(Bloomberg) -- China’s local governments are growing increasingly reliant on money transferred from Beijing to pay for public services, as a drop in tax revenue and jump in Covid Zero costs pushed them further into the red last year.

Transfer payments from the central government to local levels to pay for education, health care and other general spending are expected to hit 10 trillion yuan ($1.4 trillion) this year, the Ministry of Finance said in its budget report last week. That’s equivalent to 86% of the income local governments are forecast to make from taxes and fees this year, up from 66% in 2015, according to Bloomberg calculations based on MOF data.

“It’s only reasonable for the central government to continue to transfer more funds to local governments” as they don’t have enough income and debt risks are rising, said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc.

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The ratio of income to transfer payments this year is only slightly lower than in 2022, when it reached 89% after Beijing sharply boosted payouts to help the regions pay for unprecedentedly high tax cuts and to cope with the drop in revenue due to the real estate crisis. However, the increase in transfers is rapidly exhausting Beijing’s available fiscal resources, with the payments seen climbing to nearly 94% of the central government’s non-bond income in the main budget this year.

“It’s absolutely possible that the ratio could exceed 100% at some point,” Ding said, meaning the central government will give all its income as well as some borrowed funds to the provinces and municipalities. Although a large proportion of the funds Beijing raises through selling sovereign bonds are already sent to the provinces, Beijing could borrow more given its “relatively strong” balance sheet, he said.  

Under China’s current tax sharing system, local authorities get slightly more than half of the national revenue from taxes and fees but undertake around 85% of public spending on things such as social security and education, according to analysts’ estimates. Therefore, the central government redistributes its income to provinces with an aim to narrow the regional wealth gap so that citizens in different areas have more equal access to public services. 

Levies such as tariffs and the offshore oil resource tax are collected by the central government, while local governments get money from such things as taxes on property transactions or the value-added tax on land. The general value-added tax, the biggest source of income, is shared equally at the central and local levels, but Beijing gets more of the revenue from personal and corporate income taxes.

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