A Policy Shock as Structural Break: A Recent Case in China’s Land Rent Financing for Infrastructure

• In Event: Subnational Taxation and Economic Development

Abstract

Land-based revenues have long been a fiscal instrument for subnational governments to finance infrastructure investment. This instrument inherently ties public investment capacity to the performance of the real estate market, where fluctuations in housing demand exert direct fiscal consequences. This paper takes policy shocks as structural breaks and examines the impacts of such breaks (shocks) on infrastructure investment. We exploit China's policy reversal in 2016 as a case, where the shock was the central government disallowing bank loans for real estate developers, substantially impairing their capacity to participate in the land markets. The resulting sharp contraction in residential and commercial land leasing triggered a sharp decline in land rents for local governments, weakening the fiscal foundation for local infrastructure investment. Using panel data with prefecture-municipality as the unit of analysis and adopting a DiD with IV framework, we estimate the causal impact of land revenue shock on infrastructure investment. DiD estimates indicate that the policy shock led to a 51% reduction in land lease revenues, equivalent to 5.3 billion RMB a year per city. This fiscal contraction drastically curtailed infrastructure investment. 2SLS estimates suggest that a 10% decline in land revenue translates into a 5.4% reduction in investment. Decomposition of the funding sources reveals that only 20% of this decline is directly attributable to lost land revenues, while 80% stems from contractions in self-financing and other funding sources which are dominated by local government financing vehicles (LGFVs). Meantime, the marked reduction in new bond issuances and loan balances suggests an internal reallocation of resources within LGFVs, which may amplify the impacts of the structural break. Our findings point to a broader structural vulnerability: fiscal systems that heavily rely on land-based revenues face significant constraints from land markets changes.

Authors

• Yilin Hou, Syracuse University

• Lin Li

• Lei Shao, leishao@cufe.edu.cn