The mystery of China's high investment rate: the incentive effect of tax sharing system

Liu Yongzheng, LV Bingyang and Li Yan wrote in the 3rd issue of Economic Research in 2021 that China's investment rate has been much higher than the world average level for a long time, and shows a fluctuating yet upward trend. From the perspective of finance, the most important institutional arrangement in the past two decades is the tax sharing system, which is characterized by the participation of local governments in the tax sharing of liquidity tax base. Theoretical analysis shows that when the tax sharing proportion of local governments increases, local fiscal revenue and public expenditure increase, and the positive externalities brought by taxation will exceed the negative externalities, resulting in a positive marginal effect on investment. The empirical results support the theoretical judgment, that is, the increase of the proportion of enterprise income tax and value-added tax under the provincial government has significantly promoted the increase of investment rate in prefecture level cities, and the incentive effect is more obvious in economically underdeveloped areas, while the financial crisis in 2008 weakened the investment incentive to a certain extent. The above conclusion explains the upsurge of investment accompanied by China's rapid economic development from the perspective of financial incentive.