Local surtax reform has a relatively limited short-term impact on the macro tax burden and local fiscal resources. Its more significant effects lie in simplifying the tax and fee system, optimizing the tax and fee structure, increasing fiscal autonomy, and advancing the statutory basis of taxation. This marks new progress in China's tax statutory framework and tax system reform, and it is also an important reform measure for enhancing the stability and predictability of local fiscal revenue.

In recent years, as China's economy accelerates the transition between old and new growth drivers and the real estate sector continues to adjust, the macro tax burden has generally trended downward. At the same time, local fiscal revenue, especially comprehensive fiscal resources, has been significantly affected, 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 are matters that bear on the initiative of local governments, on the better implementation of proactive fiscal policy, and on the smooth operation of the economy. These have become focal issues of widespread concern that urgently need breakthroughs. The Third Plenum and Fourth Plenum made directional and guiding arrangements in this regard, calling for "increasing local autonomous fiscal resources," "regulating tax incentives," and "researching and exploring a tax system compatible with new business forms."

To implement the July 2024 Third Plenum's proposal to "research the merger of urban maintenance and construction tax, education surcharge, and local education surcharge into a local surtax," on August 28, 2026, the Ministry of Finance and the State Taxation Administration published the "Local Surtax Law of the People's Republic of China (Draft for Comment)" (hereinafter referred to as the "Draft for Comment"). This is a key measure for implementing important arrangements. It not only marks new progress in China's tax statutory framework and tax system reform, but is also an important reform measure for enhancing the stability of local fiscal revenue. Overall, the local surtax has a relatively limited short-term impact on the macro tax burden and local fiscal resources. Its more significant effects lie in simplifying the tax and fee system, optimizing the tax and fee structure, increasing fiscal autonomy, and advancing the statutory basis of taxation. To fundamentally resolve local fiscal problems, in addition to introducing the local surtax, it is also necessary to jointly implement measures such as regulating tax incentives, reforming the tax system (so that the tax system keeps pace with the development of the digital economy, the service economy, and the artificial intelligence economy), revitalizing local state-owned assets, shifting upward the authority over affairs and expenditure responsibilities, and optimizing the transfer payment system.

Three Characteristics of the Draft for Comment and Two Issues Needing Attention The content of this reform presents three characteristics: First, the tax (fee) system is basically 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 category, rather than introducing a new tax. This not only significantly simplifies tax and fee collection, but also formally converts the previous "two fees" into a "tax" form with a basic statutory basis for collection, enhancing the statutory nature 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, local governments are granted certain autonomous management authority, enhancing local fiscal autonomy. Before the Draft for Comment, the tax rate standards for urban maintenance and construction tax were as follows: for taxpayers located in urban districts, the applicable tax rate was 7%; for taxpayers located in counties and towns, the applicable tax rate was 5%; and for taxpayers located in other areas, the applicable tax rate was 1%. The education surcharge was levied at 3% of the actual value-added tax and consumption tax paid by units and individuals, and the local education surcharge was levied at 2% of the actual value-added tax and consumption tax 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 the region's economic and social development and the promotion of the construction of a unified national market. This is an important measure for enhancing local autonomous fiscal resources.

Third, attention is paid to alignment with the previous tax and fee collection system 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 local surtax for special industries and groups as well as in response to major emergencies, retaining a window for tax incentives. It clarifies the basic elements of collection and effectively connects with the previous collection and management system. Overall, because the local surtax mainly merges the original one tax and two fees and generally carries them over, it is more about regulating taxes, simplifying collection and management, and granting local governments more management authority. Its impact on the macro tax burden and the burden on micro entities is relatively limited. Of course, further clarification or assessment of two issues is needed before implementation: first, reasonably assessing the impact on the tax and fee burden of relevant taxpayers, especially micro entities currently enjoying relevant tax incentive policies; second, comprehensively considering the use of relevant tax and fee revenue. The original "one tax and two fees" were in theory earmarked for specific purposes, and in the future it will be necessary to comprehensively consider the impact of the merger on the original expenditure areas.

Resolving Local Fiscal Difficulties Requires Reform of the Fiscal and Tax System For local governments: in the short term, they should intensify efforts to revitalize assets. Asset revitalization depends on a series of institutional supports, such as asset inventory, repair of asset property rights defects, due diligence exemption for asset disposal, and incentive mechanisms for state-owned asset assessment. Asset revitalization without institutional support will degenerate into extensive asset disposal with a single method and unsustainable results. In the long term, local governments should promote the transformation of urban investment platforms and reshape the tax base, earnestly find distinctive industries that suit their own advantages according to local conditions, and create a favorable business environment rather than relying solely on subsidies and tax incentive lowlands to attract industry.

