End of the "Land Finance" Era: Lacking Main Taxes, How Can China's Local Governments "Invest in People"?

When observing China's current economic transition, foreign observers are often struck by an apparent paradox: on one hand, central policies repeatedly emphasize shifting the development focus toward "investing in people" (touzi yu ren)—expanding public services, upgrading social security, and boosting consumer spending; on the other hand, many local governments are pinching pennies just to maintain daily operations, leading to headlines about bus suspensions, arbitrary fines, or retroactive tax audits on businesses.

One can't help but ask: As tudi caizheng (土地财政, "land finance")—the revenue model that powered two decades of urban boom—reaches its end, how are local governments supposed to keep basic operations afloat, let alone find money to "invest in people"?

To understand China's current macroeconomic dilemma, one must look beyond high-level slogans and deconstruct the actual income-and-expenditure ledger of local governments.

1. The Past 20 Years: Local Governments Were "Super Investment Banks," Not "Service Providers"

To make sense of today's predicament, we must first understand the old playbook.

In Western political economy, a local government's primary duty is providing public goods (policing, roads, K-12 education), funded mainly through local property taxes or sales taxes. But in China over the last 20 years, the operational logic was completely different: local governments functioned less like public administrators and more like profit-maximizing "mega investment banks" or property developers.

By monopolizing the primary land market, local governments acquired industrial land at low (or zero) cost to attract corporate investments, while selling residential and commercial plots to real estate developers at premium prices. The massive revenues generated from land sales (known as tudi churangjin or land transfer fees), combined with bank financing secured through Local Government Financing Vehicles (LGFVs, or chengtou companies), became the ultimate engine for local development.

Under this model, local governments did not rely on direct corporate or personal income taxes to survive; they relied on asset appreciation. Acting as businesses, their incentive was to expand assets, maximize leverage, and chase GDP growth. Labor rights, social security contributions, and safety nets were often viewed as costs to be minimized to stay attractive to investors.

2. The Math Problem: A Fiscal Vacuum After Land Revenues Collapse

Today, this self-reinforcing financial machine has ground to a halt. As the real estate market cooled, local government revenues from land sales plummeted. But the core problem isn't just "less land revenue"—it's the complete absence of an alternative, primary local tax base.

In a typical tax system:

1. Property Tax: The ideal primary tax base for local governments. However, at a delicate time when household balance sheets are fragile and housing prices are striving to stabilize, introducing a property tax risks triggering panic selling, making it virtually unfeasible in the short term.
2. Local Sales/Consumption Tax: China's consumption tax is mostly levied at the production stage and flows straight to the central government, meaning local governments cannot directly share in the gains of a booming retail market like US states do.
3. Corporate Income Tax & VAT: Constrained by weak macro demand, these tax bases are growing slowly.

This has created a dangerous "fiscal vacuum": land revenues have collapsed, new tax bases haven't been established, and local governments are saddled with massive interest payments on debt accumulated over past years.

Currently, the central government uses "transfer payments" (zhuanyi zhifu) to reallocate central tax revenues to local authorities and "debt swaps" (zhaiwu zhihuan) to replace high-interest hidden debt with lower-yield public bonds. This keeps local governments afloat, securing the baseline for sanbao (三保: guaranteeing basic livelihoods, salaries, and operations). But this financial lifeline merely maintains vital signs—it is nowhere near enough to fund trillions of yuan needed for a massive pivot to "investing in people."

3. Institutional Distortion: When "Investing in People" Hits "Survival Anxiety"

Demanding local governments "transform into service-oriented governments" and "invest in people" without supporting fiscal reforms creates perverse incentives.

Starved of stable tax revenues and facing rigid spending and debt pressure, local governments naturally resort to irrational self-preservation tactics:

• Grabbing non-tax revenue: Plugging budget deficits by hiking administrative fees and ramping up traffic and environmental fines (famou shouru or fine revenue).
• Squeezing local businesses: Conducting retroactive tax audits spanning back decades or launching aggressive cross-jurisdictional enforcement, which severely damages the local business climate.
• Shifting public service costs: Pushing public institutions like hospitals and schools toward commercialization, indirectly raising the healthcare and education burden on ordinary citizens.

These distorted behaviors run directly counter to the goals of "investing in people" and "reducing precautionary savings." As households worry about shrinking public services and businesses fear a deteriorating operating environment, consumers double down on cutting spending and boosting savings, worsening deflationary pressures across the economy.

4. The Way Forward: Rebuilding the "Physical Engine" of Fiscal Relations

Simply preaching a shift toward a "service-oriented government" is a zero-cost slogan. To make "investing in people" a reality, China must execute a deep structural overhaul of central-local fiscal relations. This isn't just about local officials "changing their mindsets"—it requires institutional engineering:

1. Centralizing spending responsibilities: Since local governments are broke, cross-regional welfare expenditures like pensions, healthcare, and basic education must be absorbed directly by the central budget to relieve local burdens.
2. Reallocating tax shares: Move the point of consumption tax collection to the point of sale and allocate it to local governments, encouraging them to shift from "chasing factories" to "improving the consumer environment and attracting shoppers."
3. Tolerating a higher central budget deficit: As local balance sheets shrink, the central government—possessing the highest creditworthiness—should issue debt to inject capital directly to households (e.g., child-rearing subsidies, enhanced safety nets), serving as the economy's "consumer of last resort."

Conclusion

To read the next chapter of China's economy, don't focus on how many trendy buzzwords about "livelihoods" or "tech innovation" local officials drop. Look at how the fiscal abacus between Beijing and local governments is being recalculated.

Without fiscal restructuring, local governments remain trapped like cornered beasts bound by debt, incapable of organically morphing into warm, "service-oriented governments." Only by filling the tax vacuum and redefining central-local finances can China achieve a true historic leap from "land-driven" to "people-driven" growth.