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Special Report

The Big Trim

China has unveiled major economic policies, including large tax cut packages, that pundits say have both short- and long-term considerations

By NewsChina Updated Apr.1

In the run-up to China’s annual session of the National People’s Congress, China’s law-making body, a major focus was the government’s economic policy. In the past months, as trade friction with the US simmered and escalated, the status of China’s slowing economic growth has been the subject of scrutiny.  

Lower Growth Target
In a keynote speech on March 5, in which he delivered the annual government’s work report, Chinese Premier Li Keqiang frequently mentioned the various “risks” the Chinese economy faces, and announced a GDP growth target in 2019 of 6.0-6.5 percent, compared to last year’s target of “around 6.5 percent.” According to official data, the Chinese economy grew by 6.6 percent in 2018.  

It is the second time that the government has set its economic growth target within a range instead of at a specific figure in recent years. In 2016, the government set its economic growth at 6.5 to 7 percent. Having experienced double-digit growth during much of the 2000s and early 2010s, China’s GDP growth has steadily declined since 2012. China’s ongoing trade war with the US over the past year has also not only begun to have a negative impact on China’s economic growth, but has injected a great amount of uncertainty as to its sustainability.  

According to Zhang Zhanbin, an economist from the Chinese Academy of Governance, setting the growth target at a range that is lower than that of last year will provide leeway for any economic difficulties the country may face while allowing space for urgently needed structural reforms.  
“It shows that the Chinese government is getting more strategic in balancing the need to boost economic growth and manage various internal and external risks,” Zhang told NewsChina.  

Tax Reduction 
Along with a lower and still robust growth target, Li also unveiled a massive tax cut package, announcing that the government aims to reduce business taxes and social security spending by more than two trillion yuan (US$298b) within the year. 

A major component of the tax cut package is to reduce the value-added tax (VAT) rate for manufacturing businesses from 13 to 10 percent and for construction and transport companies from 10 to nine percent. While the current six percent VAT rate for the service sector will remain unchanged, service industry companies will be offered more tax rebates.  

To promote the development of micro-businesses, those with an annual revenue of 100,000 yuan (US$14,900) or lower will be exempt from VAT, up from 30,000 yuan (US$4,470) last year.  
Under China’s tax code, VAT is the single biggest tax item. In 2017, for example, VAT revenue alone accounted for 38.9 percent of the government’s total tax revenue. Analysts believe that reducing VAT alone will lead to a gross tax reduction increasing from 800 billion yuan (US$119b) in 2018 to 1.2 trillion yuan (US$178b) in 2019.  

In the meantime, electricity rates for businesses will be cut by 10 percent, with internet and mobile internet fees expected to drop by 15 and 20 percent. Social security fees for businesses, which were fixed nationwide at 19 percent of an employee’s monthly salary, will now be set by provincial and regional governments, with a floor of 16 percent.  

“The estimated total tax cut of two trillion yuan will account for about one-tenth of the total tax revenue of the Chinese government,” Chen Yuyu, an economist and professor at Peking University, told NewsChina, “It is no doubt an audacious plan, and will provide a strong stimulus to the economy.”  

With the government’s tax revenue expected to shrink, Li called for governments at all levels to implement austerity measures. Li said the government would cut its administrative spending by five percent, and spending on logistics for public servants by three percent. In the meantime, authorities will require designated State-owned financial institutions and enterprises to hand over more of their profits to the government coffers.  

In addition, the government also set the fiscal deficit at 2.8 percent of GDP, or 2.76 trillion yuan (US$411b), an increase of 380 billion yuan (US$56.6b) from last year.  

This means that China will focus on using fiscal tools to deal with the current economic challenges instead of monetary policies as it did during the global financial crisis in 2008.  

China released a four trillion yuan (US$596b) stimulus package, which although it helped the country withstand the impact of the financial crisis, experts believe it sowed the seeds for structural problems, including rocketing housing prices, high debt and excessive industrial capacity. During his speech, Li stressed that China’s monetary policy will remain “prudent.” 

Aiming for the Long Term? 
While the tax reduction package appeared to be a short-term response to China’s economic slowdown and challenges posed by trade frictions with the US, many pundits in China argue that it marks a shift in China’s approach to tax policy in the long term.  

In the past couple of years, authorities have initiated several rounds of tax reforms and  
reductions. In late 2016, China launched a reform to scrap the business tax and merge it into VAT, which authorities claimed had resulted in a tax reduction of one trillion yuan (US$149b) within one year.  

In May 2018, authorities lowered the VAT rate for the manufacturing sector from 17 percent to 16 percent. Then in September, the government released a reform to the personal income tax code. According to Wang Jun, head of China’s State Administration of Taxation, the personal income tax reform resulted in a reduction of 200 billion yuan (US$29.8b) collected during the first four months of its implementation.  

Despite these reforms, most businesses operating in China have not seen a major reduction in their tax burden. Tax revenue has been growing at a rate far exceeding the growth rate of the economy in the past few years, which shows that China’s overall tax level has been increasing rather than decreasing. 

According to Liu Shangxi, head of the Chinese Academy of Fiscal Sciences under the Ministry of Finance and a government consultant on taxation policy, the reason behind the paradox lies in that the increase in the efficiency of the authorities’ tax collection capability has outpaced the governments’ efforts to reduce the tax rate. Liu said China’s existing tax code was enacted in the pre-digital era when collection efficiency was much lower.  

Therefore, to compensate for the difficulty of implementing the tax code, the government opted for higher tax rates. However, with decades of technological advances increasing collection capabilities, the existing tax code has become a major obstacle for economic growth.  

Liu Shangxi

Future Prospects 
The government has been reluctant to lower tax rates in the past. Instead, the preferred approach was to offer tax relief, including widespread tax exemptions at the provincial and local level. But as the world’s major industrial countries, including the US, the UK, Japan and France, have all resorted to tax reductions to boost their economies, China’s existing tax regime has proven to be unsustainable.  

Liu said the latest tax reform shows that authorities have finally changed their approach in addressing high tax rates, which will have a positive long-term impact on the economy.  

“Instead of temporary tax relief measures with expiration dates that pose long-term uncertainties for businesses, directly addressing tax rates can provide greater certainty for the market to facilitate longer-term investment,” Liu told NewsChina.  

Besides the tax reduction measures, Liu said authorities will announce additional tax cuts within the year.  

Prior to the NPC session, there had been much discussion about streamlining the VAT system by reducing the number of VAT brackets from three to two.  

During his speech, Premier Li said the government would continue to explore the possibility in the following months.  

According to Liu, the government had reached a consensus regarding the streamlining of the VAT system to be announced in the near future.  

In addition, authorities are considering whether to lower corporate income tax, which is currently set at 25 percent, Liu said. 

“All in all, the purpose is to nurture a healthy, competitive and attractive business environment,” Liu said. “If China can’t achieve this goal, its status as the world’s manufacturing hub and desired industrial upgrades will be in jeopardy.