[Christopher Balding] Tax cuts feed China’s consuming passion

It’s tempting to view China’s changes to the personal and corporate tax code in the context of US trade tensions. The reforms are really aimed more at Beijing’s concerns about competitiveness and economic rebalancing, and ultimately the creation of a “moderately prosperous society.”

China has many problems with tax policy. Start with the labyrinth of (mostly very high) fees and levies on individuals and corporations. According to the World Bank, China has the 12th-highest official total corporate tax rate in the world, at 67.3 percent, and that doesn’t include imposts such as value-added tax and social security. In short, it isn’t an efficient business- and worker-friendly environment.

As Beijing points out, while the official list of taxes and fees is high, the tax burden measured by government revenue is just 30 percent of gross domestic product, slightly below global averages. This discrepancy between the tax rate and the burden, however, stems from another set of problems the government is keen to address: rampant cheating and avoidance.

Small companies try to do as much business as possible in cash, and many hand out all manner of noncash benefits to employees, boosting a firm’s allowable expenses while lowering workers’ taxable income. There’s even a thriving black market in official receipts for firms to show the tax authorities, called “fapiao.” One of the reasons the government has encouraged electronic payment is that it makes avoidance harder.

The latest reforms are intended to smooth inefficiencies for individuals and free many people from the tax net. For example, incomes under 5,000 yuan ($770) per month or 60,000 yuan a year are fully exempted. Given a nationwide per capita disposable income of only around 26,000 yuan a year, many people won’t be liable for income tax.

Beijing has also taken the opportunity to engage in some old-fashioned social policy engineering. Just as the US is trying to phase out its mortgage-interest deduction, China is introducing just such an allowance. This seems likely to be clawed back if a long-rumored property tax comes to fruition, but meanwhile it will ease pressure on banks and help consumers to lower their tax bills by buying a piece of the Chinese dream.

The bill also aims to make the system more progressive, targeting high earners for the greatest collection. An official Gini coefficient of 0.47 (and unofficial estimates exceeding 0.6) place China among the world’s most unequal countries, so Beijing is anxious to burnish its socialist credentials.

However, mortgage interest deductions and allowances for children’s education are more likely to benefit the well-off. Early estimates indicate that high earners will see their tax bills drop between 10 percent and 50 percent.

This adds to pressure on Beijing to better manage its finances. According to one estimate, corporate and personal income tax reform this year will reduce government revenue by $126 billion. Using the US system with a 10-year horizon, this amounts to a tax cut of $1.5 trillion to $2 trillion for Chinese corporations and individuals. Even by Chinese standards, that’s a lot.

For a nation with an official budget deficit near 3 percent of GDP, and IMF estimates of an augmented fiscal deficit of 13 percent, the cut will strain public coffers. While official debt remains manageable, there’s growing concern about the implied guarantee of off-balance-sheet projects and state-owned enterprises. The tax reduction will stimulate growth -- but it also will stretch the government finances in a slowing, debt-burdened economy.

An unspoken driver of the reform is the worry that US President Donald Trump’s tax cuts are making China less competitive and potentially increasing capital flight.

So for Beijing, the overhaul is not just about stimulating growth, but pushing consumption -- whose share of output stalled in 2017 -- and rebalancing the economy toward a strong domestic base.

Fundamentally, Beijing needs to tackle an unfriendly business environment. China ranks No. 78 in the World Bank’s Ease of Doing Business league, but No. 172 in “dealing with construction permits” and No. 130 in “paying taxes.” One prominent business owner said he had to pay 500 categories of taxes and fees. The government’s response was that the total was only 317.

For all that China is a one-party state, the government feels tremendous pressure to deliver economic results to a population that has come to regard double-digit growth as a birthright. That’s why stimulating consumption and rebalancing the drivers are the main motivators of Beijing’s tax reform.


Christopher Balding
Christopher Balding is an associate professor of business and economics at the HSBC Business School in Shenzhen. -- Ed.

(Bloomberg)