China's former finance minister on challenges in the new round of fiscal & tax reform
Lou Jiwei outlines seven aspects, covering share of fiscal revenue in GDP, local tax system, central–local fiscal relations, VAT system, etc.
Lou Jiwei 楼继伟 served as China's Minister of Finance from 2013 to 2016. He published an essay titled "Doing Counter-Cyclical Fiscal Policy Research to Serve a New Round of Fiscal and Tax Reform" in the Journal of Fiscal Research 《财政研究》 (2025, No. 1), with excerpts shared on the WeChat account "China Wealth Management 50 Forum" (中国财富管理50人论坛).
He focuses on seven issues in the piece: (1) reasonably raise the share of fiscal revenue in GDP; (2) steadily and effectively increase fiscal revenue; (3) improve the local tax system and increase local autonomous revenues; (4) improve central–local fiscal relations and enhance the alignment between powers and expenditure responsibilities; (5) truly implement the Third Plenum (2013) requirement to establish a system matching powers with expenditure responsibilities; (6) improve the fiscal policy framework and launch a package of incremental policies; and (7) improve the VAT system to adapt to industrial-chain innovation and new business models.
Below is the translation of his piece, and all the words in bold are added by me. The translation has not been reviewed by Lou.
楼继伟：新一轮财税体制改革推进中的难点与风险
Lou Jiwei: Difficulties and Risks in Advancing the New Round of Fiscal and Tax Reform
The Third Plenary Session of the 20th Communist Party of China Central Committee systematically laid out the basic framework and core requirements for a new round of fiscal and tax reform. Building on the 1994 tax-sharing reform and the 2014 drive to build a modern public finance system, the new round should address current practical problems with clear ideas and methods, setting concrete goals and plans. Today, China's real-estate market is still adjusting, the overall tax burden as a share of the economy continues to decline, local governments face mounting revenue pressures, and debt risks are shifting in form. Therefore, the reform design should tackle key bottlenecks, effectively ease current fiscal strains, and build a modern public finance compatible with a high-standard socialist market economy and a sound macroeconomic governance system. I will highlight seven points below:
I. Reasonably raise fiscal revenue as a share of GDP
Here, "fiscal revenue" refers to broad fiscal revenue. In 2018, fiscal revenue accounted for 28%–29% of GDP. After large-scale tax and fee cuts began in 2019, the ratio fell to 26% by 2023, with tax revenue alone only 14.4% of GDP. Some articles claim China's fiscal revenue exceeds 33% of GDP; this is flatly wrong. The figure comes from simply adding up the four budget ledgers* without netting out overlaps among them. For example, general public budget subsidies to the social security fund budget reached RMB 2.5 trillion in 2023. This transfer appears as revenue in both the government fund budget and the social security fund budget. When aggregating, such cross-entries must be eliminated to avoid double counting.
*Note: China's four budget ledgers refer to General Public Budget,
Government Fund Budget, State-owned Capital Operations Budget and Social Security Fund Budget.
In 2023, government fund revenue totaled RMB 7 trillion (9 trillion at the 2021 peak), with land transfer revenue making up about 90%. Land transfer revenue is a gross figure; only after deducting land acquisition, demolition, and "seven connections and one leveling 七通一平"* site-preparation costs does the net revenue become internationally comparable. Because transactions are harder to close, land prices have softened, and costs are sticky, today's net share is only about 30%, down from roughly 45% around 2017, and in some low-price regions it is as low as 10%. On this basis, the net component of 2023 land transfer revenue was only about RMB 1.9 trillion, which is the meaningful, comparable scale.
*Note: "seven connections and one leveling 七通一平" refers to providing road access, water supply, electricity, drainage, district heating, telecommunications, and gas connections, as well as land leveling (site grading).
Using this method, China's fiscal revenue was just 26% of GDP in 2023, below the roughly 30% typical of countries at a similar income level, and well below the 35% or higher common among advanced economies. As China aims to join the ranks of moderately developed countries by 2035, meeting the associated demand for public services and infrastructure will inevitably push up the revenue-to-GDP ratio. China has also entered moderate population aging and is expected to reach severe aging around 2035, further raising fiscal resource needs. Internationally, advanced economies entering aging have gradually lifted their revenue shares. But where will the added revenue come from? Cutting taxes is easy; raising them is hard — especially under current economic conditions.
