Fiscal decentralization and urban-rural income inequality in China

China carried two important fiscal decentralization reforms in 1985 and 1994 respectively. The first one is contract fiscal system and the second one is tax-sharing system. Local government undertakes the responsibility of public goods provision for local areas when they get the financial autonomy after the fiscal decentralization. The criterion of the political evaluation mechanism is economic growth in China after the economic reform. So, local government officials invest most of the fiscal fund in industry because of the difference in investment return rates between agriculture and industry. Industry concentrates in urban areas and contributes to the increase of income level of urban residents. So, fiscal decentralization leads to the increase of urban-rural income inequality. Empirical analysis results of panel data of Chinese provinces during 1979-2004 show that fiscal decentralization promotes the urban-rural income inequality.