Why China’s finances are weaker than they seem

On 5 March, Chinese Premier Li Qiang presented the budget execution report at the National People’s Congress. In line with the draft recommendations for the 15th Five-Year Plan (FYP) at the third plenum, the report reiterated that China will stick to a proactive fiscal policy. Essentially, it means China will continue with an expansionary macroeconomic strategy. The plan is to “bolster counter- and cross-cyclical adjustments” and implement more proactive macro policies to “keep employment, enterprise operations, markets, and expectations stable”.

China’s need for an expansionary fiscal policy is also driven by 11 consecutive quarters of deflation — the longest streak in three decades. In comparison, the deflation remained negative for only two quarters following the 2008 crisis. 

In addition, the leadership also emphasised the need to promote economic recovery, expand domestic demand, drive high-quality development, and fund major national strategic tasks to argue in favour of fiscal expansion. 

The question, however, isn’t whether China needs such a policy — it certainly does. The question is how the leadership plans to mobilise the requisite financial resources. China’s fiscal situation doesn’t inspire confidence. 

To begin, China’s year-on-year growth in national general budget revenue — the primary national budget — in which both tax and non-tax receipts are collected, has been declining over the past five years. The national general budget revenue as a percentage of GDP has dropped from over 21% in 2019 to 16.5% in 2025, severely constraining China’s fiscal space. 

Declining revenues also have repercussions for China’s expenditure mandate. As the economy grows, China’s expenditure requirements also need to increase in consonance, or at least remain stable. Yet, as a percentage of GDP, China’s general budget expenditure is declining, reflecting increased fiscal pressure. 

A major contributing factor in China’s declining national general budget revenue is its declining tax receipts. China is struggling to keep its taxes afloat. Since 2019, the tax-to-GDP ratio has been in a terminal decline. From around 15.7% in 2019, China’s tax revenue as a percentage of GDP has fallen to 12.6% in 2025. 

During the third plenum, the leadership acknowledged the seriousness of the issue and underlined the need to keep the “overall tax burden at an appropriate level” and improve the “taxation policies on income generated from business operations, capital, and property”.

The central leadership also urged the government to better regulate tax breaks in the draft recommendations to the 15th FYP. Subsequently, in the 2026 budget execution report, the central leadership criticised the local governments for continuing “to offer unauthorised tax incentives and refunds as well as irregular fiscal subsidies to attract investment” despite “repeated prohibitions”. 

But it seems that the central government has thrown the local governments under the bus. Long-term data suggest that the declining tax-to-GDP ratio is not a recent phenomenon. In fact, the trend was already underway when Chinese President Xi Jinping appeared on the scene. 

Tax as a percentage of GDP rose from about 14% in 2000 to a high of 19.4% in 2013 before following a consistent downward trend. It is true that supply-side measures and tax breaks have contributed to falling tax revenue, but the central government has been promoting these measures since 2015 in the hope of supporting businesses that would bring in revenue. Even in 2024, the leadership promoted tax cuts to ease the burden on businesses. In 2025, the leadership refrained from using the term “tax cuts” as a policy measure before finally calling out the local governments for unauthorised tax cuts in 2026. 

Furthermore, the declining tax revenue is also partly a result of the central government’s crackdown on the property sector. For many years, the local governments had been utilising the enormous revenue earned from the land sales for residential and commercial spaces to subsidise the land sales for industrial use. In the process, they would also extinguish the vast sums of revenue collected from the land sales for commercial and residential use to carry out land preparation and infrastructure development for industrial use. 

The local governments would compete with each other to offer the best services to enterprises to attract greater investment. Thus, the local governments would end up spending more on land development than they would earn from land sales. Yet, they persisted with the arrangement because those enterprises, once set up, paid value added tax and corporate income tax, the two biggest sources of tax revenue for the local governments. However, as the revenue from land sales has fallen owing to the crackdown on the property sector, so have new sources of tax revenue for the local governments. 

The declining revenue from land sales also means that China’s second major budget, referred to as the managed-fund budget, has also come under duress. The local government component of the national managed-fund budget is much larger than the central government component. Hence, any shortfall in the local government-managed fund budget — owing to a decline in land sales revenue — severely impacts the national budget. 

The budget execution report has consistently shown a surplus in the national managed-fund budget, including in 2025. However, funds raised through the issuance of special-purpose bonds by local governments and ultra-long treasury bonds by the central government are recorded as revenue in this budget. In reality, these are liabilities — not genuine income — that must be repaid with interest.

Once this accounting distortion is removed and revenue and expenditure are adjusted accordingly, the data reveal that, since 2023, revenue and spending as a share of GDP have begun to diverge, with the gap continuing to widen.

In the past, local governments used land sales revenue from this fund to attract investment. As land sales revenue has declined, they have been forced to continue offering tax breaks as incentives, in the hope that these projects will generate fiscal revenue over the long term.

Nevertheless, the state of the two most important budgets — the national general budget and the national managed fund budget — suggests that China’s fiscal space is severely constrained. 

The 2026 Budget Execution Report acknowledges this, stating, “In 2026, the opening year of this period, we will need to meet significant fiscal expenditure demands on all fronts. We will see increasing obligatory spending on key areas, such as technological innovation, rural revitalisation, and industrial transformation and upgrading.”

It added, “... expenditures on government debt interest payments will continue to rise, and transfer payments will remain considerable given the need to support local governments… On the whole, we will face mounting pressure in maintaining the balance between fiscal revenue and expenditure in 2026.”

The downward pressure is reflected in China’s fiscal deficit. While China’s claim that its fiscal deficit has remained in line with the annual official target (4% of GDP for 2025), its consolidated fiscal deficit tells a different story. The consolidated fiscal deficit, which excludes revenue from the budget stabilisation fund, issuance of special purpose bonds and ultra-long treasury bonds as part of total revenue, has always outpaced the government’s set target. In 2025, it soared to 7.2%. 

China’s debt-to-GDP ratio, especially local government debt, further complicates its problem. The official debt may not be as big a problem, but hidden debt is. Independent studies highlight that outstanding local governments financial vehicle (LGFV) debt alone was as high as 45% of the GDP by 2024. This is in addition to the officially reported national debt-to-GDP ratio. 

Consequently, cleaning up illegal debt is still a challenge for China. Minister of Finance Lan Fo’an warned that local governments should observe the “iron discipline” of not adding any new illegal debt, desist from repaying old loans by incurring new loans and avoid establishing distorted financial platforms. 

Thus, China faces a difficult choice as it seeks to battle declining revenue and inflating expenditure demands. For revenues to grow, the GDP growth has to pick up. However, the fact that the target for 2026 GDP growth was downgraded to 4.5-5% makes the job even harder for Beijing.

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