II. Increase fiscal revenue in a steady and effective way
Beyond taxes, the two largest nationwide revenue items are social security fund income and land transfer income. Neither is likely to grow much. Social security fund income is slightly above RMB 11 trillion and includes RMB 2.5 trillion in general budget subsidies. Contribution rates are already high: for urban employees, basic pension contributions total 24% ( 8% employee + 16% employer ), and basic medical insurance totals 10% ( 2% employee + 8% employer ). These are high by international standards, leaving little room to raise rates. The most feasible option is to implement the delayed-retirement policy to relieve pressure and enhance sustainability. The State Council's Measures for the Gradual Delay of the Statutory Retirement Age have been issued, envisaging retirement roughly three years later and extending the minimum contribution period by about five years, an important support for the security and sustainability of social security fund income.
Land transfers depend on the real-estate market, which remains weak, so land-related revenue faces downward pressure. While most cities have relaxed price and purchase caps, lowered down-payment and mortgage rates, and set up "ensure delivery and destock" mechanisms, the sector will not return to its previous high-debt, high-leverage model. Land prices are unlikely to surge, volumes will not rebound sharply, and land-transfer income will not see large increases.
Raising government revenue must therefore rely mainly on taxes. Within taxes, VAT is the most likely to increase. The current VAT has a 13% standard rate plus two preferential rates of 9% and 6%, a standard rate that is indeed too low. When VAT was introduced in China in 1994, the standard rate was 17% with a 13% reduced rate, roughly in line with Europe.
Today, countries with VAT average around 20% for the standard rate, and Europe has risen to about 21%, largely to meet rising fiscal needs from aging. China moved in the opposite direction: the 17% standard rate was cut to 16% in 2018 and to 13% in 2019, reducing annual revenue by about RMB 5 trillion. Yet these cuts did not materially ease corporate burdens. If VAT credits are refunded promptly, firms' cash is not tied up and the tax burden does not rise. The RMB 5 trillion in cuts did not effectively translate into a surge of business dynamism.
The statutory corporate income tax (CIT) rate is 25%, roughly the international average. The U.S. is now at 21%, and President Trump has said he would like to go to 15% in his second term. Internationally, there is little space for China to raise the rate directly, and doing so risks "crowding out" quality investment and projects. The priority should be cleaning up the proliferation of fragmented tax incentives. That would both safeguard fair competition and potentially lift CIT receipts.
Personal income tax (PIT) has room to grow as a share of total revenue, but structural weaknesses make reform difficult. The 2019 Individual Income Tax Law kept the goal of a hybrid comprehensive-and-categorical system rather than moving to a fully comprehensive system, added seven special deductions to the comprehensive part, and later increased deduction ceilings for elderly support, infant care, and children's education. With higher special deductions, the basic personal allowance should have been lowered; instead, it rose from RMB 3,500 to RMB 5,000, above the average wage, so over 70% of people owe no PIT. Of the less than 30% who do pay, over 60% fall into the lowest 3% bracket, with minimal tax due.
By contrast, the U.S. uses a comprehensive PIT on a household-filing basis. Any household income must be reported. The basic deduction of USD 3,300 is about 10% of average household income. As a result, over 90% of people file returns and about 55% pay tax.
The filing system rests on two pillars: incentives (low-income households or those with kids may receive refunds) and integrity (penalties for non-filing and credit accumulation for honest filing). The U.S. PIT is the largest tax, serving both revenue collection and redistribution. Moving China to a fully comprehensive system in line with international practice would involve many interest adjustments and be genuinely hard. If aligned with common international practice, the basic allowance would fall to around RMB 1,000, not RMB 5,000, a change the public would likely find difficult to accept.
III. Improve the local tax system to expand local disposable financial resources
Local revenues now depend mainly on shared taxes: CIT, PIT, and domestic VAT are split between central and local governments and have become key local revenue sources. After the shift from business tax to VAT, local own-source taxes are mostly small items like deed tax, resource tax, and stamp duty. The Third Plenary Session of the 18th CPC Central Committee called for "adjusting central–local revenue assignments in light of tax attributes as tax reform proceeds." Ten years on, given market conditions and tax attributes, few taxes have proved well suited to local assignment.
