China Bets on $1.5 Trillion of Tax Cuts in Quest for Growth

(Bloomberg Businessweek) -- The Chinese Communist Party has embraced a school of thought more commonly associated with conservatives: supply-side economics..Beijing announced 2.5 trillion yuan ($393.3 billion) in tax cuts this month—the fifth year of such reductions, which cumulatively add up to more than 9.7 trillion yuan. At the current exchange rate, that’s more than the $1.5 trillion in tax cuts enacted by the Trump administration in 2017..In a press conference at the close of the annual National People’s Congress on March 11, Premier Li Keqiang called tax cuts the best way to boost growth, likening them to “fertilizer applied directly to the roots” of the economy. “Tax rebates look like reductions but actually are an addition. Today you give back, tomorrow you get more in return,” Li said, alluding to the core supply-side concept that tax cuts beget an increase in overall tax revenue..Yet just like former President Donald Trump’s cuts, China’s are controversial. Advocates of supply-side economics posit that allowing businesses to keep a larger share of their profits lets them boost investment and expand production. The benefits trickle down to workers and consumers in the form of increased hiring and lower prices. But many economists argue that tax cuts fuel unsustainable debt and often lead to wasteful investments. They say fiscal support would be better targeted at households than at businesses. Which viewpoint is correct will help determine the outlook for the world’s second-largest economy..In China tax revenue amounted to 21% of gross domestic product in 2021, well below the 34% average for members of the Organization of Economic Cooperation and Development. Taxes on consumption and levies on corporate profits generate the lion’s share of the government’s take, with personal income tax making up only a small share..China’s policymakers have long relied on selective corporate tax breaks to achieve long-term strategic objectives, such as boosting spending on research and development and investing in priority areas including microprocessors, renewable energy, and electric vehicles. “Preferential tax policies are needed to guide supply-side reforms to promote high-quality development and reduce the investment burden of enterprises, which will undoubtedly bring economic growth,” says Jiao Ruijin, a member of the state-run Chinese Tax Institute..Beijing has also been wielding tax cuts in a more tactical way in recent years to buttress growth, such as reducing levies targeted at small manufacturers suffering from the U.S.-China trade war. The cuts reached a record in 2020 when the coronavirus pandemic hit consumer spending on restaurants and travel. The effort—which has decreased the ratio of tax income to GDP by almost 2 percentage points since 2018—has largely focused on reductions in the value-added tax (VAT) and trimming employer contributions for workers’ medical care, unemployment insurance, and pensions..“The tax reduction and fee reduction have really helped and even saved a number of small and micro enterprises,” says Yinle Liang, head of supply chains at KPMG China. Fewer companies going bankrupt should help limit unemployment..Michael Pettis, a professor of finance at Peking University in Beijing, has argued that supply-side measures are an effective way of increasing economic growth in situations where businesses are constrained by scarce savings and high costs. “The problem is that the constraints on private business in China are, in my opinion, mostly demand-side,” he wrote in a note, advocating policies that “focus on ways of directly or indirectly boosting demand, including through higher wages and greater social transfers.”.Premier Li, China’s highest-profile supply-sider, has said he’ll step down this year, raising doubts about whether Beijing’s tax-cutting zeal will continue. Also, some economists argue that rising government deficits mean China is running out of room for further cuts. Goldman Sachs Group Inc. is forecasting that the augmented fiscal deficit, the widest measure of the gap between state spending and income, will reach 13.1% of GDP this year, up from 10% in 2018..“Large-scale tax and fee reductions are unsustainable,” says Zhao Fuchang, a researcher at the state-run Chinese Academy of Fiscal Sciences. But as in the U.S., not everyone in China agrees deficits are a risk. Because public-sector debt is mostly in a currency that Beijing issues and because inflation is low, “at the central government level, there is no fiscal constraint,” says Yan Liang, an economics professor at Willamette University..There are also questions about whether tax cuts are compatible with Beijing’s “common prosperity” agenda aimed at curbing inequality. A reduction in China’s standard VAT rate since 2018, from 17% to 13%, is a step in the right direction, says Bert Hofman, former China director at the World Bank. But to really reduce inequality, Beijing needs to curb its dependence on consumption taxes, which are regressive. To broaden the tax base, Hofman says, policymakers should consider taxing nonwage income such as capital gains at higher rates and maybe even introducing wealth and inheritance taxes..Some of China’s recent tax cuts have tended to benefit the better-off, with Beijing in December announcing extended income tax relief for foreign-born professionals, who tend to have relatively high incomes. “That was a sigh of relief for many of our companies,” says Alan Beebe, president of the American Chamber of Commerce in China. “It does have a significant impact in terms of the ability to recruit and retain expatriates.” —Tom Hancock, Jing Zhao, and Yujing Liu.©2022 Bloomberg L.P.

China Bets on $1.5 Trillion of Tax Cuts in Quest for Growth

In China tax revenue amounted to 21% of gross domestic product in 2021.

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