Stop Calling It "Malicious Dumping": The Truth Behind China's Export Boom Is Hidden in Local Tax Bills

In Western media and political narratives, the "overcapacity" and surging exports of Chinese electric vehicles, solar panels, and batteries are often chalked up to "state-directed malicious dumping" or "unfair non-market subsidies." Yet, many foreign observers remain stumped by a central puzzle: If the Chinese government has such immense power to steer the economy, why spend billions subsidizing factories to sell dirt-cheap goods worldwide instead of giving that money directly to ordinary citizens to boost domestic consumption?

The answer isn't some secretive geopolitical masterplan. It lies buried within China’s highly peculiar fiscal and tax system—specifically, its mechanism of production-based Value-Added Tax (VAT).

1. Western Countries vs. China: Where Are Taxes Actually Collected?

To understand why Chinese local governments are so obsessed with building factories, you first need to understand a fundamental difference in tax incentives between China and most Western nations.

In the US or Europe, local government revenues depend heavily on consumption taxes, sales taxes, or property taxes. Simply put, whenever residents spend money on goods or buy homes in a city, tax revenue stays local. As a result, Western local authorities have a natural incentive to improve community services, offer public welfare, and stimulate local spending—keeping people around so they spend money.

China is entirely different. China's core tax source is the Value-Added Tax (VAT), which accounts for nearly half of total tax revenue. More importantly, China’s VAT is collected at the production stage—meaning "whoever manufactures pays the tax; wherever the factory sits, the tax stays."

2. Doing the Math: Why Mayors Refuse to Subsidize Consumers

Let's run a thought experiment to see how this tax model distorts local government behavior:

Suppose the Shanghai municipal government decides to hand out 10 million RMB in car-buying subsidies to local residents. A resident uses the subsidy to buy a new energy vehicle (NEV) produced in a factory in Tianjin. What happens?

• Shanghai: Spent real cash subsidizing the consumer, but because the car assembly line is in Tianjin, Tianjin collects most of the VAT;
• Tianjin: Didn't spend a dime on subsidies, yet scored a massive chunk of VAT and boosted its local GDP just because the factory is located there.

As a Shanghai official, would you consider this a good deal? Obviously not. Under a production-based tax system, subsidizing consumption means using local tax dollars to subsidize another city's production.

Consequently, no local government in China has the incentive to spend money boosting local consumption. Instead, the most rational choice for a mayor is to pour every available resource straight into the production side!

3. Neijuan-Style Investment Attraction: How Overcapacity Was Manufactured

To grab this lucrative piece of production-side tax revenue, hundreds of Chinese cities have plunged into a frantic spiral of neijuan (hyper-competitive internal rat race) for investment attraction:

• Free land: As long as a factory sets up shop, industrial land is offered at near-zero rent;
• Utility subsidies: Local governments step in to build dedicated power lines and offer discounted electricity and water rates;
• Direct equity investments: Local government financing vehicles (LGFVs) even pump money directly into buying equipment and constructing plants for enterprises.

This mechanism acts like a massive "capacity amplifier." Every city wants to become the manufacturing hub for the region or the whole country. Even if an industry is already saturated, local governments continue subsidizing local firms to keep them alive, desperate to prevent their tax sources from falling into a rival city's hands.

The end result? More and more factories are built, generating huge excess capacity. Meanwhile, domestic consumers—lacking sufficient social safety nets and direct welfare transfers—simply cannot absorb all these products.

4. Going Global: From "Domestic Indigestion" to "Cheap Foreign Flooding"

When massive industrial capacity hits sluggish domestic demand, government-nurtured factories have only one survival tactic left: compete furiously overseas.

Factories must keep their assembly lines running because the moment production stops, local tax revenues and jobs disappear instantly. As a result, companies have no choice but to pour their products into global markets at rock-bottom prices. To foreign audiences, it looks like "Made in China squeezing out local industries with absurdly low prices," condemned as a deliberate "state strategy." But at the micro level, this is simply the inevitable release of excess capacity, forced outward by China's production-based tax incentives.

While cheap exports bring in massive trade surpluses, they fail to translate into wage growth or improved social welfare for Chinese citizens. It turns into a lose-lose-lose scenario: criticism abroad, exhaustion at home, and mountain-high local government debt.

Conclusion: The Key to Solving "Overcapacity" Lies in Tax Reform

Reducing the surge in Chinese manufacturing exports to simple "malicious dumping" neither helps resolve geopolitical trade friction nor gets to the root of the problem.

China's industrial overcapacity and sluggish domestic consumption are two sides of the same coin. The underlying driver is the severe distortion of local government incentives caused by production-based taxation. To genuinely ease trade tensions globally and revitalize domestic demand at home, China needs deep structural tax reform—specifically, shifting the point of taxation from production to consumption (letting tax revenues follow where people spend, not where goods are made).

Only when local governments can earn tax revenue by serving residents and making them feel secure enough to spend will they shift their fiscal resources from "building factories" to "investing in people." Only then will the ghost of "Chinese overcapacity" truly dissipate.