Chapter 7. Municipal finance and property taxation in China

Zhi Liu
Lincoln Institute of Land Policy and Peking University – Lincoln Institute Center for Urban Development and Land Policy

The author is grateful for the assistance of Vivian Wei Liu, who prepared the data for Figure 7.1 and for helpful comments from Andrew Reschovsky on an earlier version of the chapter.

Over the last few decades, the People’s Republic of China (hereafter “China”) has experienced unprecedented, rapid urbanisation. Taking advantage of the Land Administration Law that gave the state monopoly power to convert rural land for urban use, the municipal governments around the country have relied heavily on the revenues from public land leasing to finance urban development. This land-based finance instrument has helped China develop and modernise cities in a short period of time, but it is also running out of steam due to the scarcity of land and to the recent Amendment of the Land Administration Law that permits villages to supply rural land for urban development without going through land expropriation by local governments.

Today, 60% of China’s population lives in urban areas, and rapid urbanisation is expected to continue. The central government has also called for a transition from a development phase that emphasised gross domestic product (GDP) to a new phase of high-quality development. Municipal governments will be at the forefront to provide high-quality public services to meet the increasingly diversified needs of the majority of Chinese citizens who live in cities. Sound and sustainable municipal finance will be important for the future of urbanisation.

This chapter first describes how the current municipal finance system functions within China’s inter-governmental fiscal framework. In particular, the chapter highlights the uniqueness of China’s governance structure, its national fiscal system, the role of public land leasing in financing rapid urbanisation and the challenges of municipal finance that have resulted from the decline of land revenues and will be further impacted by the amendment. In this context, the chapter highlights the potential applications and hurdles of various municipal finance instruments, including property taxation, land value capture, public-private partnerships, and the municipal bond market, which could prove essential elements of the future municipal finance system in China. This chapter will mainly focus on the revenues of municipal governments. Expenditure assignments are also important but are beyond the scope of this chapter.

China’s administration system includes five levels of government, namely central, provincial, prefecture, district/county, and village/township. Broadly, the term “local government” (di fang zheng fu) refers to any level of government under the central level. However, the central-local relationship in the central government documents often refers specifically to the relationship between the central and provincial-level governments, not the sub-provincial governments.1

Any government body at each level, except the level of village/township, is a fiscal unit with specified revenue and expenditure assignments, as well as its own budget. The village/township governments have their own budgets, but all their revenues are transferred from higher-level governments. All governments at each level are all-purpose governments. They are responsible not only for public services but also for economic development and social affairs within their administrative areas.

There are no special-purpose governments, such as school districts, that provide a single or specialised public service to an administrative area. Nor are there governmental bodies that involve two or more administrative areas, such as metropolitan service districts in the United States. If a metropolitan area or a megacity region grows across the boundaries of two or more administrative areas (say, prefecture-level municipalities), the management and co-ordination of cross-jurisdiction matters will be taken up by the higher-level government (such as the provincial government).

China is a unitary state. In terms of budget management, government revenues are allocated among four separate budgets: general public budgetary revenues (comprising tax revenues and non-tax revenues), revenues from various government-managed funds (such as land concession revenues, railway construction funds, local education surcharge, etc.), operating revenues from state-owned enterprises, and revenues from social insurance funds. Table 7.1 shows the four sources of government revenues in 2018. It is worth noting that tax revenues account for only half of total government revenues, and the rest is from other sources of government revenues.

The OECD classifies taxes by the base of the tax, including income and profits, compulsory social security contributions paid to the general government (which are treated as taxes), payroll and workforce, property, goods and services, and other. Using this tax revenue classification, the OECD calculates the tax-to-GDP ratio for its member countries (OECD, 2018[2]). The average tax-to-GDP ratio for all OECD countries in 2017 was 34.2%, with the highest at 46% (Denmark and France) and the lowest at 16% (Mexico).

The total amount of government revenue in China shown in Table 7.1 is not readily comparable to the OECD tax revenue statistics. The government revenues from government-managed funds in China include, among other things, the gross revenues from public land leasing (i.e. land concession revenues), from which the expenditures for land acquisition and resettlement should be excluded in order to make the land concession revenues comparable with the OECD tax definition. The Peking University-Lincoln Institute Center for Urban Development and Land Policy (PLC) devised a method to calculate the share of “net” government revenues over GDP that is comparable to the OECD tax-to-GDP ratio.2 This ratio is referred to as the “general tax burden” (guang yi hong guan shui fu).

