Local surtax reform will have a relatively limited short-term impact on the macro tax burden and local fiscal capacity. Its main purpose is to simplify the tax-and-fee system, optimize the tax-and-fee structure, strengthen fiscal autonomy, and advance the principle of statutory taxation. This marks new progress in China's statutory taxation and tax system reform, and is also an important reform measure for enhancing the stability of local fiscal revenue. By Luo Zhiheng

In recent years, as China's economy accelerates the shift between old and new growth drivers and as real estate continues to adjust, the macro tax burden has generally trended downward. At the same time, local fiscal revenue, especially comprehensive fiscal capacity, has been hit markedly, and fiscal tight balance has become the norm. Against this backdrop, how to stabilize the macro tax burden and how to resolve the contradiction between local fiscal revenue and expenditure bears on the initiative of local governments, on the better implementation of a proactive fiscal policy, and on the smooth operation of the economy. It has become a focal issue for all parties and urgently needs a breakthrough.

The Third Plenum and the Fourth Plenum made directional and guiding arrangements in this regard, requiring "increasing local autonomous fiscal capacity," "regulating tax preferences," and "researching and exploring a tax system suited to new business forms." To implement the Third Plenum's July 2024 proposal to "study merging urban maintenance and construction tax, education surcharge, and local education surcharge into a local surtax," the Ministry of Finance and the State Taxation Administration published on August 28, 2026, the "Local Surtax Law of the People's Republic of China (Draft for Comment)" (hereinafter the "Draft for Comment"). This is a key move to implement important arrangements, marking not only new progress in China's statutory taxation and tax system reform, but also an important reform measure for enhancing the stability of local fiscal revenue. On the whole, in the short term the local surtax will have a relatively limited impact on the macro tax burden and local fiscal capacity; its main effects are simplifying the tax-and-fee system, optimizing the tax-and-fee structure, increasing fiscal autonomy, and advancing statutory taxation. To fundamentally solve local fiscal problems, in addition to launching the local surtax, it is also necessary to coordinate measures such as regulating tax preferences, reforming the tax system (so that it keeps pace with the development of the digital economy, the service economy, and the artificial intelligence economy), revitalizing local state-owned assets, moving upward authority over affairs and expenditure responsibilities, and optimizing the transfer payment system.

Three features of the Draft for Comment and two issues that need attention

This reform has three features. First, the tax (fee) system is largely carried over, and the overall tax burden remains stable. The local surtax merges the long-standing "one tax and two fees" — namely urban maintenance and construction tax (levied since 1985), education surcharge (levied since 1986), and local education surcharge (levied since 2010) — into a single tax, rather than introducing a new tax. This not only clearly simplifies tax and fee collection, but also formally converts the previous "two fees" into a "tax" form with a basic statutory basis for collection, strengthening the legality and stability of collection. In setting the tax rate, full consideration was given to factors such as tax system simplification, tax burden stability, and regional differences; a floating proportional tax rate is adopted, and the tax and fee burden remains basically stable. In 2025, the scale of urban maintenance and construction tax, education surcharge, and local education surcharge was 517 billion yuan, 238.2 billion yuan, and 158.2 billion yuan, respectively, totaling 913.4 billion yuan, equivalent to 5.2% of China's tax revenue and 4.2% of general public budget revenue.

Second, a certain degree of autonomous management authority is granted to localities, enhancing local fiscal autonomy. Before the Draft for Comment, the previous urban maintenance and construction tax rate standards were: 7% for taxpayers located in urban districts; 5% for taxpayers located in county towns and towns; and 1% for taxpayers located in other areas. The education surcharge was levied at 3% of the value-added tax and consumption tax actually paid by units and individuals, and the local education surcharge at 2% of the value-added tax and consumption tax actually paid by units and individuals. The Draft for Comment grants each province the right to determine its own applicable tax rate within the range of 11% to 13%, after comprehensively considering local economic and social development and the promotion of a unified national market, among other factors. This is an important measure for enhancing local autonomous fiscal capacity.

Third, attention is paid to connecting with previous tax and fee collection systems and relevant laws. For example, it provides that the State Council may, according to the needs of national economic and social development, reduce or exempt the local surtax for special industries and groups and in response to major emergencies, retaining a window for tax preferences. It clarifies the basic elements of collection and effectively connects with previous collection and administration systems.

On the whole, because the local surtax mainly merges the previous one tax and two fees and carries them over in general, it is more about regulating taxes, simplifying collection and administration, and granting localities more management authority, and its impact on the macro tax burden and the burden on micro entities is relatively limited. Of course, further clarification or assessment is needed on two issues before implementation. First, the impact on the tax and fee burden of relevant taxpayers should be reasonably assessed, especially the impact on micro entities currently enjoying relevant tax preference policies. Second, the use of related tax and fee revenue should be considered in a coordinated way. The original "one tax and two fees" were in theory earmarked for specific purposes, and in the future it will be necessary to consider in a coordinated way the impact of the merger on the original expenditure areas.

Solving local fiscal difficulties requires reforming the fiscal and tax system

For local governments, in the short term it is necessary to intensify asset revitalization. Revitalizing assets depends on a series of institutional supports, such as asset inventory, repair of asset property rights defects, due diligence and exemption for asset disposal, and incentives and assessment mechanisms for state-owned asset management. Without institutional support, asset revitalization will degenerate into extensive asset disposal that is single in method and unsustainable. In the long term, local governments should promote the transformation of urban investment platforms and reshape the tax base, effectively find distinctive industries suited to their own advantages according to local conditions, and create a favorable business environment rather than relying solely on subsidies and tax preference lowlands to attract industry.

