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From growth engine to fiscal drag: Rethinking China’s local government finance

Christine Wong

It is well known that China’s decentralised fiscal system assigns most public service provision to local governments and that, in aggregate, subnational governments account for 85–86 per cent of national budget expenditures. What is less well known but even more notable is that subnational governments also undertake and finance some 80 per cent or more of the investments in infrastructure nationally.¹ Given their large weight in the performance of both these tasks, how local governments are faring not only dominates fiscal outcomes but also has major spillovers to the broader economy. The recent travails of local government finance have clearly hampered the central government’s capacity for macro-management.

Local government finances are under severe stress from three sources: a long-term erosion of the aggregate fiscal position of government, the collapse of land revenues and a looming debt crisis. In this chapter, I argue that although these problems manifest at the local level, their root causes are structural and systemic and often stem from larger underlying problems of the wider economy. I will also explain the central role of land revenues in the fiscal system in funding capital spending and service provision (including debt servicing). Given the restructuring of the property sector and demographic trends that point to a long-term reduction in the level of land receipts, this will require substantial adjustment in China’s public finances, not just a realignment of resources between the central and local governments. Resolving the problems of local finance will require structural and systemic reform rather than partial reforms focused on local government behaviours.

Long-term erosion of the budget

In China, the government presents four ‘budgets’ in its annual report to the National People’s Congress (NPC).² Among them, the general budget is the main and by far the largest account. It draws revenue from taxes and administrative fees to finance government operations and public services. New taxes introduced by reforms in 1994 brought a long fiscal expansion that saw revenue growing robustly from the mid-1990s through the first decade of the 2000s (see Wong and Bird 2008; Wong 2021). During the period 2000–12, when China’s GDP grew at double-digit rates in the wake of its accession to the WTO, revenues were growing 20 per cent per annum, and their share in GDP climbed from 13.4 per cent to 22 per cent (Figure 10.1). As China’s economic growth moderated from 2012, revenue growth slowed and the revenue–GDP ratio plateaued. After 2015 the trend turned decisively downward under the combined weight of a further slowdown in economic growth and tax reform and tax cuts that began in 2016, including replacing business tax with an expanded value-added tax, followed by a series of tax cuts to support the economy during the Covid-19 pandemic and, later, the housing market downturn. By 2024, the revenue–GDP ratio had fallen to 16 per cent, and it is projected to fall further, to 15.5 per cent, in 2025.

Figure 10.1: China’s general budget revenues and expenditures, 2000–25

Note: The figures for 2025 are projected from the 2025 budget presented in March.

Source: National Bureau of Statistics of China (data.stats.gov.cn/english/).

Table 10.1: Social spending programs introduced under the Hu Jintao–Wen Jiabao administration

Program	Launch date	Beneficiaries (no. of people)
Free Rural Compulsory Education: To eliminate out-of-pocket costs of basic education for rural families and raise the minimum standard of school spending.	2006	150 million at peak (2007)
New Rural Cooperative Medical Scheme: To provide cooperative insurance for rural families. Later merged with the urban program and renamed the Basic Residents Medical Insurance Scheme.	2003	835 million in 2010; 963 million in 2023
Rural minimum income guarantee (Dibao): To provide income support for the poor.	2007	53.9 million at peak (2013)
Rural pension scheme to cover all rural residents. In 2014, it was merged with the urban program to become the Basic Residents Pension Scheme.	2008	1.06 billion in 2024

Source: Author’s summary.

To put this in perspective, from their peak at close to 22 per cent of GDP in 2015, revenues had fallen to 16.5 per cent by 2022—a level that was lower than the 16.7 per cent collected in 2005. This is significant because several large social spending programs introduced during the Hu Jintao–Wen Jiabao administration—such as free basic education and near-universal coverage of health, pension and income support—came online in the mid-2000s. Because of their mammoth size, these programs pushed budget expenditures up by about 7 per cent of GDP from 2005 to the peak in 2015 (Table 10.1). Since most of these programs have continued to grow, the current level of revenue collection is clearly insufficient to meet spending needs, resulting in growing deficits and spending cuts.