Figure 7.1 shows the changes in the general tax burden from 2009 to 2017. Since the tax system reform in 1994 that introduced the tax-sharing system, China has made significant efforts to increase the share of government revenues over GDP. The general tax burden peaked in 2010, reaching 33.85% of GDP. Then it declined in 2011 and 2012, increased slightly again in 2013 and 2014 before falling to a level of slightly above 30%. The declines in recent years are the result of government-enacted tax cuts.

China’s general tax burden is at the lower range of the tax-to-GDP ratio for OECD countries. However, the general tax burden in China should not be considered as low, given the fact that China is still an upper-middle-income country.

The current system of taxation in China, which was adopted in 1994, is known as a tax-sharing system. There are three categories of taxes: central, local, and shared. Central taxes are collected and fully retained by the central government. Local taxes are collected and fully retained by local governments.3 Shared taxes are collected by the central government and shared in a pre-determined proportion with the local (provincial) government where the shared tax revenues are generated. The most important feature of this system is that the central government determines the types and rates of all taxes. Practically speaking, local governments have little independent taxing power, or tax autonomy, except for setting the tax rates for several small local taxes within a range determined by the central government. Table 7.2 lists the taxes under the three categories. Table 7.3 shows the tax revenues by selected years between 1995 and 2018. It is worth noting that the share of local tax revenues has been consistently less than 50% of the total tax revenues.

In contrast, general public budgetary expenditures are highly decentralised. Since the establishment of the tax-sharing system in 1994, the share of general public budgetary expenditures by the local governments has increased steadily from 70% in 1995 to about 85% over the past eight years. In 2018, the total amount of general public budgetary expenditures was CNY 22.09 trillion, of which local governments spent CNY 18.82 trillion or 85.2%, while the central government spent CNY 3.27 trillion (or 14.8%), and transferred CNY 6.97 trillion to the provincial governments.

The central-to-provincial transfer system is highly complex, and it closes the gap between the relatively centralised revenues and the highly decentralised public expenditures. There are two types of central-to-provincial transfers: general-purpose transfers and earmarked transfers. In 2018, the general-purpose transfers accounted for 62.8% of the total transfers, while the earmarked transfers accounted for 38.2%. The purpose of the transfers is to equalise the basic public services across China, but the amount to each targeted province is not formula-based; it is more the result of central government discretion and negotiation with each provincial government.

Compared to the central-provincial fiscal framework, the inter-governmental fiscal framework at the subnational level is much more complex. As mentioned above, there are four levels of subnational governments (province, prefecture, county, and village/township). Significant variations exist among the provinces in terms of population, incomes, economic structure, level of urbanisation, as well as fiscal capacity. There are several tax-sharing arrangements between the provincial and prefecture levels. Most provinces adopt a fixed share for the type of local taxes with large and stable revenues between the provincial and prefecture governments, and assign the revenues of the small local taxes to the prefecture governments. Some provincial governments also take all tax revenues generated from the pivotal industries with provincial significance. In a few provinces (Zhejiang, Fujian, and Jiangsu), a quota is set for the total tax revenues generated from each of the prefectures; the quota amount is retained by the prefecture, and the excess amount above the quota is shared with the provincial government at an agreed proportion (Zhong, 2017[4]).

The expenditure assignments are essentially similar among the provincial, prefecture and county governments. This pattern is often criticised as “one size fits all” that ignores the comparative advantages of different levels of government in carrying out a certain expenditure responsibility. Because of that, there is a long recognised tendency that the higher-level government often presses the lower-level government to carry out the mandates that the former is not able to fully fund and implement. As a result, the latter, which has less financial resources and implementation capacity, has to carry a heavier burden of expenditure responsibilities.

This pattern of behaviour is made possible partly by the highly centralised political system. The top leader of a local government (i.e. the party secretary) is directly appointed by the higher-level party committee. For example, the central party committee appoints the provincial party secretary, the provincial party committee appoints the prefecture party secretary, and so on. This centralised political system is designed to ensure that the central policy and directives are implemented by the lower-level governments. To some extent, it is compatible with the tax-sharing system in which the central government maintains almost all taxing powers, and the local governments are given little taxing power.

