Income distribution is the key

International experience indicates that increased public spending on healthcare directly increases private consumption. Similarly, higher provisions for education and pensions reduce life-cycle savings and free up household resources for consumption. The government has recently taken commendable action to expand the coverage of pensions, but the need for broader pension reform remains urgent. Low pension levels distort consumption patterns and foster precautionary savings. Improved tax collection, further liberalization of energy and resource prices, introduction of environmental taxes, and transferring State-owned enterprises' dividends to social expenditure would allow increased social spending without straining public finances.

Fourth, an overhaul of the tax revenue sharing system between the central and local governments is needed. Revenue allocation to the local level needs to be aligned with expenditure responsibilities. Otherwise, large disparities in public social spending per person will emerge and perpetuate inequality.

Local governments' share of value-added tax revenue could be increased from the present 25 percent, which is insufficient to fund their obligations to provide social services. Alternatively, the central government could increase its funding share while maintaining the existing decentralized scheme for providing social services. Inter-provincial compensation mechanisms from richer to poorer provinces could also be adopted.

Tax reform and increased spending on healthcare, education, and pensions would reduce pressure on low-income household budgets. These measures would also reduce pressure for salary increases, which has had an impact on the economy's competitiveness. The reforms would encourage households to consume, providing the country with social stability and the economy with an important buffer against external shocks.

Robert Wihtol is director general of the Asian Development Bank's East Asia Department, and Yolanda Fernandez Lommen is head of the economics unit at ADB's China office.