The latest Third Plenum (20th CPC Central Committee) calls for "To place more fiscal resources at the disposal of local governments, we will expand the sources of tax revenue at the local level and grant greater authority for tax management to local governments as appropriate." The stated direction is to "take steps to move excise tax collection further down the production-to-consumption chain, with the power of collection steadily being passed to local governments; improve the value-added tax credit refund policy and free up the channels for making tax deductions," with an emphasis on "optimizing the ratio for taxes shared between the central and local governments." Although it also proposes creating a "local surtax" and "authorizing localities to set the rate for this tax within a predetermined range, in practice this merely consolidates the urban maintenance and construction tax, education surtax, and local education surtax. Given mobile tax bases and interjurisdictional competition, the effect in materially boosting local revenue is limited.
Some suggest raising the local share of VAT or turning VAT into a local tax. This is misguided. VAT is collected stepwise across production, circulation, and consumption, with uniform taxation and rebates at the border. Thus, most VAT-based countries treat VAT as a central tax to support a unified national market. However, centralizing VAT often leaves local tax bases thin. Solutions vary. Australia, for example, allocates a portion of VAT to states via equalization transfers. Germany and Japan collect at final consumption and then allocate across regions according to retail sales shares. In China's 1994 tax-sharing reform, the lack of robust local taxes led to a 75:25 VAT split between center and local; after the 2016 business-tax-to-VAT reform, locals were even more short of base taxes, so VAT moved to a 50:50 split. This arrangement has many drawbacks, the biggest being how to deliver timely VAT credit refunds, which will be discussed further below.
In 2019, the State Council issued the Reform Plan on Adjusting Central–Local Revenue Assignments Following Larger-Scale Tax and Fee Cuts. Beyond clarifying how VAT credit refunds are shared, it proposed moving consumption-tax collection to later stages and steadily assigning it to local governments. Subsequently, high-end watches, jewelry, and luxury goods were shifted from production/import to wholesale/retail for tax collection and were assigned to localities. But these items account for only about 2% of consumption-tax revenue (roughly RMB 40 billion ), and once the central baseline is protected, local gains are minimal, while administrative complexity rises sharply (retail has many small taxpayers, making evasion easier).
The core of consumption tax is four categories: tobacco, alcohol, vehicles, and fuel. Vehicle and fuel taxes are earmarked for highways. Less-developed regions have fewer vehicles and less traffic but much higher construction and maintenance costs (in mountainous Yunnan–Guizhou–Sichuan region, costs are 2–3 times those on plains). Central pooling of these taxes promotes regional balance. If moved downstream and assigned to localities, richer areas would reap more, undermining equity. Alternatively, the center can fund local highways through dedicated spending, functionally equivalent to moving and assigning these taxes. Tobacco and alcohol have negative health externalities. Countries generally use high rates to curb consumption and keep these as central taxes. If assigned to localities downstream, jurisdictions could be tempted to promote tobacco and alcohol sales, undermining corrective aims. Note that China's consumption tax is a selective excise, unlike the broad-based retail sales taxes in some countries like the U.S. Although the 2019 plan called for moving collection downstream and assigning to localities, progress has been modest.
By tax attributes, a property (real-estate) tax is the most suitable local tax. The Third Plenum of the 16th CPC Central Committee proposed a "property tax," essentially a real-estate tax. Shanghai and Chongqing piloted a limited urban housing property tax, but it never scaled nationally. The Third Plenum of the 18th CPC Central Committee called for accelerating legislation and advancing reform at an appropriate time. More than 20 years on, it still has not been launched, largely due to the difficulty of balancing interests. With the housing market weak, the pressure to ensure delivery, and rising inventory risks, pushing a real-estate tax now is even harder.
IV. Refine central–local fiscal relations to better align powers with spending responsibilities
At present, fiscal conditions are tight for both the center and localities, and some primary-level governments even struggle to cover basic operating costs. In this context, it is necessary for the center to raise its deficit moderately and transfer more resources to local, especially primary-level, governments. But the new round must confront medium- to long-term structural issues and fix systemic design problems; policy "muscle" alone is not enough.