There are also inter-governmental transfers between the provincial and prefecture-level governments. But this is perhaps the least known area of local public finance in China. There are essentially no centrally collected and published data on local government transfers. These data are available from provincial finance departments in some provinces. It is highly unlikely that the provincial-prefecture transfers are formula-based.

China’s urbanisation has been rapid since 1978, the year when the economic reform started. Between 1978 and 2018, the total population grew from 963 million to 1.4 billion, and the share of the urban population grew from 18% to 60%. Today, over 831 million of China’s citizens live in cities. The number is expected to reach over 1.13 billion (or 75% of the total population) by 2050. The physical expansion and development of cities have been visibly dramatic over the last two decades. Most cities, large and small, have expanded in population and land area by several times. A number of large cities, megacities and urban regions (or cluster cities) have emerged, and serve as the major centres of the nation’s economic activities. The development of three top urban regions (or city clusters), namely the Beijing-Tianjin-Hebei Region, the Yangtze River Delta Region centred on Shanghai and Hangzhou, and the Greater Bay Area of Guangdong-Hong Kong-Macau, is expected to drive China’s economy for the next few decades.

Administratively, a municipality (shi) in China is not exactly a city. It is an administrative area comprising both urban and rural areas. There is no government created specifically for an urbanised area. Usually, a municipality contains a central city built-up area and the surrounding rural districts or rural counties. A large municipality may contain several urban districts, one or two county-level cities, and several rural counties. This spatial arrangement allows sufficient geographical space for the municipalities to expand their urbanised areas. It also complicates municipal financial management, however. A prefecture-level municipality has two levels of fiscal arrangements: the prefecture-level government itself and the county-level governments, each having its own revenue and expenditure assignments. In a few provinces, the provincial governments establish the direct fiscal relationship with the rural county governments within a prefecture, leaving the prefecture-level government to manage its own finance over the central city areas.

Currently, China has 661 municipalities, with varying administrative ranks. Four municipalities are at the rank of provincial level; they are Beijing, Shanghai, Tianjin and Chongqing, also known as the centrally administered municipalities (zhi xia shi). There are 283 municipalities at the prefecture level (di ji shi) and 374 at the county level (xian ji shi). In addition, there are 1 636 county towns (xian cheng) that serve as the administrative seat of a county, and about 20 000 administratively designated townships (jian zhi zhen), mostly market towns serving the rural areas. Some of the county towns and townships are large, with populations over 100 000.

In the local tax system, there are five taxes that are related to real estate properties: urban and township land use tax, arable land occupancy tax, land appreciation tax, real estate tax, and deed tax. As the statistics in Table 7.4 show, in recent years the total revenues from these five taxes account for about 22-24% of the local tax revenues and about 2% of the national GDP. As discussed below, these five property-based taxes do not include a tax on the ownership of private residential properties (also known as property tax).

The urban and township land use tax is imposed annually on urban land in use. An organisation or individual using land in cities, county towns, administrative towns, and industrial and mining districts must pay the urban land use tax. The annual tax rates on each square metre of land used are: 1) CNY 1.5-30 in big cities (with populations over 1 million); 2) CNY 1.2-24 in medium-sized cities (with populations between 0.5-1 million); 3) CNY 0.9-18 in small cities (with population under 0.5 million); and 4) CNY 0.6-12 in county towns, administrative towns, and industrial and mining districts.

The farmland occupancy tax is a one-time tax imposed on entities and individuals who use arable land to build houses or for other non-agricultural construction purposes, based on the occupied area of farmland. Differentiated tax rates are adopted for different locations. Differentiated tax rates are adopted for different localities (mainly at the county level), ranging from 5 yuan per square meter to 50 yuan per square meter. Higher tax rates are adopted in localities with smaller area of farmland per capita.

The land appreciation tax is a one-time tax levied on the incremental value received by the entities and individuals who transfer the right to use state-owned land, above-ground structures and their attached facilities and attain income from such transfer. There are four levels of progressive rates (30%, 40%, 50%, and 60%).

According to the tax code, the real estate tax is imposed annually on owners of houses within cities, county towns, administrative towns, and industrial and mining districts. The real estate tax for self-occupied houses is calculated at a tax rate of 1.2% on 70-90% of the original value of the property. The real estate tax for rented houses is calculated based on rental income, and the applicable tax rate is 12%. Rental of personally owned residential houses is taxed at 4% of rental income; rental of residential houses by enterprises and public institutions, social groups and other entities is taxed at a preferential rate of 4%. So far, this tax is only implemented on houses for commercial use, not on private residential houses.

