This paper focuses on the role of local governments in the development of tourism in China by examining 30 Chinese provinces from 2000 to 2018. The results of empirical research show that fiscal decentralization in China provides local governments with incentives for the development of high pollution industries and of large state-owned enterprises, which do not help the sustainable development of tourism. In addition, there is an “inverted U-shaped” relationship between pollution level and tourism development. Although the growth of China’s tourism industry is pollution-based currently, tourism revenue is considered to decline once a threshold is reached. The competition from local governments for foreign investment is conducive to the improvement of environmental quality and increase in tourism revenue. Based on this, we have proposed a series of sustainable tourism development measures.