Ever since fiscal decentralization in 1994, local governments have been saddled with a smaller slice of the revenue pie and a bigger slice of the expenditure pie, leading to a desperate search for revenue streams. In the last 15 years, the real estate sector has emerged as a savior for local governments—land leases, transfer fees, and taxes have provided a revenue river. Recently, however, and in great part due to central government cooling policies such as tightened credit and higher down payments, the real estate sector has been slowing, creating significant problems for local governments. According to the Beijing Municipal Commission of Housing and Rural Development, new home sales in Beijing were down in 21.4 percent in 2012 from the previous year, and the sales of existing homes fell 52.9 percent. As a result of such declines, land sale revenue dropped 13 percent year-on-year from 2010 to 2011.
However, many local governments are not taking the slowdown, or central government tightening policies, lying down. A number of local governments have resisted implementing central government policies aimed at cooling the market.
In October 2011, the Nanjing government and the Anhui province government relaxed local mortgage rules and Foshan, a city in Guangdong province, loosened restrictions on the maximum square footage a family unit can buy. These reversals were suspended almost immediately. In early 2012, Xiangshan, a county in Zhejiang province, was rumored to have removed home buying restrictions, but local officials denied the policy change soon after. In January, Zhongshan, in southern China, increased the residential price cap and Chongqing raised the property tax threshold. In February 2012, the eastern city of Wuhu announced that they planned to waive the deed tax and to subsidize some home purchases. This policy was suspended four days later. In late February, Shanghai was rumored to be loosening its definition of who qualified as a local, allowing more people to buy second homes. However, this rumor was quickly squashed by the Shanghai government. Banks have also gotten involved: in early March, China’s four largest banks (Industrial and Commercial Bank of China, China Construction Bank, Bank of China, and Agricultural Bank of China) announced that they would charge lower rates to developers and qualified first-time homebuyers.
Why the rebellion by the local governments? Local governments, and disproportionately smaller local governments, are suffering mightily from the tightening policies due to their revenue imperatives. As briefly mentioned above, fiscal decentralization has had a huge impact on local governments: local governments’ share of revenue fell from 85 percent in 1978 to just 45 percent in 2002, while their share of total expenditures increased to 70 percent from 53 percent in the same period.
So in response, they are testing the boundaries of acceptable behavior with the central government, seeing how far they can loosen policies to maintain their revenue streams. So far, they have not been given much room. Wang Juelin, vice director of the Ministry of Housing and Urban-Rural Development Policy Research Center, noted that if the pushing continues, there is a possibility that tightening policies could get even tighter.
Will the central government, in fear of losing local government support and of a wider economic downturn, capitulate? So far, the response has been harsh and swift, clearly indicated by the speed at which local governments have retreated from their loosening policies. Shanghai Securities news cited a ministry officials as saying that the Chinese central government would “show no mercy” and “‘absolutely’ not let local governments ‘sing a different tune’ on housing policy.”
Indeed, it seems that the central government intends to maintain strict housing price policies. Wen Jiabao has reasserted the government’s policy a number of times in the last few months.
More recently, Premier Wen commented on falling housing prices in his opening address at the National People’s Congress in early March, leading some analysts to believe that looser policy could be on the way.
The central government recognizes the pain of the local governments—in an effort to ameliorate their financial woes, the central government has taken two steps: 1. They launched a trial property tax in January 2011 (to be expanded this year) that will hopefully eventually provide a more steady and sustainable stream of revenue; 2. Last fall, they began allowing local governments to directly issue municipal bonds to finance infrastructure projects. These steps will hopefully help to reverse some of the infrastructure-based reasons for local government incalcitrance in that local governments will become less dependent on the quick returns from real estate.
Until that happens, however, the central government will continue to feel significant pressure from local officials anxious to stave off economic stagnation in their jurisdictions. That being said, the central government’s awareness of the potentially major consequences of continually rising housing prices and even a property bubble, including social unrest and an economic downturn, has led them, and will continue to lead them, to hold the line on real estate tightening policies.
Eve Cary is a researcher at the John L. Thornton China Center at the Brookings Institution.