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governments to provide the social services Beijing no longer has the ability to finance. Local governments have few incentives to provide these services, however, because the political returns from doing so are lower than those derived from devoting the same resources to more showy projects demonstrative of their ability to maintain high rates of growth. A study of budgetary allocations in five provinces—Jilin, Hebei, Xinjiang, Qinghai, and Shandong—from 1980 to 1998 found that public expenditures for agricultural production fell from 7.54 to 2.15 percent of the budgets of these provinces, and spending on agriculture, forestry, and water management declined from 7.58 to 4.21 percent. In contrast, expenditures on urban maintenance, a category of spending usually associated with burnishing the image of the major urban centers, doubled.58 Because local officials are more likely to get promoted for delivering short-term high growth rates or other forms of tangible results, off-budget revenue tends to be spent on building local industries and other projects that contribute little to improvements in education, health, or the environment.

There is another reason for government officials to favor off-budget revenue. Since normal budget rules do not apply to the collection and use of such revenue, officials enjoy near total discretion. Abuse and corruption is rife. A large portion of the off-budget funds has been found stashed away in secret slush funds controlled by government officials. According to the finance minister, investigations found that theft and corruption was detected in every slush fund.59 In a report released in June 1999, the National Audit Administration claimed to have uncovered slush funds and illegal expenditures that amounted to 96 billion yuan, equal to 10 percent of the 1998 tax revenue.60

An important consequence of this dysfunctional fiscal system is the near-collapse of local public finance in many counties and townships, particularly in the interior agricultural provinces with large populations, such as Henan, Anhui, Hunan, Hubei, Jiangxi, and Hebei. Although China’s 2,400 counties and 46,000 townships provide most of the daily government services, they rely on a slim tax base, collecting 20 percent of total government revenue.61 Nationally, counties could generate revenue equal to only two-thirds of their expenditures in 1999. About 40 percent of the counties can generate revenue sufficient to cover only half of their expenditures.62

The fiscal conditions for rural township governments are even more dire. Though saddled with the mandate to pay for most local services, the most costly of which is public education, these townships have practically no tax base and must extract their revenue from farmers, mostly through an inefficient and coercive collection system. Most studies of the indebtedness of rural governments pinpoint the mid-1990s as the period when this problem began to emerge. In the 1980s and early 1990s, indebtedness was not a serious issue in rural public finance. Among the causes that contributed to the debt problem, the 1994 tax reform was singled out as the most important. Intended to strengthen the fiscal capacity of the central government, this reform placed the heaviest burdens on the politically weakest township and village governments. Unwilling to cede their share of the revenue, provincial and municipal governments increased the pressures on township and village governments to meet ever-rising revenue goals and even threatened local officials with dismissal should they fail to deliver. As a result, township and village governments were forced to cut services and increase taxes and fees on rural residents. This, in turn, fueled rural discontent and sparked tax resistance as peasants saw their taxes rise while local services deteriorated. According to one study, tax resistance was a major factor in the decline of local fiscal capacity. Unpaid taxes and fees accounted for one-third of village debts.63

The magnitude of the township and village fiscal crisis in the late 1990s was