This article was first published in Caixin Global on June 3, 2025.
As trade turbulence escalates, China’s fiscal policymakers face the dual challenge of bolstering domestic demand while maintaining sound public finances.
The imposition of tariffs by the US in early April and China’s reciprocal measures have opened a new chapter of economic uncertainty. While the situation remains fluid, it is increasingly unlikely that trade activity between the two countries will revert to pre-April levels in the near term.
This external shock is weighing on global demand and posing downside risks to China’s growth outlook. It is also dampening business and consumer sentiment, which had been on the path of recovery following a sluggish post-pandemic recovery and the protracted property sector downturn.
Against this backdrop of heightened uncertainty, China’s fiscal policy has an important role to play in supporting domestic demand and safeguarding macroeconomic stability. This year’s budget signals a more proactive fiscal stance, with a wider general government deficit, expanded local government financing quotas, and increased capital injections into state-owned banks. But given the uncertainties caused by constant changes in the US tariff measures, additional flexible and well-calibrated fiscal response — underpinned by structural reforms — may be needed to sustain growth momentum while ensuring fiscal sustainability.
Reviving domestic demand
Prioritizing high-impact public spending is critical to delivering an immediate boost to domestic demand.
In the near term, measures such as expanding social spending, targeted subsidies to strategic sectors, and commitment to the “three guarantees” (basic livelihoods, public sector wages, and essential government operations) are essential. The continuation and broadening of the consumer goods trade-in program is a step in the right direction.
Since the pandemic, local governments have used digital consumption vouchers to spur spending. However, these programs have faced limitations, such as high spending thresholds, restrictive terms and conditions, fragmented and small voucher amounts, and unfriendly user interfaces for the elderly. Several local audit offices have also highlighted weak oversight in the implementation, which has contributed to suboptimal outcomes. Future voucher schemes could be more effective if redesigned with clearer rules, better monitoring, and user-friendly platforms.
On the tax side, timely deployment of rebates, grants, and temporary relief for tariff-hit manufacturers can ease financial strain and support employment. This could involve expanding the value-added tax refund scheme and deferring corporate income tax for affected sectors. However, such measures should remain temporary and targeted, and be phased out as conditions improve, to preserve fiscal sustainability.
Strengthening the social safety net
With rising risk of job losses in export-dependent sectors, reinforcing China’s social safety net is critical to cushion income losses, stabilize household consumption and ease social pressures.
The government has taken important steps, such as strengthening its unemployment insurance system in response to the tariff shock. Notably, the government has introduced partial refunds of unemployment insurance contributions for companies that retain employees, alongside the provision of basic living allowances for jobless workers.
Yet, more can be done.
In the near term, expanding eligibility, streamlining application procedures, and accelerating benefit disbursement can enhance the countercyclical impact of unemployment benefits. Over the medium term, modernizing the broader social safety net is essential to strengthen household confidence and unlock China’s consumption potential. Priorities include raising minimum pension benefits, expanding coverage to informal and rural workers, and improving the targeting and adequacy of the minimum living allowance program.
Reinforcing local budgets
Local governments account for more than 80 percent of total government expenditures in China, yet they have come under mounting fiscal strain in recent years. This reflects a persistent mismatch between spending responsibilities and limited, often unstable, revenue sources — compounded by declining land sales and rising off-budget debt. As a result, many may lack the fiscal resources to respond swiftly to support sectors affected by the current tariff shock, potentially diluting the effectiveness of the broader policy response.
The central government has increasingly stepped in to shore up local finances in recent years, including issuing special treasury bonds, with a significant share earmarked for fiscal transfers to local governments. Looking ahead, the central government remains well-positioned to take the lead in bolstering local government finances, given its relatively moderate debt levels, ample liquid financial assets, and low borrowing costs.
In 2024, fiscal transfers to local governments under the general public budget have reached record highs, equivalent to 7.4 percent of GDP. Further improvements could focus on faster disbursement, particularly to export-oriented coastal provinces and manufacturing hubs most vulnerable to external shocks. Ensuring these local governments have timely and sufficient fiscal resources would enhance their capacity to roll out targeted support measures in a responsive and flexible manner.
In the face of ongoing uncertainty surrounding the tariff measures, both central and local governments should maintain budgetary flexibility and readiness to respond. Nonetheless, any intervention must be carefully calibrated to provide timely support while safeguarding fiscal discipline, avoiding inefficiencies and minimizing leakages.
Enhancing coordination
China’s ability to navigate the challenges posed by escalating trade tensions will hinge on the agility and precision of its fiscal response. While the current policy toolkit offers a solid foundation, further refinements are required to ensure that support is timely, well-targeted and fiscally sustainable. Strengthening coordination across central and local governments, improving communication to build public trust, sharpening the focus on high-impact spending, and accelerating social safety net reforms are crucial for mitigating the near-term impact of the external shock.
In the longer term, deeper institutional reforms will be necessary to ensure fiscal sustainability. These include establishing a clearer and more rules-based division of fiscal responsibilities between central and local governments, tightening controls on off-budget borrowing by local government financing vehicles, and improving fiscal transparency. Advancing such reforms will not only strengthen the credibility and resilience of China’s fiscal framework but also lay the foundation for a more inclusive and consumption-driven growth model.