Cover: China considers overhauling tax system to ease record local government debt

China’s December Central Economic Work Conference proposed reforms to the country’s fiscal and tax system for the first time in 30 years, highlighting the urgency for change due to current budget challenges and local government debt. [para. 1]. Reforming these systems is essential for economic stability, sustainable development and effective governance [para. 2]. Policy advisers suggest the changes should balance raising tax revenue, reducing the tax burden on businesses and allowing local governments to retain more revenue. [para. 3]. Finance Minister Lan Fo’an detailed these reforms with a focus on improving the budget system, optimizing fiscal resources and improving the transfer payment system. [para. 4].

China faces economic struggles after the pandemic, with slower income growth due to tax cuts and lower income from land sales. In 2023, national fiscal revenue was 21.7 trillion yuan ($2.98 trillion), an increase of 2.7% from 2019, while revenue from land sales fell sharply from their peak in 2021 [para. 5][para. 6]. This has put a strain on public services and the salaries of civil servants in some regions [para. 6].

In recent years, efforts to reduce taxes and fees included replacing business tax with VAT in 2016 and reducing VAT rates in 2019. Although the tax burden has fallen, many companies still feel under pressure due to efficient tax collection technologies and stricter administration amid economic challenges [para. 7][para. 8]. Yue Shumin, from Renminbi University of China, recommended that tax reform should harmonize the tax burden with economic development. [para. 9]. VAT, being the largest tax category, generated 6.93 trillion yuan in 2023, accounting for 38.3% of total tax revenue, followed by corporate income tax at 4.11 trillion yuan [para. 10]. Adjustments in the allocation of VAT are envisaged to address revenue distribution issues, particularly with the rise of the digital economy [para. 11].

Alternative sources of income are essential due to the decline in income from the sale of land. Scholars suggest revitalizing state assets, although the sustainability of such measures is questionable. Some steps include capitalizing on public data, but regulations limit the scale of data assets [para. 13][para. 15]. Increasing the rate of government debt financing also seems necessary; Local government debt reached 40.74 trillion yuan at the end of 2023 [para. 17][para. 18].

Reducing expenses is just as important. There has been a noticeable shift towards public services and optimization of fiscal expenditure by clearly defining the roles of government [para. 20]. Ma Haitao from the Central University of Finance and Economics suggested creating a dynamic list of fiscal spending and investing more in key sectors such as science, technology and healthcare [para. 22]. In addition, measures to control local government spending have been highlighted and piloted in regions such as Shanxi and Qinghai [para. 23].

The adjustment of fiscal responsibilities between central and local governments is an essential part of the reforms. In 2023, domestic expenditure accounted for 86% of public expenditure, despite domestic revenue accounting for only 54% [para. 25]. Previous reforms classified many responsibilities together, but specifics such as teacher salaries should fall under central government roles [para. 27]. The scale of central transfer payments to local governments has increased, exceeding 10 trillion yuan in 2023, but this change has led to inefficiency and dependency [para. 29][para. 30].

Experts such as Lou Jiwei, a former finance minister, suggest that the central government should shoulder the costs of its responsibilities, potentially increasing central staff and devolving roles from local governments. [para. 32].

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