China’s finance ministry expects low government revenue growth this year

Before adjourning last week, the National People’s Congress approved the realised 2023 budget and finalised the 2024 central government budget plan. According to the finance ministry, the combined revenues of the central government and local governments last year amounted to 21.7 trillion yuan (17 % of GDP), while combined spending was 27.5 trillion yuan (22 % of GDP). Thus, last year’s overall budget deficit was 5.8 trillion yuan (4.6 % of GDP) of which roughly 900 billion yuan in net terms was covered from various government funds and capital gains from state-owned enterprises. The finance ministry expects only modest nominal revenue growth this year (3 %) as some pandemic-era tax relief has been extended and new tax breaks have been granted to prioritised economic sectors (e.g. corporate R&D). Moreover, revenue last year was boosted by some companies paying their deferred 2022 taxes in 2023. Given China’s slowing revenue growth, the budget only assumes a nominal increase of 4 % and thus allows for a slight increase in the budget deficit. Overall, the finance ministry characterises revenue and expenditure prospects as “quite grave”.

China’s official figures on budget revenues and expenditures only provide a partial picture of public sector finances. Local governments engage in significant off-budget financial activities, particularly via local government financial vehicles (LGFVs). Also revenue to local governments from sales of land use rights is diverted not to budget but government-managed funds. The real estate downturn is reflected in the collapse of revenues from land right sales. As recently as 2020, sales of land use rights corresponded to 8.3 % of GDP, while they amounted last year to just 4.6 % of GDP. The more comprehensive IMF figures, which take into account off-budget activities, put the estimate of public sector spending considerably higher, resulting in a broader measure of government deficit equal to 13 % of GDP last year, as well as a rise in government debt overall to 116 % of GDP (BOFIT Weekly 8/2024). The IMF expects the deficit this year to stabilise at approximately the 2023 level. Even as the central government plans further increases in borrowing, the economic predicaments of many local governments continue to worsen limiting their ability to support economic growth.

Tax revenues have represented 80–85 % of central and local government budget revenues in recent years, with value-added taxes (VAT) accounting for over 30 percentage points of the take, corporate income taxes just under 20 percentage points and personal income taxes 7 percentage points. The largest spending categories last year were education (3 % of GDP), social security and unemployment insurance (3 % of GDP), agriculture and forestry (2 % of GDP) and healthcare (2 % of GDP). Even if the growth in debt-servicing costs has slowed in recent years, it was still grew extremely high over the past decade. In 2023, debt-servicing costs of on-budget debt corresponded to 1 % of GDP. The cost of servicing off-budget debt is known to be significant, even if precise figures are unavailable.

For 2024 budget, only the central government provides some more extensive plans, which is typical as local government budgeting process are still ongoing. The central government’s defence spending overall rose by 7 %, which has been a typical increase in recent years. In addition to defence spending, the emphasis has been given to spending on technological advancement, rural development and environmental protection. The government will direct 10 billion yuan in new funding for industrial development and raise spending on science and technology by 10 % from the 2023 level, as well as offer the above-mentioned corporate tax breaks on R&D. The central government announced plans to issue 1 trillion yuan in 50-year special bonds to finance strategic and security projects, adding that it also has plans to issue extra-long maturity bonds in coming years. The special bond quotas for local governments have only been increased this year by 100 billion yuan to 3.9 trillion yuan. Revenue transfers from the central government to local governments will rise by 4 %, or slightly more than anticipated revenue growth. Nearly half of budget revenues are collected by China’s central government, even if local governments are responsible for 85 % of budget spending.

The budget memorandum released by the finance ministry expressed concern over low revenue growth and the reduction in local government income from land right sales as they exacerbate the problems of already struggling local governments. At the same time, the finance ministry raised the issue of irregularities in local government investment projects and their financing. Some local governments and organisations have blatantly violated a range of laws, regulations and official instructions in various ways. Strengthening the management of local government debt is set as one the policy targets this year, which includes “a suite of debt resolution measures” and assuring that “hidden” accumulation of debt no longer increases. Already earlier this year, officials ordered roughly a dozen severely indebted provinces to suspend their infrastructure projects.