China’s central government is taking significant steps to address the fiscal challenges faced by its regional governments, focusing on boosting consumer spending as a key remedy. Recent decisions from the Communist Party meeting suggest a pivotal shift in fiscal policy, with Beijing poised to redistribute tax revenues and ease the financial strain on local authorities.
As part of a major overhaul of the country’s tax system, Beijing plans to divert a portion of the consumption tax—currently collected solely by the central government—toward local governments. This move, one of the most substantial tax reforms in decades, is designed to enhance local revenue streams and reduce the fiscal pressures on regional administrations.
Liu Jing, chief China economist at HSBC Holdings Plc, highlighted the potential benefits: “The tax reforms indicate a greater responsibility for central government spending while increasing revenue for local governments. This adjustment is expected to broaden the tax base for local authorities and incentivize them to develop strategies to stimulate consumer spending.”
China’s regional governments are grappling with an unprecedented fiscal deficit, which reached 15 trillion yuan ($2.1 trillion) last year and is projected to continue into 2024. Despite the expected boost from the consumption tax, which contributed 1.6 trillion yuan last year, this measure alone is insufficient to resolve the fiscal crisis.
Citigroup Inc. economists, including Yu Xiangrong, view the fiscal reforms as a modest improvement rather than a comprehensive solution. “The proposed fiscal adjustments appear to be a pragmatic, albeit limited, remedy, with ongoing constraints on local government debt,” they noted.
The proposed reforms, detailed in resolutions from the Third Plenary Session of the Communist Party, will gradually shift more fiscal authority and revenue to local governments. This includes delegating the collection of excise taxes further along the production-to-consumption chain.
Bloomberg Economics comments on the reforms: “The plenum’s discussions on aligning local government spending and resources are a positive development. Persistent budget deficits and heavy debt loads have long hindered local growth and financial stability.”
According to Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA, local governments are expected to receive a larger share of the consumption tax and value-added tax revenues. Furthermore, they may gain authority to expand the range of products subject to consumption tax, which currently includes luxury goods, alcohol, cigarettes, and gasoline.
Although the consumption tax is expected to contribute a relatively small portion of local government income initially, its role is anticipated to grow over time, providing a more stable revenue stream for local authorities, as noted by Xing Zhaopeng of Australia and New Zealand Banking Group.
Additional reforms include granting towns more flexibility in setting local surcharges for education and other services, easing regulations on spending from special local bonds, and expanding control over non-tax revenue sources.
The resolutions also emphasize the need to address “hidden debt risks,” referring to off-balance sheet borrowing by entities linked to local governments. This continued focus aims to bring more of this borrowing onto official balance sheets, potentially increasing debt and repayment obligations.
While the decentralization of tax collection is seen as a rational approach, challenges such as tax avoidance, especially from e-commerce, could complicate enforcement, as noted by Bert Hofman, former head of the World Bank’s office in China. “This approach may not expand the overall fiscal resources but could lead to more efficient spending if implemented effectively,” Hofman said.
