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This paper studies the trends of economic development across provinces and cities in China between 1978 and 1993 and proposes regional development policies in light of the recent tax reforms in 1994. The significance of this paper is that a huge amount of historical data is used, including price indexes at provincial levels. With a solid data base, we use econometric tools to analyze possible reasons for economic convergence across China. Jian, Sachs, and Warner's research (1996) shows that the pattern of China's regional economic development varies across time: converges somewhat between 1952 and 1965; significantly diverges between 1965 and 1978; and significantly converges between 1978 and 1993. However, in the period of economic reform, it is divided into two distinct periods: 1978- 90 (convergence) and 1990-93 (divergence). Based on the above results, this paper studies the reasons of such convergence or divergence and proves with data that the growth of township and village enterprises (TVEs) has been the driving force of Chinese economic development. The surge of TVEs speeds up development in the poor areas, converging to the rich ones. TVEs promote economic development both through increases in production value and increase in efficiency. TVEs in the coastal regions grow faster, but this did not lead to regional disparity until 1990. However, since 1990, the gap has widened significantly and this is evidenced by TVE statistics like assets, loans, investments, and production efficiency. The tax reform in 1994 changed progressive corporate income tax rates into flat tax rates, which in effect has a negative impact on balanced regional development. This is in effect increased corporate tax rates from 21% to 33% for TVEs in the interior. These rates are much higher than the favorable tax rates enjoyed in the special economic zones and all kinds of development zones, most of which are along the coast. Thus, such a change reduces the competitive ability of the interior provinces and may lead to further widening of the gap between the coast and the interior. In order to promote healthy and balanced regional economic development, on the one hand, it is necessary to further open the interior provinces and cities and encourage exploration of natural resources. On the other, it may be a better idea to adopt progressive corporate tax rates so as to encourage development of small scale enterprises, especially the TVE development.


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