China’s tax conundrum: the bifurcation of GDP growth and tax revenues

When the world’s second-largest economy struggles to collect taxes despite reporting steady growth, it signals more than a domestic fiscal problem—it hints at a structural shift in the global economic order. While China’s economy reportedly grew at a rate of 5.3% in the first six months of 2025, national tax revenue shrank by 1.2%, and if the country cannot sustain the fiscal base to support its economy, the ripple effects will be felt from commodity-exporting nations that rely on Chinese demand, to multinational companies depending on Chinese consumers and even to global capital markets sensitive to Beijing’s spending power.

The sizeable divergence has been increasingly apparent since 2018 and marks a departure from a historical pattern in which China’s GDP and tax intake increased hand-in-hand. Tax income in fact grew faster than the economy between 2008-2014, but in the decade since then, it has done so only in 2017, 2018, 2021 and 2023. Tax revenues shrank year-on-year in 2020, 2022 and again last year, when they fell by 3.4% to ¥17.5 trillion ($2.5 trillion)—a trend that extended into the first half (H1) of this year.

Getting a true read on China’s growth has always been tricky, with longstanding skepticism about the reliability of headline GDP data. Now, the decline in tax receipts—which economists have generally treated as a dependable shadow of GDP—adds to the puzzle that is the modern Chinese economy and raises questions about the level of fiscal strain it is under.

“There’s a big divergence between the very stable picture projected by the government through the 5% GDP growth rate versus many other metrics that have underwhelmed, including tax,” said Gary Ng, senior economist for Asia-Pacific at Natixis Corporate and Investment Banking. “While China’s economy is not collapsing, the virtuous cycle of growth, income and profits has weakened, making it harder for the government to collect taxes.”

Falling tax revenue

China’s tax system is a multifaceted structure comprising a variety of taxes levied by central and local governments. The single largest source of tax revenue is the value-added tax (VAT) introduced in 2016 to replace the business tax. VAT is collected by the government on practically every transaction, from rent to purchases of refrigerators, and revenues rose by 2.8% year-on-year in H1 2025 to ¥3.64 trillion, or 39% of total tax receipts for the six months.

Next is corporate income tax, which fell by 1.9% to ¥2.49 trillion in H1, followed by 1.7% growth in consumption tax to ¥898 billion. Individual income tax expanded by 8% to ¥794.5 billion. The four taxes together comprised 84% of China’s tax take in H1 of this year.

The government also collects a number of smaller taxes, including stamp duty on real estate and stock market transactions, resource taxes and taxes on the purchase of vehicles and tobacco.

Central authorities collected 36.2% of China’s tax revenue in 2023, down from 39.1% in 2020, while the share attributed to governments at the provincial level and below also dipped from 36.7% to 32.2% over the same period. Social security contributions, primarily collected by local governments, jumped from 24.2% to 31.5%. Collections aside, China’s system does not give local governments any independent taxing authority.

Overall, China’s tax revenue in H1 2025 stood at just 14% of GDP, a drop from 18% a decade ago, according to calculations based on official figures. But this figure, unlike in other countries, does not count social security contributions as tax revenue. China’s total social insurance contributions stood at ¥4.53 trillion in H1—factoring in this raises the tax-to-GDP ratio for H1 to 21%, compared with 23% for 2024. By comparison, the average tax-to-GDP ratio in the OECD in 2023 was 33.9%, with the US at 25.2%.

“The kind of social security contribution that China has would count as tax revenue in most countries around the world,” said Cui Wei, a law professor at the University of British Columbia and author of The Administrative Foundations of the Chinese Fiscal State. “The Chinese government itself refers to it as non-tax revenue.”

However, when the tax-to-GDP ratio is calculated, it is clear that China’s has trended down for more than a decade, in part due to the implementation of substantial tax cuts since leader Xi Jinping came to power in late 2012. What this means is open for discussion, but the reality is the growing gap between tax revenues and the growing GDP number.

“The Chinese government is now under much greater budgetary constraint than it was 10-15 years ago, and the long-term consequences of this depend on your view of the government approach,” said Cui, who served as senior tax counsel for China’s largest sovereign wealth fund. “If you think you should ‘starve the beast’—limiting government spending by cutting taxes—maybe that is what is happening. If you think the government should be doing much more redistribution to help poorer regions and people, that’s still happening but has stalled to some extent.”

The divergence raises questions about the quality and structure of growth, according to Joe Peissel, an economic analyst at Trivium China. “If headline GDP is expanding while tax revenues fall, it could suggest growth is increasingly coming from sectors or entities that are lightly taxed—such as state-linked investment, informal activity or segments receiving heavy tax breaks. It also reflects China’s broader pivot away from high-tax sectors like real estate toward lower-margin industries like advanced manufacturing or services.”

At the same time, Peissel believes the shrinking ratio is less important than what it implies about China’s financial health: “The drop in the tax-to-GDP ratio is certainly notable, but not necessarily alarming on its own. What matters more is whether spending obligations are being met, and whether the fiscal gap is growing in unsustainable ways.”

A taxing problem

Explanations about why China is taking in less tax despite steady reported GDP growth include deflationary pressure, tax breaks and industrial shifts. Deflation, a broad decline in prices, has been persistent, with clear and significant pressure visible at the producer level, according to the Ministry of Finance. The Consumer Price Index has been steady with the occasional dip into negative territory, but the Producer Price Index—which measures the cost of goods as they leave the factory—has fallen year-on-year every month since October 2022.

