Fiscal Incentives and Health Risk Protection: How Central–Local Fiscal Relations Shape Rural Households’ Medical Burden in China

Background: The majority of the funding for the New Rural Cooperative Medical System (NCMS) is derived from fiscal subsidies, comprising central transfer payments and local fiscal matching subsidies. Local governments’ strategic behavior in response to central transfer payments may further impact NCMS compensation spending and medical economic risks. Methodology: Accordingly, this paper investigates, from both theoretical and empirical perspectives, the impact pathways through which local fiscal matching subsidies influence the medical economic risks faced by insured rural households, with central transfer payments serving as a moderating factor. This paper constructs a dynamic game framework involving the central government, local governments, and household sectors. It further applies a mediation effect model and related econometric methods to conduct empirical analysis using 87,630 observations from the China Family Panel Studies (CFPS). Results: The results show that, first, local fiscal matching subsidies significantly reduce catastrophic health expenditures for rural households under the income effect of central transfer payments. However, under the substitution effect, the opposite occurs, as local governments adopt non-cooperative strategies in response to central transfer payments. Second, these impacts exhibit regional heterogeneity, with stronger effects in eastern regions, regions with more developed secondary industries, and regions with higher fiscal self-sufficiency rates. Third, local fiscal matching subsidies influence medical economic risks through compensation spending, under the moderating role of central transfer payments. Conclusions: This paper provides a novel perspective on why the NCMS struggles to provide effective protection, thereby enriching the existing literature. Furthermore, it provides policy guidance for fiscal and healthcare reforms in countries with similar contexts to China. Based on these insights, we argue that, during the future integration process of the Basic Medical Insurance for Urban and Rural Residents, clear boundaries should be defined for local fiscal matching subsidies, and the moderating role of central transfer payments should be strategically leveraged.