For the central government, in the short term it is necessary to increase transfer payments to localities, raise the proportion of equalization transfer payments, and enhance the scale and discretionary degree of transfer payments received by local governments. Continuously increasing transfer payments is not a long-term solution, but in the short term it is very necessary and will help local governments get through the key stage of continued real estate adjustment, debt-resolution pressure, and the transformation of old and new growth drivers. In the medium and long term, it is necessary to stabilize the macro tax burden, improve the division of authority over affairs and expenditure responsibilities between the central and local governments, and reform the government investment and financing system and mechanisms through fiscal and tax system reform. Specifically, this can be achieved through the following reforms.

First, gradually stabilize the macro tax burden and reverse the trend of its continuous decline. First, the implementation of proactive fiscal policy should shift from focusing on tax and fee cuts on the revenue side to focusing on expanding expenditure on the expenditure side, and new tax and fee cuts should be approached with great caution to avoid the generalization of tax preferences. Second, regulate tax preferences and clean up tax policies illegally introduced by local governments. For earlier preferential policies that naturally expire, the approach should generally be not to extend them, and separate study should be conducted if they are truly needed. Tax preferences should take into account the industrial life cycle and the economic cycle. As an industry moves from the infant stage to the mature stage, tax preferences should be gradually phased out to avoid encouraging "involutionary competition." Temporary preferential policies introduced during major internal and external shocks should not be solidified and deposited, and relevant policies should be promptly canceled once the related factors disappear. Third, optimize and adjust taxes that have little impact on ordinary people but help promote common prosperity and green development. For example, promote the expansion of the consumption tax to high-pollution and high-energy-consumption consumer goods and high-end services; strengthen tax collection and administration on the overseas income and wealth of ultra-high-net-worth groups, and study inheritance tax and gift tax; promote a moderate increase in resource tax and environmental protection tax rates to reduce waste of resources and energy and safeguard national energy security; and promote equal rights and equal tax burdens for oil and electricity, levying corresponding taxes on road damage caused by new energy vehicles. Fourth, study digital asset taxes and excess profit adjustment taxes in the era of the digital economy and artificial intelligence. The AI era intensifies "strong supply and weak demand," and the distribution of wealth and income becomes more polarized, making it necessary to study an "excess profit adjustment tax."

Second, promote fiscal and tax system reform, clarify the relationship between the government and the market, scientifically define government responsibilities and scale, and constrain the continuous expansion of local government scale. First, clarify the relationship between the government and the market and scientifically define the scale of government. It is necessary to deepen the reform of administrative institutions, strengthen performance management, shrink the government boundary, streamline administration and personnel, and effectively reduce the number of people supported by fiscal funds. Second, deepen the reform of the central and local fiscal systems to reduce pressure on local governments, especially grassroots governments, and in particular help local governments avoid becoming governments of unlimited liability. Gradually move authority over affairs and expenditure responsibilities upward to the central government, reduce local government expenditure responsibilities and fiscal pressure, and gradually implement vertical management and departmental substantiation for affairs such as public security, food and drug regulation, and old-age insurance. Third, promote price reform for public utilities to avoid the fiscal pressure caused by continuous large-scale inefficient fiscal subsidies, and change hidden subsidies into explicit subsidies.

Third, explore the establishment of a debt and capital budget, strengthen local government debt management, and reduce local reliance on debt. First, as soon as possible, gain a clear understanding of the asset categories, quality, and cash flow generated by long-term large-scale special bond investment, and as soon as possible sort out and clarify assets belonging to different departments such as finance, state-owned assets, and government offices administration. Second, establish a debt and capital budget to clarify where debt is used, what assets are formed, and how it will be repaid, forming institutional constraints. A debt budget is a budget that plans in detail the scale, structure, and principal and interest repayment plans of government debt, and is an upgraded version of the current debt limit management. A capital budget is a budget prepared for fiscal expenditure activities such as government fixed asset investment that can form public fixed assets. In particular, assets formed by special bond debt have certain returns or potential returns, and it is necessary to actively increase the return rate of related assets to avoid waste of assets and resources. Third, improve the assessment system and constraint system, and strictly prevent new hidden debt. Improve the performance assessment system, reduce the weight of GDP (gross domestic product) growth assessment, and increase indicators for debt risk prevention and control.

Fourth, deepen the reform of the local government investment and financing system, match corresponding funding sources according to the return characteristics and investment cycle of projects, and form a pattern in which treasury bonds, local general bonds, local special bonds, and urban investment bonds each play their own role. First, for purely public welfare projects, fiscal funds should be used for support. Among them, national and cross-regional projects should be supported by treasury bonds, projects with no returns for localities should be supported by local general bonds, and projects with certain returns for localities should be supported by local special bonds (given that there are fewer and fewer qualified special bond projects, the new scale of this part should be controlled in the long term). Second, urban investment enterprises should in principle no longer undertake purely public welfare project construction, and should focus on participating in operating projects with certain business returns but insufficient willingness for social capital to participate, adopting market-oriented financing methods to reduce the formation of hidden government debt from the source. For quasi-public welfare projects with certain operating income but relatively low returns in which urban investment enterprises participate, participation mechanisms should be improved, including clarifying the government contribution ratio and debt repayment responsibility, and the methods of providing investment subsidies or operating subsidy funds.