China economy

Tax cut back on the table for China’s legislature but impact on growth likely to be modest

Taxpayers are hoping for a bigger win to ease cost of living pressures but a consumer-driven surge in spending is not expected to offset trade war

PUBLISHED : Monday, 27 August, 2018, 6:01am
UPDATED : Monday, 27 August, 2018, 3:21pm

Chinese lawmakers are debating an amendment to the nation’s tax code this week but analysts say any extra cash for consumers will be unlikely to offset the impact of the trade war with the United States and other economic headwinds.

The Standing Committee of the National People’s Congress, China’s legislature, will consider a revised version of the tax bill, which failed to pass on its first reading in June.

The initial proposal was rejected when many legislators – supported by a strong online campaign – called for a bigger reduction in the individual tax burden for most Chinese citizens.

While the size of the tax cut is still be determined, it is unlikely to achieve the government’s aim of stimulating consumer spending enough to offset the effects on exports and investment of the financial deleveraging campaign and the escalating trade war with the United States, analysts said.

China set to cut tax rates for middle classes in bid to stimulate consumer spending

Details of the second reading have not yet been disclosed and it is unclear whether the current version has the support it needs, or whether further amendments will be required, delaying final passage for several more months.

The initial bill introduced a series of changes, including a shift toward taxation based on annual rather than monthly income and a rise in the tax threshold that would have seen average monthly incomes rise from 3,500 yuan (US$509) to 5,000 yuan.

Also on the table were more tax deductible items and broadened access to lower tax brackets.

Lawmakers and taxpayers were largely in agreement that the initial proposal was too modest and public interest in the amended tax bill has been high.

There were 131,207 suggested improvements to the bill posted by 67,291 internet users during the comment period from June 29 to July 28, according to the official website of the National People’s Congress.

Why China cannot rely on consumers to spend their way out of the trade war

In late July state media agency C hina News Service proposed raising the monthly tax-free income level to 10,000 yuan (120,000 yuan per year) this time around.

Internet users have suggested bringing down the highest tax bracket from the current 45 per cent and allowing deductions for aged care expenses.

“I think the exemption should be further lifted to at least 10,000 yuan per month, considering my rent in Beijing costs me at least 3,500 yuan, not to mention I have other necessary spending,” a commenter named Zhu Ling said on Weibo, China’s Twitter-like social network.

Others argued against the current design of tax deductions.

“I think single people are discriminated against by the bill,” a Weibo user nicknamed “general of the sheep” wrote. “A couple, each of whom earns 8,000 yuan per month, can avoid tax because they could use [the cost of their] kids’ education as a deduction, but a single man like me who earns 12,000 yuan will have to pay much more. It is not fair.”

Why China’s high-income earners dread the new tax law that will come into effect in January

Consumers are clamouring for the tax cut to ease the increasing difficulty of making financial ends meet.

“Inflation in the past few years, particularly the surge in housing costs, has pushed up the cost of living significantly,” said Freeman Bu, a tax partner at Ernst & Young (China) Advisory Ltd. “People hope the reform will lower the tax burden and lift disposable income.”

But it is unlikely legislators will raise the monthly exemption above 6,000 yuan per month (72,000 yuan per year), based on previous drafted amendments, Bu said.

Nor will the tax cut provide a “big bang” stimulus for consumer spending.

“One shouldn’t overestimate the positive impact … the low to middle income group [of consumers] will benefit more, not the middle class or high-income groups,” said analysts with Guotai Junan Securities in a note issued in late July.

Ernst & Young estimates that changes in exemptions and tax brackets – including raising the monthly tax exemption allowance by 40 per cent to 5,000 yuan per month – would trim the monthly burden of a taxpayer with a gross monthly wage of 60,000 yuan by 16 per cent, to 11,006 yuan.

Individuals at lower income levels will fare better. Someone with a 10,000 yuan monthly salary will see their tax bill slashed by 71 per cent to 115 yuan.

The draft bill also broadens the definition of those subject to tax to include any non-Chinese citizen who has lived in China for more than 183 days, as well as tightening the collection process, the Guotai Junan report said.

In general, a 10 per cent cut in the individual income tax burden would free up to 120 billion yuan (US$17.5 billion) in disposable income, which would not be large enough to give a strong boost to consumer spending, the report said.

Total retail sales of consumer goods reached 36.6 trillion yuan (US$5.78 trillion) in 2017, up by 10.2 per cent year on year, according to official data.

“In contrast with the United States, where taxes on corporates and individuals are more balanced, China’s tax system is skewed more towards corporates,” said Christopher Balding, associate professor of business and economics at the HSBC Business School in Shenzhen and author of “Sovereign Wealth Funds: The New Intersection of Money and Politics.”

“Only considering the individual tax cut, the impact on the economy will be minimal,” he said.

But, like the US, China is mulling a more comprehensive tax reform package to not only stimulate consumption, but also kick start new businesses, the overall impact of which would be stronger, he said.

China’s tax revenue increased 10.7 per cent to 14.4 trillion yuan in 2017, posting double-digit growth for the first time in five years. On the other hand, the economic growth rate slowed to 6.8 per cent last year – down from 14.2 per cent in 2007.

Tax revenue from individuals grew faster, by 18.6 per cent to 1.2 trillion yuan in 2017. For the first seven months this year, individual tax revenue jumped 20.6 per cent from the same period last year to 922.5 billion yuan, already surpassing the total raised in 2015.

Consumer spending, on the other hand, has been losing steam.

Retail sales growth in May slowed to its lowest rate in 15 years as Chinese households felt the pinch of rising housing costs and weak income growth, raising doubts about China’s efforts to rebalance the economy towards domestic consumption and away from credit-driven investment.

If the second reading is approved on Friday, the amendment will take effect on January 1 next year. It will mark the seventh change in the individual income tax law since 1980, but the first in the past seven years.

However, if objections remain, a third review would be required, potentially with a later effective date.