Tax breaks a welcome boost for China's small businesses

Owners of small mainland businesses will no doubt welcome the State Council's decision to waive value-added and business taxes for those with monthly sales turnover below 20,000 yuan (HK$25,000) as a pilot for a longer-term plan. It is expected to benefit more than six million small businesses, and will have a profound impact on the economy if made a permanent policy.

The central government is employing a proactive fiscal policy at a time when economic growth shows signs of slowing rapidly. Rather than resorting to the past policies of massive bond issuance or expanded investment projects, policymakers are cutting taxes further and delegating political powers in an effort to stimulate the private-sector economy.

This macro-oriented economic policy is similar to the ideas of supply-side economists who advocate pragmatic economic approaches, which are likened to "supplying water for fish to grow".

Economics tells us that increasing taxes could simply crowd out investment by businesses, while cutting taxes could stimulate investment and consumption. But the tax cut for small businesses would only lead to a reduction of no more than 40 billion yuan a year, or about 13 billion yuan from August to the end of this year.

If the VAT replaces business tax this year, the total tax cut for this year would reach about 120 billion yuan, or only 1.1 per cent of the country's 12 trillion yuan in public revenues this year. Bigger tax cuts should therefore be made possible if the country seeks to make stable growth and employment a macroeconomic policy.

The current economic imbalance in the country has stemmed mainly from over-investment, overcapacity and inadequate consumption. So cutting VAT as the top source of tax revenues may work wonders.

Since consumers eventually pay VAT, relieving their tax burdens could help boost consumption, business investment and production. According to experts, lowering the standard VAT rate from 17 per cent to 15 per cent would lead to a fall in tax revenues of 500 billion yuan a year, thus effectively driving economic activities.

We know the government has not been well off this year. While money needs to be spent in many areas, revenue growth has fallen short of targets. But achieving revenue targets this year remains the government's top priority. It would appear impossible for the government to aim for revenue targets while launching tax-cutting measures and pledging no excessive tax. But this is no excuse for not cutting taxes, since the government has the capacity to solve the problems.

The executive meeting of the State Council on July 24 emphasised ways to unleash accumulated deposits. This would be just one good way to deal with the current financial predicament. The current balance of state coffers and fixed deposits in commercial banks totals an estimated 4 trillion yuan.

Unleashing just half that amount would not only meet revenue shortfalls, but also allow for another tax cut of 1 trillion yuan. This would also help expand the pilot scheme for replacing business tax with VAT to cover more businesses and more industries.

The effort to offer temporary tax waivers to small businesses while looking at a permanent tax system reflect the government's sincerity and determination to support enterprises. This is also a long-term strategy to support the private-sector economy. Since most small and medium-sized enterprises are private businesses and they are the main source of creativity and job opportunities, caring about them could help secure China's economic future.

Tax incentives for small enterprises are basic and common in mature economies. In Finland, for instance, taxes are very low for business starters and small enterprises, although Finnish taxes are high in general.

Finnish small businesses mostly do not pay tax. Instead, they are allowed medical insurance and subsidies for their first two years. This policy has helped make Finland a highly competitive economy.

The temporary tax incentives offered to China's small businesses should be made a clearer, permanent policy in the near future, and available to all individual businesses.

While the current policy is to waive taxes for individual businesses earning less than a certain level of income, it will no longer apply to them once they have registered to become enterprises. This policy of treating taxpayers according to their mode of operation rather than the size of business contradicts the principle of "ability-to-pay taxation" and must be changed.

In addition, the threshold for VAT and business tax should be raised significantly - from the monthly turnover of 20,000 yuan now to 50,000 yuan as a start.

Many small businesses in processing, manufacturing or merchandising enjoy a profit margin of only 5 to 20 per cent. Pegging the tax-free threshold at 20,000 yuan would only put businesses into a difficult state.