Taxation serves not only as an instrument for governments to raise fiscal revenue but also as a critical institutional arrangement linking the state and the market, shaping the behavioral patterns of local governments as well as market structures. Since the reform and opening-up, China has established a tax system centered on corporate taxation, grounded in the source-based taxation principle, and underpinned by shared taxes including value-added tax (VAT) and corporate income tax. For decades, this tax structure has coordinated with inter-local competition, official promotion incentives and industrial policies to fuel investment promotion, infrastructure development, manufacturing expansion and the formation of industrial clusters.

Nevertheless, as the economy shifts toward high-quality development, emerging shifts including a downturn in the real estate sector, subdued price levels, the boom of platform economy and flexible employment, and shrinking profitability in traditional industries have distorted the incentive effects embedded in the existing tax regime. At present, the macro tax burden keeps declining alongside expanding central fiscal transfer payments, leaving local governments with insufficient autonomous fiscal resources. Constrained by the incumbent institutional setup, local authorities remain biased toward production over consumption, prioritizing resource allocation for enterprises and production links while lacking incentives to invest in public services, resident welfare and consumption-friendly environments. Such behavioral bias further distorts the macroeconomic structure via redundant capacity expansion, cutthroat price competition and overreliance on exports, manifested as inadequate domestic consumption and cutthroat intra-industry rivalry.

Starting from prevailing strains in current fiscal operations, this paper dissects the incentive mechanism for local government behavior inherent in the existing tax structure and its ensuing macroeconomic repercussions. It argues that the core agenda of the next round of fiscal and taxation reform extends far beyond revenue sourcing; more importantly, the reform is designed to restructure developmental incentives for subnational governments. Looking ahead, the reform shall shift from the single-track incentive framework focusing solely on enterprises toward a dual-track system balancing corporate and household interests. Concrete measures include gradually shifting the collection link of consumption tax downstream and appropriately transferring relevant tax proceeds to local governments, overhauling local surtaxes to boost subnational autonomous fiscal capacity, further advancing the comprehensive, household-based and residence-oriented reform of individual income tax, and developing a modern tax governance system adaptable to platform economy, flexible employment and capital-flow-based tax administration. Throughout the reform process, policymakers shall strike a sound balance among efficiency, equity and fiscal sustainability, enabling well-functioning markets and proactive governments to jointly bolster high-quality economic development in the new era.