Follow the Money: Fiscal Incentives and Tax-Base-Oriented Public Expenditure in Chinese Counties

This study explores how fiscal incentives influence county-level spending priorities in China. Using a county-level panel dataset from 2000 to 2006, we find that higher retention rates of tax revenue from local production activities incentivize counties to allocate expenditures toward capital construction that enhances the productive tax base. Political motivations and transfer payments amplify this effect. While this fosters local investment and output expansion, it simultaneously crowds out education and administrative expenditure that do not yield immediate fiscal returns. Our findings elucidate the underlying mechanism of fiscal incentives and provide valuable insights into designing incentive structures to achieve targeted policy objectives.