Local government investment has played an important role in China’s economic growth since its open-door policy. However, local investment has been salient difference in China’s reform process. During 1978-1993, local governments heavily invested in processing and manufacturing industry. In contrast, local governments have steered their funding into infrastructure investment since 1994. The purpose of this project attempts to analyze local government investment in China’s reform era. In contrast to political tournament model which has pervasive influence in China study in recent years, this project views fiscal incentives as a principal factor to affect the decision of local government investment. Fiscal incentives perspective emphasizes that local governments make efforts to collect fiscal revenues according to different fiscal systems. Therefore, dramatic differences in local government investment result chiefly from the changes in central-local fiscal relations in China’s reform era. To gain fiscal revenue, local governments heavily invest in processing and manufacturing industry under the revenue-sharing system (RSS). The tax-sharing system (TSS) reform in 1994, however, shifts local tax base to business tax and value-added tax. The amount of these taxes is closely associated with the supply of local infrastructures. Accordingly, local governments plunge into local infrastructure investment.
