China's Fiscal Problem Will Persist Under the Current Growth Model

China's fiscal landscape in 2025 is marked by a series of acute warning signs. The core issue is a widening "scissors gap", where stagnant revenue growth has been dramatically outpaced by resilient expenditure, pushing the public debt to an alarming new high.A closer diagnosis reveals that persistent deflation is the key trigger for China’s fiscal problems, as it simultaneously crushes the two sources of fiscal revenue: corporate income tax and land sales and other property related taxes. On the former, the erosion of the tax base, and especially squeezed companies’ profit margins, directly suppress corporate income tax revenue. On the latter, collapsing property-related taxes has become a fatal blow, as land sale alone account for a very large share of local government fiscal revenue.Facing the rising debt burden and persistent welfare- and aging-related expenditures, the Chinese government has become more cautious about non-essential fiscal spending, particularly infrastructure investment, which has traditionally served as a key counter-cyclical tool during economic downturns. The recent evidence suggests that overall fiscal policy remains broadly neutral, but such fiscal prudence may reduce the government’s room for maneuver in downturns, raising concerns that policy could tilt in a less counter-cyclical direction and thereby not revert deflationary pressures.To tackle the looming risk of a systemic local debt crisis, the Chinese government is opting to execute a major strategic pivot: rebalancing the fiscal relationship between the central and local authorities. In other words, central government takes more tasks to help local governments de-risk.One could question whether this strategy has started to work. The deflationary pressure is rooted in China’s growth model that fuels overcapacity. As long as policy continues to stress national security and supply-chain autonomy, resources will be directed toward strategic high-tech industries, suppressing labor demand and restraining household income growth, thereby weakening domestic consumption. Coupled with protectionist barriers that limit overseas markets, the imbalance between strong supply and insufficient demand reinforces price competition, prolongs deflationary pressure, and leaves fiscal challenges unresolved.In conclusion, China's fiscal strain will not be a short-term storm but a "new normal" requiring long-term adaptation. Without a profound paradigm shift - away from an over-reliance on investment and supply expansion toward a balanced model that prioritizes domestic consumption and market-driven efficiency - the path to long-term fiscal sustainability will be fraught with challenges. The central government's balance sheet, in turn, faces an unprecedented and protracted test.