Yueran Zhang senior contributor

Tax Cuts in China! But What Are the Consequences?

The People's Bank of China (via Flickr/禁书网中国禁闻)
The People’s Bank of China (via Flickr/禁书网中国禁闻)

Facing the slowdown of China’s economic growth, China’s central government has adopted expansionary fiscal policies to rejuvenate the economy as it did in 2008. Yet two policy-related announcements from the past two weeks suggest that this wave of fiscal adaptation might be fundamentally different from changes in 2008: tax cuts, instead of direct investment from the government, are playing a major role.

On July 25, the State Council announced a tax reduction policy targeting micro- and small-sized enterprises: starting August 1, companies that have monthly sales of less than 20,000 RMB are exempted from paying value-added and business taxes. According to estimates, the tax exemption will benefit more than 6 million companies and the total tax reduction will add up to 30 billion RMB (about US$4.9 billion) annually. Moreover, it is hoped that the policy will encourage more people, especially new college graduates, to start their own businesses, thus alleviating the unemployment problem.

But the policy, though apparently well-intended, has also generated some controversy. Most importantly, some doubt whether as many as 6 million people will actually benefit. As the Beijing News points out, monthly sales of almost all micro-sized companies in the manufacturing sector exceed 20,000 RMB (about US$3,300). Monthly sales of 20,000 RMB are approximately equivalent to daily sales of 700 RMB, a sum at which even most retailers and vendors could not survive. Moreover, since some industries are seasonal, companies may have average monthly sales below the specified amount, but exceed it during peak sales seasons, thus not meeting the criteria for the tax exemption. As the actual beneficiaries are likely to be far fewer than the official estimation, some like Weibo user @千山俺独行 have said the policy is “only kind words口惠而实不至.”

The tax cuts for micro enterprises are accompanied by the expansion of another tax reform program. On August 1, the tax reform measure replacing business tax with a value-added tax was expanded nationwide in the transportation industry and six service sectors. It taxes the value of commodities or services produced by taxpayers, and is calculated by deducting input tax from output tax, while the business tax draws from all business revenues at all points along commodity chains. As this reform measure eliminates repetitive taxation, it lessens the tax burdens of enterprises.

According to China Business, as of April 2013, the reforms, which were first implemented in Shanghai beginning January 1, 2012, resulted in 20 billion RMB in tax cuts. The program was then expanded to Beijing, Tianjin, and seven other provinces in the fourth quarter of 2012, and the tax cut effects were also salient. Therefore, the State Council decided in April that the policy would be implemented nationwide on August 1. Nevertheless, as the growth rate of fiscal revenues declined significantly in the first half of 2013, many wondered if the central government would still be willing to implement the reform. Finally, their concerns were alleviated as the reform expansion went forward as planned on August 1.

Despite the fact that some transportation and logistics enterprises have complained that their tax burdens are actually heavier than before, most agree that tax cuts have been effective. However, the reforms may be problematic in two ways.

First, they may compromise the fiscal health of local governments. Under the current tax system established in 1994, business tax revenues are all kept by local governments, while value-added tax revenues are split 75% – 25% between the central and local governments respectively. Thus, a switch from a business tax to a value-added tax means a significant drop in local governments’ fiscal revenues. Although the central government, in order to appease the local governments, has agreed to leave all the tax revenues from the reform to the local governments, they will still suffer mild revenue losses, since the reform aims to reduce tax burdens in general. Receiving no compensation for this sacrifice, the local governments will shoulder the cost of the tax reforms alone, threatening their already worsening fiscal health.

Second, the reforms may affect the balance of power between the central and local governments. Replacing the business tax, which the provinces are in charge of collecting, with the value-added tax, which the central government is in charge of collecting, strengthens the central state’s fiscal power at the expense of the local governments’ autonomy. When the local government was in charge of tax collection, it enjoyed the freedom to modify tax rates, set tax exemptions, or collect taxes early (though strictly speaking, those practices were extralegal or illegal); now, all of those “informal rights” are gone. As China Business has reported, many local taxation bureaus are reluctant to give up their power to the national taxation system. Needless to say, the central-local power conflict has added another layer of uncertainty to the ongoing reforms.

Whether the new policies could have the desired long-term effect on the economy remains to be seen, as complicated social and political realities in China can always result in unintended consequences for well-intended policies. It is also too soon to say whether the policy reform suggests that structural tax cuts could become a sustained policy pattern in the future. What is certain is that China’s central government is at least developing new ways to deal with economic stagnation from those that emphasized government investment: it has begun to see encouraging the agency of market and society as a better option than direct state intervention.

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Yueran Zhang

Yueran Zhang is a student at Duke University, class of 2015, currently majoring in sociology and math. He spent all of his life before college in Beijing.
  • HenryQ

    Could it be that the switch from commodity tax to added-value tax is intended to counteract the already widespread corruption in local governments?

  • thomas

    the fiscal revenue may be misused by the local government for some useless projects which is actually a waste of money,but what will central gov do with such revenue?Can it reasurre its people that it won’t invest those useless projects or “lend” it to some poor African bros without interests?