“The deflation dynamics around the macroeconomy basically mean that China is losing price momentum, with the reduction in the value of goods and services impacting the tax base,” said Ng. This has been particularly felt in VAT, the rate of which has already been slashed over the past seven years—in 2018, the top rate was reduced from 17% to 16%, and again in 2019 to the present 13%.

“This decision is hard to justify in terms of tax design,” adds Cui.

In 2018, the government also introduced VAT refunds for certain strategic industries and export products, which were then expanded in 2022 in a bid to help businesses with cash flow. While this has reduced tax coming into state coffers, Cui said this is a short-term phenomenon and the messaging of this policy has been muddled.

“In 2022, towards the end of the pandemic, there were lots of calls for tax cuts,” says Cui. “The government said it would rebate VAT revenue faster and presented it as a large tax cut, but it was in fact just a deferral. VAT will still be paid, just later.”

China’s shift away from traditional sectors that were once big tax contributors, such as real estate and mining, has understandably weighed on tax take as well. “Tax collection has failed to keep up with economic growth mainly due to a decline in revenue from the sale of land and taxes from property,” says Andrew Collier, a senior fellow at Harvard Kennedy School who is working on a book about the collapse of the Chinese housing market. “Taxation from business taxes has been relatively flat, but it’s the reliance on one-off revenue from the property market that has impacted China’s fiscal position.”

China is not the first major economy to experience a disconnect between headline growth and government revenue. Japan in the 1990s faced a similar tax shortfall during its “lost decade,” and in the US, federal receipts dipped relative to GDP in the early 2000s following large tax cuts and sectoral shifts. What makes China’s case unique is the combination of persistent deflation, systemic dependence on property-related revenues and the opacity of GDP data itself.

The overall effect of these factors is belt-tightening to some extent across central and local government due to China’s eroded fiscal capacity, according to Ng. The small tax take has dampened the state’s financial firepower in some areas—a tangible example at the national level is that the basic pension for the country’s 150 million pensioners will rise by an average of just 2% this year, the lowest annual increase on record and far below inflation in essential goods like food and healthcare.

“This is one of the approaches that the central government has resorted to in order to control expansion of expenditure,” says Ng, who also noted that reduced fiscal revenues at the local level have forced Beijing to shoulder some of the burden that lower-level governments would otherwise have carried in the past for building infrastructure or certain projects.

Local authorities have been left in dire financial straits by the years-long property bust and subsequent impact on land and housing sales that were previously a big revenue generator. “Since then, the local governments have been running increasingly higher deficits in order to pay for basic social services and government salaries,” says Collier.

“The fiscal pressure on them is huge,” agrees Ng. “They are in survival mode and just trying to break even.” The strain on local finances has been underlined by reports of cash-strapped local authorities chasing companies for taxes dating as far back as the 1990s. In one case, a Shanghai-listed food and drinks manufacturer said it had received an ¥85 million tax bill covering 1994-2009.

Similarly, reports from provinces such as Guizhou and Heilongjiang describe local governments delaying salary payments for civil servants and cutting back on infrastructure maintenance. “This form of austerity undermines consumer confidence and economic activity,” says Peissel.

“Incidents like these reflect the severe revenue pressure that the local governments are facing. They don’t really have any other choice but to resort to these means to get money,” says Ng. And while central authorities have stepped in to try to ease local governments’ financial constraints, experts argue this is not a long-term solution and another round of structural fiscal reforms will be needed eventually to address mounting issues.

Show me the money

Thoroughgoing reform of the local government financing system would appear to be warranted, but Beijing has so far shown little appetite for making the choice. The tax system was last reformed in 1994 by Premier Zhu Rongji, moving significant income from the provinces to the central government but creating a shortfall in taxation for local governments.

“They filled that hole in revenue by monetizing the sale of land, a very profitable approach until the property bubble collapsed in 2021,” says Collier.

Trying to plug the fiscal gap through a new system will be difficult due to China’s structural economic problems, according to Collier. He noted that the property market in the future will be substantially lower than it is now, while the global market for China’s exports—accounting for one-third of GDP growth—will become increasingly difficult due to trade tensions.

The ideal solution would be to revive nominal GDP growth, which decelerated from 4.6% in 2023 to 4.2% last year—the slowest on record outside of the pandemic years. “Beijing needs to get the economic machine running again to generate inflation. The reason is that debt is usually digested by nominal growth. When nominal GDP grows faster than debt, then you naturally have a lower debt-to-GDP ratio,” said Ng.

New taxes, including a long-mooted property tax on owner-occupied housing, are not likely forthcoming, either. “Most of us who have been analyzing Chinese public finance can’t believe that we’re still having the same conversation about the property tax that we had 20 years ago,” said Cui, who points a finger at vested interests for distorting the issue.

He also disagrees with the common refrain that a property tax on residences would be very difficult to collect. “China could implement the same property tax that is in the US, Canada and a majority of countries worldwide; it is not a technical challenge.”

Revenue reset required

The Chinese economy is already facing myriad challenges, so the last thing that the government needs is a reduction in fiscal headroom caused by shrinking tax receipts. The issue underscores how China needs to increase its capacity to extract revenue from the economy, but the required changes to the fiscal and tax systems are complicated. Until Beijing bites the bullet for a revenue reset, more pain will lie ahead.

“There will be major cutbacks in social services, particularly for the less well-off provinces inland,” said Collier. “Eventually, China will have to tax businesses and property in a more regulated manner, but it will be a very difficult transition.”