National data reveal an imbalance. In 2023, central general public budget revenue was just under RMB 10 trillion; local own-source general public budget revenue was RMB 11.7 trillion; together, national general public budget revenue was RMB 21.7 trillion, of which local accounted for 54% and the center 46%. Transfers from the center to local totaled RMB 10.3 trillion, meaning the center transferred more than its entire own revenue, financing part of it with deficit. For example, central-level spending was RMB 3.82 trillion while the central deficit was RMB 4.06 trillion, implying central spending was entirely deficit-financed. This structure is unsustainable and rare among major economies.
Two internationally comparable indicators underscore the point. On revenue assignment, in mature market economies the center typically takes over 60%; in China's general public budget it is only 46%, and even lower if other revenue categories are included. On spending responsibilities, central governments in mature economies typically account for over 50% of expenditure (the OECD average is 61% ), whereas China's central share is under 12%, clearly too low. The root cause is a misalignment of functions ("powers") between central and local levels: some responsibilities that should rest with the center are assigned to localities, or ambiguously defined as "shared."
In 2023, shared-responsibility transfers amounted to RMB 3.67 trillion, the largest transfer item. Yet standards for dividing shared functions are not precise, principles are unclear, and even the underlying logic differs across sectors.
For instance, responsibilities bearing on a unified national market are assigned to local managers, who may relax enforcement to favor local interests. Take basic pension insurance for urban employees: because it affects the unified national labor market, it should be a central responsibility, but it has long been shared. Since 2018, the system has been transitioning toward national pooling; tax authorities are gradually centralizing collection, but standards and contribution bases remain set by local social security agencies. To preserve local competitiveness, many set bases and rates below national norms. In 2022, accelerating national pooling was proposed, but a lengthy transition is needed before truly unified central collection and disbursement is achieved. As required by the Third Plenum of the 18th CPC Central Committee, this is a matter of the unified national market and belongs to the center.
One consequence of misalignment is that central civil servants account for only about 6% of the national total, whereas the OECD average on a comparable basis is 41%. Similar misalignments exist below the provincial level. Notably, upper-level governments often prefer to issue documents and targets to lower levels and then check compliance through inspections and assessments. This model does not fit modern national governance; its institutional efficacy is weak. Therefore, pushing fiscal resources further downward is not the right direction. Instead, appropriate strengthening of central responsibilities — raising the central spending share and reclaiming functions that should not be delegated to localities — is more consistent with reform logic.
V. Truly deliver the mechanism proposed in 18th CPC Third Plenum that aligns powers with spending responsibilities
In a narrow sense, this task might seem complete. In a broader and more accurate sense, however, "powers" include management authority: whichever level holds a responsibility should also manage it. On this broader definition, the task is far from done. The latest Third Plenum requires that matters concerning unified national market rules and administration be treated as central responsibilities. As noted, urban employees' basic pension insurance affects the unified labor market and should be central, yet it has been labeled "shared," with management mainly local; it is only now shifting toward central management.
A larger problem is that matters nominally assigned to upper levels are managed by lower levels. On paper, the function is "central," but management is delegated and backed by earmarked transfers. This may appear to align powers and spending, but in substance management authority and fiscal responsibility are not aligned. For example, cross-regional judicial functions should be centrally managed. Yet China has long organized courts by administrative tier, with each people's congress tier setting its own by-laws, which has produced cross-regional inequities. China did not establish circuit courts for many years; in 2015, the Supreme People's Court created circuit tribunals, but these are not first-instance courts — they are outposts of the SPC. Ultimately, a true circuit-court system is needed.
Cross-regional enforcement should likewise be centrally managed. China still lacks a centrally commanded national police force akin to the U.S. FBI dedicated to cross-regional judicial and law-enforcement work. Some argue there are no explicit legal barriers to local police acting across regions, but that absence of constraints has, in practice, disrupted the unified market, manifesting in problems like arbitrary fees and fines and issues in distant-water fishing, all traceable to this institutional gap.
VI. Improve the fiscal policy toolkit with a package of incremental measures
The economy is complex at present. Manufacturing is broadly stable and trade is relatively normal, but expectations, confidence, consumption, and private investment are all weak. New situations and problems may emerge, requiring timely budget adjustments to raise fiscal effectiveness, fully implementing the Central Economic Work Conference decisions following the September 26, 2024 Politburo meeting.
