China is introducing a new concept for taxpayers in a bid to encourage consumers to play their part in stabilising growth amid the trade war with the United States. The Chinese government announced at the weekend that tax deductions would be available for the first time in an attempt to reduce the tax burden and address the rising costs faced by urban middle-class Chinese consumers. The new scheme will allow taxpayers to reduce the proportion of their income subject to tax by subtracting certain expenses, and it targets the most discussed – and worried about – items among China’s middle class: housing, education, health care and aged care. Analysts have said for some time that China’s weak social safety net for health and elderly care, combined with soaring costs for housing and education, has given consumers strong incentives to save to pay for these expenses. In theory, allowing these costs to be deducted from taxable income should encourage consumers to save less, increasing the money they have to spend and contributing more to the key plank of the government’s plan to stabilise growth as the economy weathers the impacts of the trade war. Desperate middle class takes big risks to get money out of China But analysts are unsure if the new tax scheme will do much to get consumers to spend more, particularly in the short term. “Tax deductions for individuals are totally new in China,” the Trivium consultancy said in a note. “So the ultimate effect will depend on how smoothly the process is handled, and on public awareness of how to make use of the new deductions.” Taxpayers are unlikely to bank on big tax savings initially because of the novelty of the tax deduction concept, as well as a lack of detail on how the scheme will operate. The deductions will not take effect until January 1 and details of the process remain unclear. For example, will taxpayers be allowed to reduce their income subject to tax immediately, or will they have to wait for an annual tax reconciliation, similar to the tax reporting date in the US? Given the uncertainties, consumers may well take a “wait and see” attitude before spending any tax windfall from their deductions. Still, if they can figure out how to use the deductions, taxpayers should find more money in their bank accounts: Homeowners will be allowed to claim up to 1,000 yuan (US$145) a month against mortgage interest payments on a first property; Renters will get a tax-free allowance of 800 to 1,200 yuan a month; Parents will be allowed a 12,000 yuan tax deduction against the annual cost of each child’s education expenses; Adults will be allowed to offset between 3,600 and 4,800 yuan of the annual cost of their own education; People with “serious” illnesses will receive a 60,000 yuan annual tax allowance; People who care for elderly parents will be entitled to tax relief on up to 2,000 yuan per month. Together with the increase in the monthly taxable income threshold – rising from 3,500 yuan to 5,000 yuan from this month – Beijing’s personal income tax cut package is the biggest in the country’s history. The question mark hanging over China’s middle class Nevertheless, analysts expect only a modest boost to Chinese growth and consumption. Ting Lu, chief China economist at Nomura International in Hong Kong, wrote in a research note that the newly announced deductions would reduce Chinese residents’ annual tax payments by a total of 116 billion yuan (US$17 billion). This would translate into an annual 81 billion yuan consumer spending increase, accelerating consumption growth by 0.22 percentage points and the nominal GDP growth rate by a mere 0.08 percentage point, he estimated. Moreover, the resulting reduction in taxes may be offset by increases in other levies, according to Liu Mingyan, an analyst with the China Minsheng Banking Corp. “Social welfare payments are likely to rise next year, offsetting the impact of the tax cuts,” he said, referring to the Chinese government’s plan to tighten collection of pension, health care insurance and unemployment insurance taxes, which together account for 40 per cent of wages. “Most of the tax burden on Chinese consumers is not from direct taxes like personal income tax but rather from indirect ones such as the sales tax and the value-added tax, which are hidden in the prices of products they buy.” Liu said the deduction plan would not solve this double taxation problem, which has long weighed on consumers’ ability and willingness to spend more. The Chinese personal tax cut is modest compared to personal tax regimes in Hong Kong and the US. For instance, China will allow a deduction of up to 12,000 yuan a year for each child’s education, while the same deduction in Hong Kong is worth seven times that – HK$100,000, or 88,500 yuan a year. Beijing’s personal tax rates are also higher than in the US. China’s top tax rate is 45 per cent for those earning more than 960,000 yuan (US$138,000) a year, while the US charges a maximum of 39.6 per cent for a single person whose annual income is above US$418,400. Fu Weigang, executive dean at Shanghai Institute of Finance and Law, said Beijing’s tax regime would be challenging to implement in a country that lacked a tradition of personal tax planning and refunds. It was “unfortunate”, he said, that China had borrowed taxation techniques from the US without taking this into consideration. “The enforcement cost [of the tax deduction regime] could be quite high, including many certification problems, such as ‘how to prove your mother is your mother’, for example,” he said. China says lull in home sales led to slower consumer spending growth in first six months Shen Xinfeng, an analyst with Northeast Securities, agreed. “Implementing these cuts will be very difficult. There will be large difficulties in identifying the spousal relationship, family members, and providing expense certificates, all of which need to be standardised,” she wrote in a note. Calculations by Northeast Securities also suggest that most taxpayers will be unlikely to change their spending behaviour because the deductions will make little difference to their take-home pay. People with monthly incomes of 35,000 yuan before tax could save 11.74 per cent of their earnings, but residents with pre-tax incomes of no more than 6,500 yuan a month would save a mere 1.15 per cent or less, said the firm. With an average monthly income before tax of 3,813 yuan last year, most urban Chinese workers would see little benefit from the tax deductions. It has been clear for some time that the Chinese government needs to take steps to reduce the tax burden on middle-class families. China wants its middle class to spend big … but they have bills to pay Rising costs, worries about their personal income outlook, and increasing personal debt have caused some consumers to engage in a “consumption downgrade”, choosing frugality over consumption just as China’s economic growth slowed to 6.5 per cent in the third quarter, the lowest in nearly a decade. Headline retail sales growth did rise to 9.2 per cent in September, from 9 per cent in August but, adjusted for inflation, the growth rate actually slowed to 6.4 per cent from 6.6 per cent – underscoring the challenge the government faces to get consumers to open their wallets. The Chinese government has been paying lip service to individual tax cuts for years, while government revenues from income tax have been rising much faster than its economic output to finance the expanding state apparatus and new infrastructure investments. Liu Kun, China’s finance minister, told state-run Xinhua that China’s overall tax burden was not high compared to other countries. Nevertheless, personal income tax payments in China surged 21.1 per cent to 1.1 trillion yuan in the first nine months of this year, almost on a par with personal income tax revenue for all of 2017. Additional reporting by Reuters