The deed tax is a one-time tax imposed on the transferee (entities and individuals) of land and houses within China for the market price for the transferred right to use the land or the right of ownership of the house, or the price margin resulting from the exchange of land use rights and house ownership. The tax rates are 3-5% of the purchase price of the house. The purchase of a housing unit under 90 square metres by individuals or households, for whom this is the only housing unit, is taxed at a preferential rate of 1%. The purchase of a housing unit over 90 square metres by a household, which is the only housing unit of the household, is taxed at half of the applicable tax rate.

As part of the new round of the tax system reform, the government plans to implement a property tax (i.e. a tax on the ownership of private residential properties), and a national property tax law is being drafted. This has been a major topic of public debate. If the property tax is introduced, there will be a need to restructure the five taxes related to land and housing properties. This topic is discussed later in this chapter.

As discussed earlier, land concession revenues constitute a significant source of government revenues. To a great extent, the rapid urban development over the last two decades was attributable to the ability of the municipal governments to mobilise financial resources. The performance of municipal finance was shaped by the tax-sharing system and the legal framework for land management that gave the local governments monopoly power to provide land for urban development. According to the Constitution, urban land is owned by the state, and rural land by the village collectives. The Land Administration Law (before the recent amendment) gave the state the power to control and regulate land use, and monopoly power to convert rural land into urban land through land expropriation. The law also allowed the state to sell the urban land use rights, through market competition, to real estate developers for commercial and residential development. Therefore, to supply land for urban expansion, a municipal government would acquire land from rural areas, service the land with basic infrastructure, and sell the land use rights to real estate developers, often through a bidding process for commercial and residential development. According to government regulation, the compensation to the villages and villagers for rural land taken was set at the agricultural production value (or the value of land in its original use). As rapid urbanisation created significant demand for urban commercial and residential development, real estate developers bid very high prices for the land use rights, often significantly above the total costs of land acquisition, resettlement and basic infrastructure. Under these circumstances, the municipal government would profit handsomely from such a public land leasing operation. The profits would then be used to invest in the urban infrastructure needed to support urban development.

The land concession revenues, which accounted for nearly 20% of the total government revenues and 70-80% of total revenues from government-managed funds, are kept almost 100% as local government revenues, which are then used mainly for capital expenditures.. Figure 7.2 shows the size of the land concession revenues as compared to the size of local general budgetary revenues. In most years since 2001, the land concession revenues were at least as high as 30% of the local general budgetary revenues; in some years, the ratio reached over 60%.

However, a significant amount of the land concession revenues is spent on land acquisition and resettlement related to the public land leasing operations. In fact, the share of land acquisition and resettlement costs over total land concession revenues has steadily increased from about 45% in 2009 to 60% in 2015 (Liu and Xiong, 2018[5]). The share stood at 70% in 2017.

Land is also used as collateral for the municipal government to borrow from commercial banks, and loans are often backed by future land concession revenues. For years until its amendment in 2014, the Budget Law did not allow local governments to borrow directly from commercial banks or raise funds directly from capital markets. Facing the constraint, municipal governments created municipal government-owned local government finance vehicles (LGFV) – also known as urban development investment corporations – to borrow, often using land as collateral.

The borrowing through LGFV has caused a major local government debt problem. A 2013 State Audit Report revealed a total of CNY 17 trillion in outstanding local debt, an amount equivalent to 28.6% of the national GDP in 2013. Over the last few years, efforts were made to reduce the share of outstanding local debt over the national GDP. The central government imposed a debt ceiling on local government borrowing and pledged that there would be no bailouts. Moreover, the central government permitted a small number of local governments to issue bonds in order to ease their repayment pressures. These measures appear to have been successful in getting local debt under control. The State Audit Office reported that the local government outstanding debt stood at CNY 15 trillion or 20.2% of the national GDP by the end of 2016, and the Ministry of Finance reported that the amount was CNY 18.4 trillion or 20.4% of the national GDP at the end of 2018.

