Why richer, older China needs changes to its social contract

Chinese policymakers need to build out rather than restrict the social safety net of pensions and healthcare for the elderly portions of the population
Looking ahead, the number of people paying taxes needs to increase in a manner that raises revenue but is fair and ideally more progressive

Stuart P.M. Mackintosh

Published: 8:30pm, 9 Apr 2024

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No one likes getting old. The pains and strains of becoming elderly wear on us. The worries about how to ensure we can provide for ourselves in old age looms largest of all, as countries’ birth rates fall, lifespans extend and costs mount.

Nowhere feels this more acutely than China, where a staggering 300 million people are heading into their golden years and a great portion of retirees have minimal or no pension. We also see smaller families because of the now-abandoned one-child policy. As a result, families might find it harder to care for their parents as they age or fall ill.

The challenges are multifaceted. The government needs to build out rather than restrict the social safety net of pensions and healthcare for this growing segment of the country’s population. If adopted, gradual increases in social spending would be taking place at a time when the economy is slowing, straining budgets.

How should China pay for an ageing population and support economic growth? Lessons from other countries suggest that a combination of tax increases (widening the base, extending coverage), more generous social welfare (pensions and other family-friendly provisions) and pensionable age shifts (upwards over a decade or more) could provide a partial answer.

Few people like taxes, but applied fairly, consistently raising taxes to support the provision of pensions and services to seniors and families is a necessary part of the social policy response and will drive revenue. The personal income tax peak rate in China is 45 per cent, which is comparable to other countries. But the reality is far too few middle-class and wealthy Chinese pay taxes and too few Chinese workers pay income taxes.

Looking ahead, the number of people paying taxes needs to increase in a manner that raises revenue but is fair and ideally more progressive.

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In 2019, only 6 per cent of China’s tax revenue came from individual income taxes. US taxpayers provided 42 per cent of total revenue in 2021. China’s corporate tax of 25 per cent is more in line with Western countries. Value-added tax (VAT) is the giant, accounting for 45 per cent of revenues, compared to 17 per cent in the US and about 22 per cent in the European Union.

Looking at China’s tax structure, the tax burden is less fair and progressive than it could be. Increasing China’s income tax revenue by widening coverage and application, alongside reductions in VAT, would relieve pressure on the poorest in society.

Workers might be willing to pay a different balance of taxes if they see improved social welfare and can expect more generous pension provisions in the decades ahead, alongside a slightly longer working life.

Getting this right will be politically difficult, as we have seen in France, Germany, the United States and elsewhere. But reforms of the tax and social contract are needed.

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China’s leaders need to strengthen social welfare provisions, particularly pensions, to lower the country’s savings rate and convince individuals to spend more on services and their lives. People are not foolish. Families know they must provide for all contingencies when they become old. Hence, China’s savings rate was a massive 46 per cent in 2021.

If the government plans staggered, gradual and clearly communicated tax and social welfare changes in the coming decades, China’s citizens can gain more confidence in having a stronger social safety net for themselves and their families when they reach old age. In turn, households’ calculus will shift and a change in mindset can take root.

China needs to save less and spend more on services to drive economic growth and the evolution of the country’s marketplace, firms, investments and productive outcomes. Significant reductions in the personal savings rate will take time and requires a stronger safety net. China’s leaders need not aim for the other end of the scale and reduce household savings to the levels seen in the US, but a median route to economic growth and retirement security is possible.

China is getting rich. It is the world’s second-largest economy and still growing faster than many of its competitors, even as that growth rate slows amid economic headwinds. However, China is also getting old.

It perhaps is time for Chinese policymakers to begin the complex task of using more of the country’s considerable collective wealth to better provide for the ageing demographic cohort through better-designed taxation and collection. In doing so, the government can help set the stage for continued economic growth and a fiscally and socially sound future.

Stuart P.M. Mackintosh is executive director of the Group of Thirty

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