China’s shrinking tax revenue poses challenge to economy and response to US tariffs

Xi Jinping

A sharp decline in China's tax intake is feared to limit the government's capacity to handle its growing economic woes, ranging from a crumbling housing market to over-leveraged local governments. The deficit also hampers Beijing's capacity to deal with rising tariffs introduced by US President Donald Trump, who last month increased levies on Chinese imports to 20 percent and threatened further, as reported by The New York Times.

China's Finance Ministry said last year's tax revenue dropped 3.4 percent, defying official estimates of 5 percent GDP growth before deflation adjustment. It is a considerable drop in a nation where tax revenue had continued to be steady even during previous economic slowdowns. The last such declines had occurred during pandemic lockdowns of 2020 and 2022.

Causes of the revenue decline

Deflation is one of the main reasons. Sliding prices are eating into profits and shrinking the government's share from value-added taxes (VAT), China's biggest source of revenue. VAT collections fell short of forecasts by 7.9 percent in 2023. Official reports steered clear of using the word "deflation," instead referring to "lower than anticipated producer prices."

In contrast, personal income taxes declined 7.5 percent short of projections as layoffs and flat wages worsened. Customs duty revenues declined 9.2 percent as imports decreased, with consumers, battered by the housing bubble collapse, cut back on spending on imported goods.

Sales of land—a huge source of finance for local government—have fallen sharply during an extended property downturn. Developers are bankrupt, with a resulting plunge in revenues that once contributed up to 80 percent of local government revenues. Fitch Ratings puts national and local government revenues, including land sales, down from 29 percent of GDP in 2018 to 21.1 percent forecast in 2025.

Budget deficits and sparse stimulus avenues

Even with record borrowing, the federal government is finding it difficult to come up with the money to significantly stimulate consumption or increase social welfare. While China increased its official budget deficit goal to 4 percent of GDP this year, analysts estimate the actual deficit—after stripping out creative accounting of borrowing as revenue—is more like 9 percent.

Proposals to impose new taxes have been stalled. China does not have taxes on real estate, inheritances, and capital gains, which are major sources of revenue in the West. Fears of hurting property values or the stock market and public opposition have held back reforms.

Ex-Finance Ministry researcher Jia Kang said China's tax collection system is now strict, with little leeway for cheating, but admitted that the nation has structural impediments to broadening its tax base.

Political opposition to welfare expansion

Repeated promises to increase consumer support—such as increased pensions, healthcare, or unemployment insurance—have come to nothing. Analysts argue this is not only due to fiscal limits, but also ideological opposition from President Xi Jinping, who cautioned in 2021 against "falling into the trap of welfarism's idleness."

China's failure to bring in revenues or increase social spending makes it worse equipped to handle its economy's defence against global shocks, like Trump's pressure through trade. Ironically, counter-vailing duty measures for exporters aimed at helping offset tariffs such as VAT refunds have contributed to revenue deficits after China's exports jumped to the brink of nearly $1 trillion surplus last year.

With tax revenues flagging and debt growing rapidly, China has a tight fiscal future ahead despite multiplying economic problems. Experts say unless new revenue sources are found, Beijing could be compelled to make tough decisions between servicing debt, social expenditures, and economic stimulus.