China to give local governments bigger share of tax revenues to continue crucial infrastructure investments
- Local governments will receive 50 per cent of the country’s value-added tax revenue, as well as a share of income from sales taxes, according to China’s State Council
- Shanghai was the only one of 31 mainland provincial-level regions not to report a fiscal deficit in the first half of 2019
China will distribute what could amount to trillions of yuan of national tax revenue to struggling provincial and municipal governments to finance infrastructure investment programmes in a bid to support the slowing economy.
China’s State Council said this week that it would make permanent a provision that gives local governments 50 per cent of the country’s value-added tax (VAT) revenue, while also gradually handing over additional revenue from sales taxes. While the cabinet did not elaborate, this could divert trillions of yuan to local government.
The move comes at a time when local fiscal revenues are drying up, in part because of personal and business tax cuts mandated by the central government to support the economy. This has posed fiscal and financial risks to China’s economy as municipal governments are usually not only a public service provider but also the owner and operator of the region’s largest infrastructure projects, key industrial enterprises and local financial institutions.
While China’s centralised administrative system does not allow a local government to declare bankruptcy – as the city of Detroit did in the United States – many local governments are running out of money, with Shanghai the only one of 31 mainland provincial-level regions not to report a fiscal deficit in the first half of 2019 from the initial distribution of revenue.
Tax revenue distribution between the central and local governments has traditionally been very uneven, favouring the decision makers in Beijing since 1994. For example, for every 100 yuan (US$14) in taxes paid by car manufacturers and distributors, local governments receive only 17 yuan (US$2.4), according to a research report by China International Capital Corporation, an investment bank.
For the nation as a whole, China’s central government took 48 per cent of the country’s fiscal revenues in the first eight months of 2019, leaving the vast local government apparatus – which includes 31 provincial governments, 330 municipal governments as well as around 2,800 county governments – sharing the remaining 52 per cent.
Local governments in China are forced to rely on “redistribution” of revenue from Beijing, local land sales and new debt generated through special financing vehicles. Chinese local government debt totalled 21 trillion yuan (US$3 trillion) at the end of August, according to official figures, although the hidden liabilities of local authorities are estimated to be much larger.
Analysts said the latest move to give a more revenue to local governments is too small to fully address local fiscal tensions. The cabinet said it would allow local governments to share sales tax revenues, but the revenue from four key items – cigarettes, petrol, cars and liquor, accounting for about 99 per cent of consumption taxes – is not included.
“It only scratches the surface. Fiscal and tax reform remains a major bone of contention amid the economic slowdown and the slowdown in land sales revenue,” said Wang Jun, the chief economist of Zhongyuan Bank, a mainland lender.
Value-added tax is now the largest fiscal revenue source in China, contributing 4.5 trillion yuan (US$632 billion) to the Chinese government in the first eight months of 2019. China has been implementing a 50 per cent sharing mechanism with local governments to encourage them to use the revenue to replace direct business taxes, with the State Council’s decision this week making that incentive a permanent rule.
Consumption tax, which also covers many luxury items including watches, cosmetics and yachts, rose 18.5 per cent in the first eight months of 2019 to 1 trillion yuan (US$140 billion), while national tax revenues dropped 0.1 per cent to 11.7 trillion yuan (US$1.64 trillion) in the first eight months of the year.