China Initiates Sweeping Targeted Tax Reforms to Alleviate Fiscal Strain

Beijing Tackles Mounting Fiscal Pressures

China has commenced a comprehensive program of targeted tax reforms, a strategic move designed to mitigate a burgeoning budget deficit and alleviate severe financial strain on local governments. The reform agenda, largely shaped during the Communist Party's Third Plenary Session in July 2024, seeks to overhaul the nation's fiscal system with changes expected to be implemented by 2029.

The impetus for these reforms stems from a combination of factors, including a growing national budget deficit, shrinking local government revenues, and an estimated $12.58 trillion (92 trillion Yuan) in local government debt, as reported by Reuters. Local administrations have been particularly impacted by a downturn in the property market, which has significantly reduced income from land sales—a critical revenue source. This situation is exacerbated by the legacy of the 1994 fiscal reforms, which centralized tax revenues, leaving local governments with chronic budget shortfalls and a heavy reliance on non-tax revenues and financing vehicles.

Key Pillars of the Reform Agenda

The proposed tax reforms span several critical areas, aiming to create a more balanced and sustainable fiscal structure:

• Consumption Tax Reform: Plans are underway to shift the collection stage of the consumption tax to a later point in the supply chain and gradually assign its collection to local governments. This move, articulated by Vice Finance Minister Wang Dongwei, is intended to expand local revenue sources and enhance the consumption environment.
• Individual Income Tax (IIT) System: Reforms will deepen the individual income tax system, standardizing policies for business, capital, and property income. This includes clarifying specific definitions, calculation methods, and collection processes.
• Real Estate Tax System: Efforts are focused on improving the real estate tax system, encompassing the Land Appreciation Tax (LAT), Urban Land Use Tax (ULUT), and Property Tax, with legislative advancements steadily progressing.
• Central-Local Fiscal Relations: A core objective is to refine the financial relationship between central and local governments. This involves expanding local tax revenue sources, adjusting tax-sharing mechanisms, and potentially increasing the central government's share of spending responsibilities. Finance Minister Lan Fo'an has emphasized these adjustments.

Broader Fiscal Overhaul and Enforcement Measures

Beyond specific tax adjustments, China's reform initiative includes a broader overhaul of its fiscal system. This involves enhancing the budget system through stronger coordination of fiscal resources and advancing zero-based budgeting reforms. To manage the substantial local government debt, authorities plan to expand the scope of special-purpose bonds and establish a comprehensive monitoring system to prevent and mitigate hidden debt risks.

The government is also focusing on optimizing tax incentives, particularly by targeting national strategic areas to improve their effectiveness. Notably, new tax support measures, effective from April 1, 2024, have been introduced for state assets transferred to supplement social security funds, including Value-Added Tax (VAT) exemptions and non-taxable income provisions for certain investment activities.

In a bid to plug budget shortfalls, authorities have intensified tax enforcement, pursuing unpaid taxes from companies and individuals, some dating back decades. This includes expanding the scope of existing tax sources by removing exemptions and stepping up compliance. The legislative framework for taxation is also being strengthened, with 13 out of 18 tax types now having a legislative basis, and further legislation for VAT and consumption tax expected to accelerate.