As they are on the frontline of service provision, local governments bear the brunt of this fiscal erosion and widening deficits. Under the current revenue-sharing arrangements, local governments ‘earn’ about 55 per cent of total revenues but account for 85 per cent of expenditures and depend on central government transfers to fund the gap.

In Figure 10.2, we show that the fiscal erosion and the need to fund transfers have in recent years squeezed the central government as well. In the years since 2022, the central government has turned over all its revenues to transfers.³ Even so, many local governments are unable to meet their spending needs. In their review of the 2022 budget implementation, the Finance and Economics Committee of the NPC noted the ‘relatively prominent’ funding gap at the grassroots (county) level, and that many faced ‘difficulty in meeting the “three guarantees”’ of payroll, government operations and basic services (MoF 2023). In the same year, a survey of 521 counties and cities by the Chinese Academy of Fiscal Sciences, a Ministry of Finance inhouse think tank, found ‘most’ local governments admitting to ‘leaving a considerable portion of policy mandates unmet’ due to funding shortages (Cheng 2023a).

Figure 10.2: Transfers as a share of central government revenues, China

Note: Data for 2025 are projected from the 2025 budget presented in March.

Source: National Bureau of Statistics of China (data.stats.gov.cn/english/).

The growing dependence on land revenues

Land has long been a key source of financing for local governments (Wong 1997, 2013). From the 1990s, as China’s rapid urbanisation created enormous need for infrastructure, local governments began to tap land as a source of finance, both directly and as collateral for borrowing off-budget through local government financing vehicles (LGFVs). Even after the 2015 reforms allowed local governments to issue bonds for capital spending, land has remained the main source of funds for investment as well as debt servicing for both the special project bonds (SPBs) and the LGFV debt that is not included in local government balance sheets (Wong 2023).

In addition, over the past decade land revenues have been increasingly used to finance recurrent expenditures in local government budgets. This began in 2015, when budget reforms promoted more unified management of fiscal resources and local governments were encouraged to draw on land revenues to supplement budgetary resources. In 2022, for example, local governments brought in RMB1.2 trillion ‘from other budgets, reserve funds and carry-overs’.⁴ Nearly all of it presumably came from land revenues, which make up more than 80 per cent of government fund revenues; social security funds are earmarked for pension and health expenditures and the state capital operating budget for state-owned enterprises. Then finance minister Liu Kun confirmed in early 2023 that 15 per cent of revenues from the local government fund budget have been transferred annually into the general budget (Cheng 2023b).

Figure 10.3: Local government gross receipt of land revenues

Source: Ministry of Finance data via CEIC (www.ceicdata.com/en).

Figure 10.4: Funds brought into local government general budgets

Source: Calculated from annual budget reports and CEIC data (www.ceicdata.com/en).

Indeed, as general revenues declined and fiscal pressure grew, it appeared that local governments stepped up efforts to raise land revenues, which grew from 5 per cent of GDP in 2016 to 8.3 per cent in 2020 (Figure 10.3), and local governments tapped these revenues through ‘inter-budget transfers’ to fund as much as 9 per cent of their budget expenditures—until the Covid-19 pandemic and housing sector meltdown disrupted this funding source (Figure 10.4) (Wong 2023).

In nominal terms, gross receipts from land peaked in 2021 at RMB8.7 trillion, compared with RMB11.1 trillion in local government general revenues, and made up 43 per cent of the combined fiscal resources under local government disposal.⁵ Their collapse in recent years has sharply curtailed local governments resources, forcing the central government to step up transfers and precipitating a debt crisis as it cut sharply into local governments’ debt-servicing capacity.

The looming local government debt crisis

Local government debt has long been a problem in China. Large-scale local government borrowing began in the 1990s, when rapid urbanisation ushered in by market reforms created huge demand for new infrastructure. As the same market forces were eroding the monopoly profits of SOEs that had been the mainstay of government revenues under the planned economy, government revenues plummeted, from more than 30 per cent of GDP in 1978 to 10 per cent in 1995–96. Amid this steep fiscal decline, capital spending was largely pushed out of the budget, the fiscal system was decentralised and local governments were left on their own to cope with the needs of urban growth (see Wong 2009). With neither budget resources nor the legal authority to borrow, local governments turned to tapping the rising value of land and borrowing off-budget through state-owned urban development corporations and other financial vehicles to finance infrastructure (Wong 2013).