For the central government: in the short term, it is necessary to increase transfer payments to localities and raise the proportion of equalization transfer payments, enhancing both the scale and discretionary degree of transfer payments obtained by local governments. Continuously increasing transfer payments is not a long-term solution, but it is very necessary in the short term and will help local governments get through the critical stage of continued real estate adjustment, debt resolution pressure, and the transition between old and new growth drivers. In the medium and long term, it is necessary to stabilize the macro tax burden through fiscal and tax system reform, 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. Specifically, this can be achieved through the following reforms.

First, gradually stabilize the macro tax burden and reverse the trend of its continued decline. First, the implementation of proactive fiscal policy should shift from focusing on tax and fee reductions on the revenue side to mainly expanding expenditure on the expenditure side. New tax and fee reductions should be approached with extreme caution to avoid the generalization of tax incentives. Second, regulate tax incentives and clean up tax policies illegally introduced by local governments. For previous preferential policies that naturally expire, the general approach should be not to extend them, and genuinely needed ones should be studied separately. Tax incentives should take into account the industry life cycle and the economic cycle. As an industry life cycle moves from infancy to maturity, tax incentives should be gradually phased down to avoid encouraging "involutionary competition." Phased preferential policies introduced during periods of major internal and external shocks should not be solidified and sedimented, and should be promptly canceled once the relevant factors disappear. Third, optimize and adjust tax categories that have little impact on ordinary people but help promote common prosperity and green development. For example, promote the expansion of consumption tax to high-pollution, high-energy-consumption consumer goods and high-end services; strengthen tax collection and management on the overseas income and wealth of ultra-high-net-worth groups, and study inheritance tax and gift tax; moderately raise resource tax and environmental protection tax rates to reduce resource and energy waste and safeguard national energy security; promote equal rights and equal tax burdens for oil and electricity, and levy 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 wealth and income distribution become more polarized, making it necessary to study an "excess profit adjustment tax."

Second, promote fiscal and tax system reform, clarify the relationship between government and market, scientifically define government duties and scale, and constrain the continued expansion of local government scale. First, clarify the relationship between government and market and scientifically define government scale. It is necessary to deepen the reform of administrative and public institutions, strengthen performance management, shrink the government boundary, streamline administration and staffing, and effectively reduce the number of people supported by fiscal funds. Second, deepen the reform of the central-local fiscal system, reduce pressure on local governments, especially grassroots governments, and in particular help local governments avoid becoming governments of unlimited liability. Gradually shift upward the authority over affairs and expenditure responsibilities to the central government, reduce local government expenditure responsibilities and fiscal pressure, and gradually materialize vertical management and departmental substantiation of authority over affairs in areas such as public security, food and drug regulation, and old-age insurance. Third, promote price reform of public utilities to avoid the fiscal pressure caused by continued 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, ascertain the asset categories, quality, and cash flow conditions formed by long-term large-scale special bond investment, and as soon as possible sort out and clarify the 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. The debt budget is a budget that provides detailed planning for the scale, structure, and principal and interest repayment plans of government debt, and is an upgraded version of the current debt limit management. The 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 on relevant assets to avoid waste of assets and resources. Third, improve the assessment system and constraint system to strictly prevent new hidden debt. Improve the performance assessment system, reduce the weight of GDP (gross domestic product) growth assessment, and increase debt risk prevention and control indicators.

Fourth, deepen the reform of the local government investment and financing system, match corresponding funding sources according to the return characteristics and investment cycles of projects, and form a pattern in which government bonds, local general bonds, local special bonds, and urban investment bonds each perform their own duties. First, for purely public welfare projects, fiscal funds should be used to provide guarantees. Among them, national and cross-regional projects should be guaranteed by government bonds; projects with no returns for localities should be guaranteed by local general bonds; and projects with certain returns for localities should be guaranteed by local special bonds (given that qualified special bond projects are becoming fewer and fewer, the new scale of this part should be controlled in the long term). Second, urban investment enterprises should in principle no longer undertake the construction of purely public welfare projects, 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 government hidden debt from the source. For quasi-public welfare projects with certain operating income but relatively low returns in which urban investment enterprises participate, the participation mechanism should be improved, including clarifying the government contribution ratio and debt repayment responsibilities, and providing investment subsidies or operating subsidy funds.