, except when prescribed by the laws or the State Council.

It deviates from the first draft, which proposed local governments could do that with the approval of the State Council. Some scholars and policymakers have argued that local governments should be given the debt-issuing power to make their ends meet.

Since 1994, when China implemented a major fiscal reform redefining the distribution of fiscal incomes between the central and local governments, the latter have been suffering from inadequate financial resources to fulfill their duties. The recent pile-up of their debts - 10.7 trillion yuan ($1.7 trillion) by the end of 2010 or more than a quarter of the country's GDP that year - are a reflection of their financial constraints.

But it is also well known that some local governments often decide to invest without fully considering their financial affordability, thus creating unnecessary debts. Some of them borrow heavily simply to boost local GDP figures, which help the political careers of local officials but leave the debt burdens to their successors.

Such willful borrowing has not been effectively supervised and checked by lawmakers or the public.

Without a proper supervision mechanism in place, the local governments could create more financial problems if they are allowed to issue debt bonds.

The central authorities should help local governments that are trapped in financial trouble to tap more financial sources. Tax reforms, of resource tax for example, should be expedited so that the local governments can earn more tax revenue.

The tax revenue-sharing regime fixed in the 1994 reform can be adjusted, too, to give the local governments access to more fiscal resources. And the central government can increase fiscal transfers to the local governments to ease their burdens.

Also, the local governments should provide policymakers with plans on how they would deal with existing debts and prevent new debts from arising.

Although current debts are yet to push China's overall debt level to the warning line, the country cannot afford to see them snowballing.