Over the last few years, a few economic and policy changes have occurred that will have a lasting impact on municipal finance. First, China’s economy has entered a new growth stage known as the “New Normal” since 2014. National GDP growth no longer registers a rate close to the 10% per year as before. Instead, the rate has dropped to under 7% a year. Demand for land slows accordingly for most cities except the most economically viable cities at the top of the urban hierarchy, such as Beijing, Shanghai, Guangzhou, Shenzhen, and Hangzhou. With a weakened land market, many municipal governments are seriously concerned about the sustainability of land-based finance in the near future. On the other hand, the compensation for rural land taking has also risen in recent years as farmers continue to press for higher compensation. This narrows the net revenues from land concessions.

Very recently, in August 2019, the National People’s Congress passed an amendment to the Land Administration Law. The amendment essentially removes the monopoly power of the state to covert rural land for urban development; instead, village collectives are permitted to lease their rural land for urban development as long as new land use conforms with spatial planning. When the amendment takes effect in January 2020, it is expected that the municipal governments will lose much of the land concession revenues. One piece of good news is that the central government recently decided to assign the excise tax revenues (CNY 1.1 trillion in 2018) to the local governments. Nevertheless, municipal governments face a significant challenge: What alternative, stable source of municipal revenues for urban development will there be? To answer this question, the current round of fiscal policy reform set to greatly affect municipal finance provides context.

The current round of fiscal policy reform started after the Third Plenary Session of the 18th National Congress of the Communist Party of China, which was held in November 2013. The principal objective of the reform is to optimise the tax structure while maintaining the level of overall tax burden on the economy. It is also considered a key measure under the government’s “supply-side” reform initiative that aims to cut the high tax and non-tax burdens on the real economy. It requires an increase in direct tax revenues and a reduction in indirect tax revenues.

China’s taxation system is characterised by the dominance of indirect taxes. By definition, an indirect tax is a tax that is paid to the government by a firm or entity in the supply chain but is passed on to the consumers as part of the price of a good or service. A direct tax is a tax paid directly by a person or a firm. In China’s taxation system, direct taxes include corporate income tax, individual income tax, vehicle purchase tax, vessel tax, deed tax, and real estate tax. Calculated from the tax revenue data published by the Ministry of Finance, direct tax revenues accounted for 40% of total tax revenues in 2018. In comparison, direct tax revenues usually account for over 50% of total tax revenues in OECD countries.

As there is still no property tax on the ownership of private residential properties, the share of tax revenues from individuals (instead of firms) is small in China. As the data in Table 7.5 show, individual income tax revenues accounted for 8.9% of total tax revenues (not including social security contributions) in 2018. In comparison, on average, 33.1% of total tax revenues (excluding social security contributions) came from individual taxpayers in OECD countries in 2016.4

The dominance of indirect taxes in the tax-sharing system is partly a legacy of the planned economy where the government collected “profits” from state-owned enterprises as the main source of fiscal revenues. When the tax-sharing system was established in 1994, China was still a low-income country. The system only taxed the personal incomes of foreigners and Chinese individuals with very high incomes, and excluded the majority of the people as a source for taxation. In 2011, the central government raised the threshold of individual income tax from CNY 2 000 per month to CNY 3 500 per month. The decision was highly popular, but it substantially limited the number of individual income taxpayers to less than 50 million people, or less than 4% of the total population. In 2018, the central government further raised the threshold to CNY 5 000 per month. Under the taxation system dominated by indirect taxes, most Chinese citizens are not used to paying direct taxes. This explains a strong social tendency to resist the introduction of broadly based direct taxes, such as property tax on the ownership of private residential properties.

Over the past five years, the reduction of indirect tax revenues has been achieved through the conversion of business tax to value-added tax, both of which are indirect taxes. The reduced amount of indirect tax revenues amounted to about CNY 1 trillion a year (Gao, 2017[6]). This revenue reduction is to be made up of other taxes if the level of public expenditures is maintained. China recently introduced a resource tax and will soon roll out a new environmental tax; both are local taxes. The amount of revenues from these two new taxes will be far from adequate to close the revenue gap, however.5 On the side of direct taxes, there is no room for higher corporate income tax as the policy is to reduce the tax burden of enterprises. Therefore, the hope for a solution lies with personal income tax and private residential property tax. Otherwise, the government will have to rely on borrowing, which will increase fiscal risks, particularly at the local level, where the burden of local public debt is already heavy.

In the context of the new round of fiscal policy reform and the difficulties encountered in the personal income tax reform process, much of the fiscal policy needs to be reformed at the subnational level. The key is to seek more sustainable own sources of municipal finance. The following section will discuss property taxation, land value capture, public-private partnerships and the municipal bond market.