First, in 2025 the deficit ratio should be raised to ensure sustained and stronger fiscal support. In my view, the deficit ratio should be around 5%, a substantial increase from 3% in 2024. COVID-19 was a nationwide public-security event, and the center should have borne the full cost of disease control, but localities actually shouldered a large share. A higher deficit would bolster central resources and allow more transfers to local governments to ease their strains. If 5% proves difficult, about 4% would be acceptable, but it should be sustained for at least two years, with continued support to localities. The priority is not launching many new construction projects but paying down government arrears to firms that undertook public-investment projects, thus protecting public credit, boosting business confidence, and upholding market order.
Second, issue more ultra-long special government bonds to continue supporting major national strategies and enhancing security capacity in key areas, as well as a new round of large-scale equipment upgrades and consumer goods trade-in programs. Expand the issuance and use of local government special bonds, widen eligible sectors, and allow broader use as project equity capital.
Third, fully implement debt-workout measures. In 2025, resolve RMB 2 trillion or more of hidden debt through swaps and repayments, settle about RMB 800 billion in overdue payables of local governments, and save around RMB 200 billion in interest. Together, these extraordinary counter-cyclical steps would increase fiscal outlays and strengthen guarantees in priority areas.
VII. Upgrade the VAT system to support supply-chain innovation and new business models
When VAT was introduced in 1994, China adopted a production-type VAT under which equipment and buildings could not be credited. Most firms therefore had little end-period excess input credit ( "VAT carry-forward" ). VAT is collected on the value added at each stage as output VAT minus input VAT; any residual uncredited amount becomes a period-end carry-forward that can be rolled into the next period, so the cost pressure was limited. Starting in 2012, China shifted to a consumption-type VAT, allowing credits for equipment, plants, and office buildings. As a result, end-period carry-forwards have risen and must be refunded in a timely manner.
A consumption-type VAT, paired with a timely refund system for carried-forward input credits, is the most effective way to raise government revenue without distorting markets. Firms transmit the tax burden; consumers ultimately bear it. In incidence terms, VAT is regressive. Given that low-income households have higher Engel coefficients and spend a larger share on food and everyday goods, most systems introduce lower or preferential rates to mitigate regressivity. Therefore, multiple VAT rates are warranted, but tiered rates unavoidably affect innovation along supply chains and the development of new business models.
In 2016, when business tax was shifted to VAT, the central-local revenue split for VAT was adjusted to 50:50. This change made the refund of carried-forward input credits much harder. For example, suppose a project in a less-developed region purchases equipment mainly from a developed region. At the supplier's location, VAT is collected as output minus input tax; in the destination region, that becomes input tax, creating a carry-forward eligible for refund. If the refund is actually paid out, the less-developed region lacks the fiscal capacity, leading to an inequitable outcome. If it is merely carried forward as input credit, the less-developed region may see little or no VAT revenue for years, greatly straining local finances.
To keep VAT neutral and make refunds workable, the State Council in 2019 required that, of the 50% local share of VAT credit refunds, 15% be borne by the enterprise's home jurisdiction and 35% be apportioned across localities in proportion to their shares of the local VAT allocation. This is an initial fix. Even so, after a few years, period-end carry-forwards neared RMB 3 trillion.
In 2022, a special policy made the center fully cover refunds of period-end carry-forwards for micro and small firms; total refunds reached RMB 2.4 trillion, with the central government covering 92%, essentially clearing the stock in one go.
However, as service-oriented manufacturing expands and new manufacturing models emerge, the carry-forward issue will recur and may even impede supply-chain innovation and new-format growth. One option is to shift the VAT collection point to the sale of finished goods and allocate VAT revenue across regions based on marginal revenue, thereby eliminating the impact of input-credit carry-forwards; alternatively, restore the standard VAT rate to 17%, implement immediate refund upon assessment for carried-forward credits, and firmly curb prepayments. In this way, although the statutory rate would rise, firms' perceived tax burden would not increase markedly.
Taken together, these seven areas underscore that public finance is the foundation and a key pillar of national governance. Designing a new round of fiscal-and-tax reforms means confronting unavoidable challenges. In particular, raising the share of public revenue in national income, improving and reforming the tax system, strengthening the local-tax architecture, and rebalancing central–local fiscal relations all imply adjustments to the governance toolkit, require careful logical analysis, and affect the balance of interests. Under today's economic conditions, it is also essential to coordinate short-term expansionary measures with medium- to long-term reforms, and to ensure sound policy mixes and synergy among reforms. Enditem