The size and viability of local government debt came under central government scrutiny in the wake of the massive RMB4-trillion stimulus during the GFC. Under permissive policies, LGFVs proliferated and quickly became the most active users of stimulus funds, adding rapidly to their stock of debt (Wong 2011; Bai et al. 2016). To get a handle on the problem, central authorities ordered nationwide audits of local government debt and found that, by 2013, local governments had accumulated as much as RMB30 trillion in debt (or more than 40 per cent of GDP) when guaranteed and partially guaranteed debts were included (NAO 2013).

Reining in local government debt and off-budget borrowing was a top priority of the fiscal reforms in 2015. The central government’s approach was two-pronged. First, it gave local governments the legal right to borrow through bond issuance under annual quotas approved by the NPC—known as ‘opening the front door’. Second, it sought to stop the unregulated borrowing off-budget and bring the existing debt onto local government balance sheets and under unified budget management. Over the period 2015–18, RMB14.4 trillion in low-interest government bonds were offered to swap out high-cost LGFV debt, and LGFVs were banned from further borrowing on behalf of local governments, to ‘close the back door’.⁶

Figure 10.5: Local government outstanding bonds

Source: Ministry of Finance (www.mof.gov.cn/en/data/).

With the introduction of local government bonds, the official debt of local governments has grown rapidly, especially after 2018, with its share of GDP growing from 20 per cent to 35 per cent in 2024 (Figure 10.5).

Despite the reform, however, off-budget debt has grown rapidly. Estimates vary, partly due to differing coverage. Based on projections from LGFV bond issues, the International Monetary Fund (IMF) estimates that LGFV debt grew from RMB40 trillion in 2019 to RMB66 trillion in 2024 (Bloomberg 2024). Added to the official debt of RMB47.5 trillion, total (‘augmented’) local government debt reached RMB113.5 trillion by 2024 and was equal to 84 per cent of GDP (Figure 10.6). If state guidance funds were included, total augmented local government debt would rise to 92 per cent of GDP (IMF 2024). In addition, there are informal debts that may add as much as 5–10 per cent more, including widespread and mounting payment arrears to construction companies, suppliers, contractors, public employees, civil servants and even ordinary citizens.

The reason for the continued growth of off-budget debt after 2015 can be found in the funding structure for investment in infrastructure, which shows a persistent, huge gap between annual investments in infrastructure and local government borrowing capacity as approved by the NPC (Table 10.2). This gap is expected to be filled by land revenues, fiscal resources and private investments through public–private partnerships and the like. When these resources fall short, local governments turn to LGFVs and, with the collapse of land revenues, this shortfall has grown in recent years even in the face of growing SPB quotas.

Figure 10.6: Estimated augmented local government debt

Sources: Ministry of Finance (www.mof.gov.cn/en/data/). Hidden debt estimate is from IMF (2024).

Table 10.2: Local government investment in infrastructure and funding gaps, 2016–21 (RMB billion)

Year	Local government investment in infrastructure*	Quotas for local government general bonds	Quotas for local government SPBs	Funding gap
2016	9,510	780	400	8,330
2017	11,200	830	800	9,570
2018	11,626	830	1,350	9,446
2019	12,068	930	2,150	8,988
2020	12,176	980	3,750	7,446
2021	12,225	820	3,650	7,755

Note: ^* Calculations based on an average 80 per cent share by local governments.

Sources: Ministry of Finance (www.mof.gov.cn/en/data/); Liu and Liu (2022); Wu (2022).