The 19th National Congress of the Communist Party of China, held in October 2017, continues to emphasise fiscal policy reform. Specifically, it continues to call for the deepening of tax system reform, and the improvement of the local tax system. A crucial task is to continue the current round of fiscal policy reform by increasing the share of direct taxes. The focus is on the introduction of a property tax. In 2018, the government revealed three principles for the rollout of a property tax. First, a property tax law has to be passed by the National People’s Congress before the rollout of the property tax. Second, the central government will give full authorisation to local governments for the implementation of the property tax, which implies local flexibility on tax rates and exemptions. Third, the rollout should be taken step by step, implying that the cities that are ready to implement the tax may do so first. Furthermore, the residential property tax will be based on property value assessment, and the other taxes on the construction and transaction of properties will be lowered.

By all indications, the government is determined to move ahead with the rollout of the property tax, even though there is no specific timetable yet for the property tax law to be presented to the National People’s Congress for approval. Even if the law is passed by the National People’s Congress in the near future, it will still take a few years for many municipalities to establish a working system of residential property assessment and administration. Therefore, it will be years before residential property tax becomes one of the main sources of municipal revenues.

However, the introduction of property tax will be significant in shaping urban governance in the future. Residential property tax is a local tax, introduced on the justification that the revenues would be used by municipal governments to provide local public services, which would constitute a percentage of property value. As such, taxpayers are expected to demand the right to influence and participate in municipal decision making and the monitoring of municipal expenditures. This bottom-up pressure will fundamentally change the management style of municipal leaders, from responding mainly to directives from the higher level, to responding to the needs of urban residents.

The political hurdles for the introduction of a property tax on the ownership of private residential properties are obvious and very strong. Few households who owned one or more housing units will be happy to pay the property tax. The tax would represent a considerable outlay for an average household. Suppose that the annual amount of new property tax revenues from urban areas accounts for 1% of the national GDP of CNY 90 trillion (as of 2018), it would amount to CNY 900 billion in total, or CNY 1 033 per urban resident. Nonetheless, one could question why a property tax was implemented in a large number of countries (including many with lower per capita income than China) for many years, but not in China.

In fact, the central government studied the feasibility of the property tax in the early 2000s. It is a significant missed opportunity, that the property tax was not introduced just a few years after the housing policy reform to transform housing provision from welfare to market in 1998 and right before the start of the housing boom that lasted until 2013. Today, over 90% of urban households own one or more housing units. They form the strongest public resistance to the property tax.

Given the urgency to strengthen the municipal finance system when the traditional land-based finance is losing steam, it would be ideal if the property tax were introduced immediately. A possibility is to adopt a wide tax base and a very low rate to start with. The rate may be determined locally by municipal governments, depending on the income affordability of their urban households. The acceptance of urban households is critical in changing the culture of not paying direct taxes. Introducing the property tax would require tremendous political will and perhaps a bit of luck in terms of timing for the economy. Once a property tax with a low rate is accepted, municipal governments will have the opportunity to gradually raise the property tax rate to the point that balances affordability and revenue needs for public services.

The government should consider allowing time for multiple-home owners to adjust their home investment portfolios before the property tax law comes into effect. Most current urban housing units were built and purchased after the housing reform of 1998. Many households own multiple housing units that they keep vacant. This phenomenon is caused by various distortions, such as lack of household investment alternatives, weak social security coverage, and very low carrying costs in the absence of a property tax. For these households, the property tax burden would be very high if the owners do not sell or rent out the extra or vacant housing units. Considering that they made the purchase of the properties at the time without a property tax, the government should allow them a certain period of time to adjust their housing investment portfolios after the national property tax law is passed by the National People’s Congress. A simple way to do so is to make the law effective two to three years after its approval.

As seen above, China has a large number of municipalities, county towns and administrative townships. Most of these municipalities and towns are not ready to implement a residential property tax, due to lack of institutional capacity for property value assessment and property tax administration. However, a number of large municipalities have been making significant efforts to establish a city property database and develop property valuation methodologies. Some are ready to implement the property tax. Therefore, it makes a great deal of sense for the central government to allow the municipalities that are prepared to implement the property tax to go ahead as soon as the national property tax law is effective. At the same time, the central government and provincial governments may consider funding a capacity development programme to assist other municipalities in developing property assessment and administration systems. A financial incentive programme based on the inter-governmental transfer system may be considered by the central government to reward municipalities that make substantive efforts to roll out the property tax.

