The reform of the "local surtax" will be launched.

To address local financial difficulties, the central government plans to further develop a new local tax—local additional tax.

The recently released “Report on the Implementation of the 2025 Central and Local Budget and the Draft 2026 Central and Local Budget” (hereinafter referred to as the “Budget Report”) outlines measures for deepening fiscal and tax system reforms this year, including improving the local tax system, expanding local tax sources, and promoting reforms of local additional taxes.

Currently, China does not have a local additional tax; it is a new tax still under research. The 20th Party Congress’s Third Plenary Session in July 2024 first proposed studying the merging of the urban maintenance and construction tax, education surcharge, and local education surcharge (collectively known as one tax, two fees) into a local additional tax, with local governments authorized to set specific applicable rates within certain limits.

Professor Liu Jindong, Vice Dean of the School of Finance and Taxation at Shandong University of Finance and Economics,关注 the reform of the local additional tax. He told First Financial that the Budget Report explicitly calls for promoting this reform, signaling an important step forward. While the idea of merging “one tax, two fees” seems straightforward—since they already exist and merging them appears like “putting old wine in a new bottle”—the reality is complex. The reform involves changes to the tax base, adjustments to tax rates, and coordination of supporting measures. It is not a simple merger and will require gradual implementation during the “14th Five-Year Plan” period.

Many Challenges in Reform

Since the full implementation of the VAT reform replacing business tax in 2016, traditional mainstay taxes like business tax have been phased out. Although increasing the share of VAT revenue shared with local governments helped maintain local financial stability, the loss of a main tax base, combined with economic downturns, sluggish real estate markets, external trade shocks, and tax cuts and fee reductions, has intensified local fiscal revenue and expenditure conflicts.

To solve local fiscal difficulties, increase local autonomy, and expand local tax sources, the central government proposed the local additional tax. The statements in this year’s Budget Report indicate that the reform of establishing this new tax is steadily progressing.

Wang Yongjun, a professor at the Central University of Finance and Economics, told First Financial that the local additional tax has unique advantages compared to revenue sharing and central transfer payments. It ensures that local governments can fairly and stably share large, mobile tax bases like VAT, while also granting them the autonomy to set necessary and critical tax rates—closely linked to local expenditure and budget autonomy.

Lu Zhiheng, Chief Economist at Yuekai Securities, previously told First Financial that the local additional tax could enhance local fiscal independence and motivate local governments. Converting the education surcharge, which has long been levied as a fee, into a local additional tax simplifies the tax system, facilitates collection and management, improves taxpayer compliance, and stabilizes local fiscal revenue.

The central government’s move to merge “one tax, two fees” into a local additional tax is related to their similarities. Currently, the urban maintenance and construction tax, education surcharge, and local education surcharge all target the same taxpayers—units and individuals paying VAT and consumption tax—and share the same tax base, based on the actual VAT and consumption tax paid.

However, there are differences. For example, the urban construction tax is a tax, while education surcharge and local education surcharge are government fees, classified as non-tax revenue. Merging them involves changing from “two fees” to a tax. Additionally, their rates and purposes differ.

According to the Ministry of Finance, in 2025, the urban maintenance and construction tax is projected to reach 517 billion yuan, a 2.9% increase from the previous year. The scale of education surcharge and local education surcharge has not yet been disclosed. Both fees are based on VAT and consumption tax, taxed at a combined rate of 5%. The Ministry of Finance data shows that in 2025, total domestic VAT and consumption tax revenue will be approximately 85.804 trillion yuan; at a 5% rate, the combined “two fees” revenue is estimated at about 429 billion yuan. Theoretically, the total revenue from “one tax, two fees” could approach 1 trillion yuan.

As with all taxes, establishing the local additional tax in the future depends on defining core factors such as the purpose of taxation, taxable objects, tax base, rates, preferential policies, and administration. This requires careful consideration of multiple factors, including controllability of collection, tax burden, stability of local fiscal revenue, and the optimization of fiscal relations between central and local governments.

Liu Jindong stated that in the future, allowing local governments to set specific rates within a certain range could lead to complex impacts. For example, to attract investment, local governments might engage in “bottom competition” by lowering rates, which could exacerbate regional disparities—wealthier areas might benefit more, leading to the “Matthew effect” where the rich get richer and the poor get poorer.

He emphasized that the local additional tax is a benefit tax. Wealthier regions with concentrated economies and more benefiting enterprises tend to have higher tax capacity and willingness, creating a “tax clustering rent” effect. Conversely, less developed regions may struggle with higher tax burdens, and local governments may not afford many tax incentives, making their fiscal situation more strained.

Liu Jindong also pointed out that the establishment of the local additional tax is just one part of the overall tax reform. It must be coordinated with other reforms, such as the reform of consumption tax, which involves shifting some tax collection points to wholesale and retail stages. This will expand the tax base of the local additional tax and require ongoing adjustments to VAT deduction chains, potentially changing the tax base further.

“Therefore, after the simple ‘three-in-one’ integration, the local additional tax is expected to undergo continuous optimization and adjustment. The goal is to expand its scale to fulfill its role as a supplementary revenue source while tightening regulations to mitigate potential negative effects,” Liu said.

Setting the Rate Is Critical

Since the “one tax, two fees” share the same taxable objects and bases, some experts believe that the future scope and base of the local additional tax will likely follow the previous framework. However, how to set the rate reasonably remains a key issue.

In a paper published in “Taxation Research,” Liu Jindong and colleagues estimated that if the local additional tax is based on total domestic VAT and consumption tax revenue, with rates set at 10%, 12%, 15%, 17%, and 20%, then at a 20% rate, the scale in 2023 and 2024 could exceed 1.65 trillion yuan. This would surpass the local share of corporate income tax and be second only to the local share of VAT, highlighting the potential importance of this reform in reshaping local fiscal power.

Liu Jindong suggested that the central government could set a rate range for the local additional tax, within which local governments determine specific rates and submit them for approval by the local people’s congress. Additionally, the central government should develop a comprehensive evaluation system based on local fiscal gaps, future expenditure plans, and regional economic concentration to guide local rate-setting more accurately.

“This approach can prevent local governments with small fiscal gaps, low public expenditure needs, or low regional concentration from setting excessively high rates, leading to over-collection. It can also prevent highly concentrated regions from setting too low rates, causing revenue loss and unhealthy regional competition for investment, thus maintaining healthy macroeconomic operation,” Liu said.

Implementing the local additional tax is a current measure to increase local fiscal autonomy and ease fiscal difficulties. Besides revenue measures, reforms such as transferring some consumption tax revenue to local governments, optimizing sharing ratios, and increasing general transfer payments are also important.

Liu Jindong believes that while the introduction of the local additional tax will directly increase local fiscal revenue, it is not intended to be the main source of local finances. Its primary purpose is to strengthen fiscal management and ensure healthier fiscal operations in the future.

He also suggested that, given that the main taxpayers are enterprises, the local additional tax should mainly be limited to productive uses benefiting enterprises—such as urban infrastructure, employee training subsidies, and digital skills training—to improve tax compliance and create a virtuous fiscal cycle. In the future, expanding the scale of the local additional tax moderately while reducing unreasonable enterprise-related charges could help create a fairer, more transparent, and predictable business environment.