As to what lies behind the growth of infrastructure investment—aside from the incentives for local officials to show ‘political achievements’—a big driver is the central government’s preference for infrastructure investment for fiscal stimulus and assigning it mostly to local governments. Since the 1990s, local governments have accounted for 70–90 per cent of the total infrastructure investment (Wong 2013, 2014). During the pandemic, and after it to counter the economic drag posed by the housing market meltdown, policymakers called for an ‘all-out push’ on infrastructure investment and local governments were allocated quotas for SPBs of more than RMB20 trillion over the period 2019–24, adding 14 per cent of GDP to official local government debt. During the same period, an additional RMB26 trillion was added to LGFV debt, according to IMF estimates (Bloomberg 2024).

Squeezed by the slowing economy and weakening revenue receipts, the risk of default on local government debt rose sharply in 2022–23, exacerbated by a looming spike in debt maturities. The steep drop in land revenues hit LGFVs especially hard since a large proportion of their debt is tied to infrastructure and development projects, most of which depend on land finance. To avert the rising default risks, in late 2023, the central government rolled out a debt resolution program that offered refinancing bonds and concessions from state-owned banks to restructure the maturing loans of at-risk LGFVs (Wong 2025). A blanket guarantee of all maturing debt of LGFVs through 2025 helped to calm corporate bond markets, but the huge debt overhang and pressure to deleverage have continued to strain local finances and drag on economic growth. An additional package was approved by the NPC Standing Committee in November 2024, offering a total of RMB10 trillion in SPBs over the next three to five years to replace LGFV debt.⁷

To date, the approach remains the same as that applied in 2015. Holding firm to the belief that ‘each family must carry its own child’, the program offers no debt relief to local governments. The program aims to bring off-budget debt onto local government balance sheets under unified budget management and reduce the debt-servicing burden by offering low-cost government bonds, to buy time for local governments to gradually work down the debt and return to fiscal sustainability.

However, the debt resolution program is unlikely to achieve its objective of returning local governments to a sustainable level of debt. First, the much higher current level of debt on local government balance sheets does not leave much room for taking on off-balance-sheet debt.

This is shown in Figure 10.7, where the stock of official local government debt grew in 2024 to 172 per cent of fiscal capacity—calculated as the sum of local government general budget revenues, local government fund revenues and central government transfers.⁸ This far surpasses the ‘red line’ of 120 per cent set by the Ministry of Finance for monitoring local government debt risks in 2016 (State Council 2016). Even under the more permissive ‘traffic light’ standards proposed in 2020, the debt ratio is currently near the high end of the ‘yellow light’ of 120–200 per cent (Li 2021).

Nor will the debt resolution program change the dynamics of the local government debt problem since it does not address the core issue of how to finance infrastructure without loading local governments with more debt. Until the central government stops using infrastructure for stimulus and assigning it to local governments, the long-term dynamics of the fiscal system continue to be towards debt financing and debt accumulation, both on and off budget.

Figure 10.7: Sustainability metrics for official local government debt, 2017–24

Sources: Ministry of Finance data from budget reports (www.mof.gov.cn/en/data/); and CEIC (www.ceicdata.com/en).

The urgent need for reform

China is currently on an unsustainable fiscal path. The challenge extends beyond the misalignment of resources and responsibilities between the central and local governments. There is simply not enough revenue to meet expenditure needs. Addressing this fiscal gap requires more than just redistributing shares of revenues and expenditures; it requires a comprehensive overhaul of the system.

The government faces a dual crisis: declining tax and land revenues, compounded by a hardline debt resolution campaign since 2018 that has severely constrained local government finances. The resulting fiscal squeeze has triggered a host of dysfunctional behaviours—from service cuts, delayed salaries and pay cuts for public employees to surging fines and fees, hasty liquidation of state assets and alarming reports of ‘profit-seeking law enforcement’ targeting enterprises, particularly affluent, non-local firms. These practices are eroding investor and consumer confidence, ultimately threatening China’s economic growth.

With China entering its third year of deflationary pressures, a large fiscal stimulus is urgently needed to fend off the risk of falling into a Japan-style deflationary spiral. Injecting funds to support the housing sector recovery should be a priority given the outsized role housing plays in GDP, wealth holdings and consumer confidence. Direct subsidies to consumers would also add a quick boost to consumption and build confidence, in addition to providing much-needed assistance to hard-hit families at the bottom of the income distribution.