Internationally, many cities use various area-based land value capture (LVC) instruments to finance urban infrastructure. Notable instruments include betterment contributions, special assessments, exactions, impact fees, land readjustments, rail and property co-development, inclusionary housing, transferable development rights and tax incremental finance (German and Bernstein, 2018[7]).

In a broad sense, the mobilisation of revenues from competitive land concessions by China’s municipalities is also an LVC instrument. For most municipalities, this is the only LVC instrument in use. However, a few cities (such as Shenzhen and Nanchang) have started to learn from the Hong Kong experience in using rail and property co-development to finance urban rail investment. Also in Shenzhen, a variant of land readjustment is adopted for the redevelopment of urban villages, in which a portion of the profit from the redevelopment is used to fund neighbourhood public infrastructure (Liu and Zeng, 2019[8]). Moreover, some cities adopt a development-oriented approach to locate the new urban rail lines and stations in the under-developed corridors with an expectation that the land value will rise for capture once the investment is announced and implemented (Yang et al., 2016[9]).

These cases demonstrate the potential for wider applications of LVC in Chinese cities. However, there is no policy and legal framework for local governments to adopt most of the LVC instruments. In the case of rail transit development in the Pearl River Delta Region of Guangdong Province, it was found that the provincial and relevant municipal governments did not have a ready institutional and policy framework to handle the value capture issues (Li et al., 2013[10]). If China intends to introduce the LVC instruments, a policy and legal framework should be established to enable the local governments to do so.

China started using public-private partnership (PPP) arrangements to finance and deliver infrastructure in the 1990s. The Build-Operate-Transfer (BOT) financing model was extensively used in tolled roads and urban water supply projects. However, PPPs slowed after the central government pumped an economic stimulus package of CNY 4 trillion into the economy in response to the adverse impact of the global financial crisis in 2007-08. A significant portion of the package was spent on infrastructure. PPPs were revitalised in 2014 when the central government decided to tame local government debt by closing the LFVs and opening the front door to PPPs. Then PPP projects emerged rapidly. In just two years, China became the biggest PPP market in the world. By August 2019, the total value of all PPP projects recorded in the national PPP management system amounted to CNY 13.9 trillion and the total value of the PPP projects in the pipeline amounted to CNY 3.4 trillion (China Public Private Partnerships Center, 2019[11]).

PPP financing in China is unique. It emphasises financial co-operation between the government and society, instead of the private sector due to the significant presence of state-owned enterprises. The scope of PPPs extends from economic infrastructure (such as urban rail, water supply, wastewater treatment, etc.) to land development, real estate projects, affordable housing, nursing homes, ecological repair and protection projects, shantytown redevelopment, urban village redevelopment, and urban regeneration. Many PPP projects are a public good in nature and have little capacity to generate a revenue flow from users. Therefore, these projects entail a significant viability gap to be financed by local governments, often with an annuity arrangement funded by government revenues, particularly the expected future land concession revenues.

China does not have a clear regulation on the local fiscal commitments to PPPs, neither for direct liabilities (such as viability gap payments) nor contingent liabilities. Therefore, the fiscal risks to municipal governments with significant fiscal commitments to PPPs are substantial. It is imperative for the central government and provincial governments to strengthen the legal and regulatory framework for the management of fiscal commitments. One measure would be to set a limit on the viability gap finance to not exceed a certain percentage (say 30%) of the total cost of the PPP project.

As discussed earlier, commercial bank loans are one major source of finance that municipal governments rely on to finance urban infrastructure projects. Most loans have a term less than eight years, which is often not long enough to match the life of a project. Moreover, these loans often involve land as collateral and are backed mainly by future land concession revenues. As the role of land in municipal finance is expected to decline, it is necessary to develop alternative long-term investment financing instruments. A viable alternative is the municipal bond market. In the United States, the municipal bond market provides a mechanism for more than 50 000 state and local government units to raise funds for public purposes, such as infrastructure, schools and public buildings.

