The rise in livelihood expenditure has been a key aspect of China’s local fiscal policies, but its institutional drivers remain underexplored. This study uses panel data from 2012 to 2021 at the prefectural level and a difference-in-differences model to investigate the effects of tax reduction policies on local expenditure strategies. Results show that while tax reduction leads to lower overall local expenditure, the share of livelihood spending increases. Additionally, the distance from administrative centers and fiscal decentralization affect expenditure behaviors. The paper argues that intergovernmental relations, through transfer payments and policy guidance, are crucial in safeguarding livelihood expenditure, offering insights into the socialist system’s advantages and local government incentives.