This article also appears in The Atlantic, a Tea Leaf Nation partner site.
As China’s economic growth loses steam, its government has started to place more burdens on the shoulders of its citizens. According to the Xiaoxiang Morning Post (@潇湘晨报), at the end of October, the Treasury Bureau of Zhejiang province asked companies to pay business taxes which were not due until 2013. Ye Tan (@叶檀), an economics and finance commentator, wrote on Sina Weibo, China’s Twitter, that the phenomenon was not confined to Zhejiang. “I just received a call from a friend who is an entrepreneur in northeastern China. He said that local officials were collecting taxes for 2013. If companies refused to pay, officials would look up account books [and find an excuse to fine them].” @猪肉脯lora adds that Jiangsu province also follows this practice.
We’ve seen this before
As expected, the chatter kindled web users’ discontent. @行者平疆 traces the phenomenon to hundreds of years ago, saying that the government is just following an “old tradition.” “It reminds me of what happened under the ruling of emperor Chongzhen [the last emperor of the Ming Dynasty from 1628-1644 A.D.]. The government went crazy creating new taxes, then in a single breath collected 40 years’ worth.” @早安我的城市 sees the phenomenon as a dangerous signal. “Historically, these actions have only been seen during wartime. But now it’s happening during peacetime too. If the trend continues, our country won’t be a country anymore.”
Why the rush?
By pre-collecting taxes, the government is trying to offset a decrease in revenues. The growth rate of public revenues on a year-on-year basis was “only” 10.9% during the first three quarters of 2012, compared to 22.4% in the same period in 2010 and 29.5% in the same period in 2011. Although the growth of public revenues still far exceeds those of GDP and per capita income, many local governments have opted not to adopt austerity policies to rationalize their balance sheets, instead desperately searching for more revenue to cover their spending.
China’s revenue stagnation can be traced to two chief factors. First, there is the slowdown in economic growth. In the second quarter of 2012, the year-on-year GDP growth rate was 7.6%, the first time the number has been lower than 8% since the outbreak of the global financial crisis. In the third quarter, the rate fell to 7.4%. Lower aggregate demand reduces the country’s taxable base.
The second reason is a reduction in revenues from China’s unique and troubling system of “land finance” (土地财政). The term refers to a local government practice of appropriating land from farmers with low compensation, then selling the parcels at high prices to real estate developers. (Strictly speaking, what is bought and sold is not the land itself but the right to use it, as legally speaking, all land in China is ultimately publicly owned.)
In recent years, as China rapidly urbanized and housing prices skyrocketed, so-called land finance was tremendously profitable. In 2010, the practice brought 2.9 trillion RMB to government coffers (about US$465 billion) making up about 35% of overall public revenues. But since 2011, China’s powerful State Council has implemented a set of strong measures to cool the real estate market. As a result, the land finance sector has been shrinking. In the first half of 2012, land finance revenue decreased by 27.5% on a year-on-year basis.
These numbers are troubling on their surface, but behind them lies something more profound: The state’s propensity to reap a disproportionate amount of economic gain vis a vis the private sector, one of the most severe problems resulting from China’s “strong state, weak society” political structure. Three elements undergird this predatory public finance system.
The underpinnings of today’s problems
The first element is China’s 1994 tax reform. In the 1980s and early 1990s, tax collection was devolved to local governments, who kept most of the revenue. This system piqued local governments’ enthusiasm to catalyze regional economic development, and laid a foundation for the economic takeoff during the first stage of China’s economic reform. But drawbacks emerged as time passed. In the 1990s, China’s central government had such weak financial capacity that many large-scale development projects could not be initiated. The central-local power relationship was highly unequal as the central government had to borrow heavily from its local counterparts.
In 1994, the central government enacted a radically new policy, in which it appropriated most tax revenue, then paid out those revenues at year end to local governments to cover their expenses. Local authorities responded by finding new revenue streams. During late 1990s, local governments tended to impose arbitrary charges on peasants as a way to generate revenue. After the turn of the century, as China’s urbanization gathered steam, land finance became the major source of cash for local authorities. Thus, a “predatory state” came into being as the central and local authorities struggled for financial power.
Second, China’s taxation system does not follow the “no taxation without representation” principle. Although the 2000 Law on Legislation (立法法) confers taxing power on the National People’s Congress (NPC) and its standing committee, the NPC has authorized the State Council to make law on taxation issues since 1984. This power transfer from the legislature to the executive grants the latter almost unlimited power to introduce new taxes.
The third factor is an opaque budget. The 1994 Budget Law (预算法) gives the NPC the right to examine and approve budgets of government bureaus, but it rarely exercises this power. Even more problematic is ordinary citizens’ lack of access to budgetary information. In 1997, the State Secret Bureau and the Treasury Bureau defined government budgets as state secrets which were not publicly disclosable. Eleven years later, the State Council released the Regulation on Open Government Information (政府信息公开条例) which requires government bureaus to release budget information. But the law lacks teeth.
Worse still, a large part of public finance happens outside the budget system. Since the 1994 taxation reform, in each year actual total public revenues have exceeded budget projections. In 2011, the revenue excess was 1.4 trillion RMB; this year, the number is estimated to be as high as 900 billion RMB, despite the slowdown. According to conventional practice, most of the excess is to be spent within the same fiscal year it is received. In this regard, the role of the budget system in regulating public revenues and expenditures is seriously weakened.
Hopes for reform
With the presence of strong incentives to generate more public revenues and the absence of checks and balances, China’s public finance system poses a long-range threat to China’s economic and political spheres. No one knows whether the new leadership will endeavor to repair this flawed system. At least the National People’s Congress is planning to amend the Budget Law within a few years. Hopefully, that event will provide the catalyst for a reform that China badly needs.