The municipal bond market is potentially viable in China, as urbanisation continues and the market for institutional investors (pension funds, endowments, foundations, and other institutional asset owners) expands. China’s local government bond market started just a few years ago and has grown rapidly, driven mainly by the local debt-swap programme. Outstanding local government bonds reached CNY 14.7 trillion in 2017. However, the local government bond market is still under-developed, and its development is constrained by severe impediments, including low liquidity, weak credit discipline and structural fiscal deficit in local governments (Lam and Wang, 2018[12]). Much needs to be done by both the central and local governments to remove these impediments.

Sound and sustainable municipal finance will be crucial for China’s municipal governments to provide quality public services to meet the growing needs of the majority of the Chinese population. However, municipal finance reform faces significant hurdles. China’s general tax burden is high, and there is pressure for the government to cut taxes on the supply side (i.e. indirect taxes) in order to help businesses remain competitive. It has proven difficult to maintain the level of general tax burden due to the difficulties in raising revenues from direct taxes.

Municipal governments are losing revenues from public land leasing due to the new amendment to the Land Administration Law. Finding stable own source revenues will be crucial for municipal governments to fund continuing urbanisation. China missed an opportunity to implement a property tax before the housing boom. Today, it is extremely difficult for the house-owning public to accept the tax. If not implemented, the problem of finding a sustainable own source revenue will continue to challenge municipalities. In a broad sense, a property tax is a significant missing piece in China’s tax reform strategy that aims to better balance indirect and direct taxes.

Despite the political hurdles, there are ways to make the introduction of a property tax less painful to the public. These include starting with a low rate, allowing time for ownership adjustment, and allowing municipalities to implement the tax as soon as they are ready. Moreover, China could learn a great deal from international experiences in land value capture and the management of fiscal risks associated with PPP projects. Finally, China should make further efforts to remove the impediments that constrain the sound development of the municipal bond market.


[11] China Public Private Partnerships Center (2019), Monthly Report of PPP Projects, (accessed on  August 2019).

[6] Gao, P. (2017), “Taxation Reform under the New Normal of Economic Development”, Economic Herald, in Chinese.

[7] German, L. and A. Bernstein (2018), Land Value Capture: Tools to Finance Our Urban Future, Lincoln Institute of Land Policy, Cambridge, MA.

[8] Gielen, D. and E. van der Krabben (eds.) (2019), Infrastructure Contributions and Negotiable Developer Obligations in China, Routledge, London.

[12] Lam, W. and J. Wang (2018), “China’s Local Government Bond Market”, IMF Working Paper, No. WP/18/219, IMF, Washington, DC.

[10] Li, G. et al. (2013), “Value Capture beyond Municipalities: Transit-Oriented Development and Inter-city Passenger Rail Investment in China’s Pearl River Delta”, Journal of Transport Geography, Vol. 33, pp. 268-277.

[5] Liu, S. and X. Xiong (2018), “Dual-track Urbanization under the Dual Land Ownership System”, Academic Journal of Urban Planning, in Chinese, pp. 31-40.

[1] Ministry of Finance (2018), National Government Final Account,

[3] National Bureau of Statistics of China (2019), National Bureau of Statistics of China,

[2] OECD (2018), Revenue Statistics 2018, OECD Publishing, Paris,

[9] Yang, J. et al. (2016), “Density-Oriented versus Development-Oriented Transit Investment: Decoding Metro Station Location Selection in Shenzhen”, Transport Policy, Vol. 51, pp. 93-102.

[4] Zhong, X. (2017), Local Finance, The Renmin University of China Press, Beijing.


← 1. The provincial-level administrations include 23 provinces, five autonomous regions, four centrally administered municipalities (Beijing, Tianjin, Shanghai and Chongqing), and two special administration regions (Hong Kong and Macau).

← 2. In 2013, using officially published statistics, the PLC calculated the Chinese government revenues consistent with the OECD definitions and classifications of government revenues. The method was documented in an unpublished technical report of the PLC. The share of government revenues over GDP was calculated by the PLC for each year from 2009 to 2017 (see Figure 7.1). The 2018 share of government revenues over GDP is not available as the data on the expenses incurred for land acquisition and resettlement in the public land leasing were not available at the time of writing.

← 3. In 2018, a tax administration reform took place at each level of subnational government. The central government tax bureau merged with the local tax bureaus. This reform merged the collection management of central and local taxes, but did not affect the tax-sharing arrangements.

← 4. The data were obtained from OECD.stat on revenue statistics at

← 5. In 2018, the local revenues from the resource tax amounted to CNY 0.16 trillion or 2.1% of local tax revenues.

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