For the longer term, it is imperative for authorities to formulate a plan for reforming the structure of the fiscal system, starting with tax reform to rebuild its revenue mechanism. After four decades of economic and demographic transformation, a thorough reassessment and restructuring of public expenditures are also essential to ensure fiscal sustainability.

References

Bai, Chong-En, Chang-Tai Hsieh, and Zheng Michael Song. 2016. The Long Shadow of a Fiscal Expansion. NBER Working Paper No. 22801. Cambridge: National Bureau of Economic Research. doi.org/10.3386/w22801.

Bloomberg. 2024. ‘China Unveils $1.4 Trillion Debt Swap, Saves Stimulus for Trump.’ Bloomberg News, 8 November. www.bloomberg.com/news/articles/2024-11-08/china-unveils-839-billion-debt-swap-to-rescue-local-governments.

Cheng, Siwei. 2023a. ‘What Are the Risks of Local Financial Operations? Research and Calculation by the Academy of Finance and Sciences.’ Caixin, 28 February. economy.caixin.com/2023-02-28/102002952.html.

Cheng, Siwei. 2023b. ‘Liu Kun: Local Finances Will Gradually Improve, and the Impact of the Decline in Land Revenues on General Expenditures Is Controllable.’ Caixin, 1 March. economy.caixin.com/2023-03-01/102003242.html.

Cheng, Siwei. 2024. ‘The Details of the Local Debt Reduction Policy Are Clear, and the Total Debt Reduction Resources Will Increase By 10 trillion Yuan in Five Years.’ Caixin, 8 November. economy.caixin.com/2024-11-08/102254984.html.

International Monetary Fund (IMF). 2024. People’s Republic of China: 2024 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for the People’s Republic of China. IMF Staff Country Reports No. 258. Tokyo: IMF Asia and Pacific Department. doi.org/10.5089/9798400284281.002.

Li, Xunlei. 2021. ‘How Big is the Risk of Local Debt in My Country?’ Panorama Network, 9 April. weyt.p5w.net/article/2566301.

Liu, Zhi, and Xiuying Liu. 2022. ‘Is China’s Infrastructure Development Experience Unique?’ Journal of Chinese Economic and Business Studies 21, no. 3: 323–40. doi.org/10.1080/14765284.2022.2040074.

Ministry of Finance of the People’s Republic of China (MoF). 2023. ‘Report of the Financial and Economic Committee of the 14th National People’s Congress Regarding the Implementation of the Central and Local Budgets in 2022 and the Draft Central and Local Budgets for 2023.’ Xinhua, 9 March. www.mof.gov.cn/zhengwuxinxi/caizhengxinwen/202303/t20230309_3871498.

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1. 1 The exact figure cannot be ascertained because a significant portion is financed by the off-balance-sheet borrowing of local government financing vehicles.

2. 2 The four budgets and how they evolved are discussed in detail in Wong (2024).

3. 3 In 2020, the government introduced a RMB1-trillion special treasury (‘Covid’) bond to supplement the additional RMB1-trillion deficit in response to the pandemic. In 2022, the central government called up a special remittance of RMB1.65 trillion from central government institutions to meet the shortfall.

4. 4 Report on the execution of the central and local budgets for 2022 and on the draft central and local budgets for 2023 at the first session of the Fourteenth National People’s Congress, 5 March 2023 (State Council 2023).

5. 5 General revenues and government fund revenues are the main fiscal resources under local government disposal. There are also revenues from the state capital operating budget and the social security fund budget, but these are earmarked for use in their relevant areas—for state-owned enterprises and pension and healthcare expenditures, respectively.

6. 6 This is discussed in Wong (2018).

7. 7 This consists of RMB6 trillion in additional quotas of SPBs, to be used in three equal-sized increments over three years (2024–26), and the use of RMB800 billion annually from the allocated SPB quotas over five years (2024–28) (Cheng 2024).

8. 8 Fiscal capacity calculations are based on figures projected from the first 10 months of 2024, except for transfers, for which the budgeted figure is used. Government fund revenues include mostly gross receipts from land sales, which constitute 75–90 per cent of the total, and significantly overstate the availability of disposable revenue.