“Why is China so worried about the United States’ tax cuts?”
This has become one of the top trending questions on social media in China since US President Donald Trump announced less than two weeks ago what was billed as the biggest tax cut for businesses and individuals in more than three decades.
The ensuing debate has focused on China’s own lopsided and much criticised tax regime, which is out of step and uncompetitive, and has reignited calls for the Chinese government to take more radical steps to overhaul the tax code to help spur economic growth.
Logically, the Chinese authorities should have welcomed the opportunity to help jump-start the issue. In fact, anticipating a new wave of tax cuts by major developed countries such as Britain and France, Premier Li Keqiang (李克強) chaired a State Council meeting in the middle of April to approve a raft of measures resulting in 380 billion yuan (HK$430 billion) in tax cuts, on top of 200 billion yuan in non-tax charges in the first quarter.
Noting that many countries were considering tax cut measures, Li reportedly said China should have the sense to “jump the gun” in the new round of global competition and employ effective measures to bolster the competitive edge of the Chinese firms.
In this context, China’s negative reactions to Trump’s tax cuts are mystifying, to say the least.
The People’s Daily ran a scathing commentary, accusing Washington of starting a “tax war” by proposing to cut the corporate tax from 35 per cent to 15 per cent, and throwing the international tax order into “chaos”. It worried that export-oriented countries would suffer as they were not able to compete in tax reductions.
A senior tax official told an official news portal that Trump’s tax cuts were selfish and unworthy of a responsible major power, adding that “we are firmly and explicitly opposed to competition in taxation” although the interview was soon deleted for reasons unknown.
The official view has attracted widespread ridicule on social media but it has added fuel to the debate with many prominent economists now arguing that China still has ample room for overhauling its tax regime and increasing the redistributive role of fiscal policy.
Over the past few days, state media have started to change tune by playing up that China started to cut taxes and other government charges to help businesses long before Trump’s announcement while citing the American mainstream media as slamming Trump’s tax cuts as unrealistic and aimed at helping the rich.
It is interesting to note the strong whiff of nationalistic sentiment in the negative official reactions to the US tax reform regarding why Beijing should follow Washington’s footsteps when it comes to its own domestic agenda.
Such thinking is counterproductive. China should know better: preferential treatment in the special economic zones, including a 15 per cent corporate tax rate for foreign investors, is one of the major factors which has attracted massive amounts of foreign investment and turned the country into “the world’s factory”.
In recent years, China’s economic climate has become tougher after the government unified its corporate tax rate at 25 per cent and as the costs of doing business – including labour costs and arbitrary government charges – soared amid an economic slowdown.
Ever since Premier Li came to power in 2013, cutting taxes and other costs and red tape have become a hallmark of his cabinet.
In the period from 2012 to 2016, China’s gross domestic product (GDP) slowed from 7.8 per cent to 6.7 per cent, but the growth in its tax revenues fell from 11.3 per cent to 4.8 per cent with the sharp drop suggesting the strength of tax cuts.
Last May, Li kicked off the country’s biggest tax overhaul in more than two decades by rolling out VAT to cover all the service industries and replace the business tax. This was aimed at easing the tax burden and encouraging factories to upgrade and innovate. At last month’s cabinet meeting, Li announced a flatter structure of VAT, which would streamline its current brackets into three, effective from July: 17 per cent, 11 per cent, and 6 per cent, depending on the goods.
Despite all those measures, the complaints about the tax burden from Chinese entrepreneurs, particularly from the manufacturing sector, have been on the rise.
The design of China’s tax regime is partly to blame as it relies too much on indirect taxes such as VAT and business tax, and about 90 per cent of its total tax revenues are borne by businesses. By comparison, US companies pay mainly corporate tax, accounting for about 11 per cent of the total government revenue.
On top of 25 per cent corporate income tax and VAT of up to 17 per cent, Chinese companies have to bear an additional 13 per cent tax for urban construction, education and flood prevention.
Furthermore, the businesses are also required to contribute up to about 40 per cent of employees’ base monthly salary for social security including retirement and medical insurance.
To make things worse, Chinese firms have to contend with a barrage of arbitrary charges imposed by the central government and local authorities, and there can be several hundred kinds of these each year.
Zong Qinghou, founder of the country’s largest beverage company, complained this year that his company paid more than 500 kinds of fees to the authorities at various levels, prompting the central government to launch a thorough probe which found his company effectively paid 317 kinds of fees, stripping out the duplicated reporting. The actual figure still shocked the nation. Premier Li was forced to admit there were too many arbitrary fees but he also acknowledged the difficulties to reduce those charges because of strong resistance from bureaucrats.
As a result, the government must redouble its efforts to reduce arbitrary charges and consider further lowering the corporate income tax, VAT, and social security contributions.
More importantly, it should also seriously consider introducing property tax and other direct taxes to make up for the shortfall caused by the cuts in corporate income tax and VAT.
Meanwhile, the government should also step up efforts to overhaul its problematic individual income tax regime which accounts for about 7 per cent to 8 per cent of China’s total tax revenue, compared to about 46 per cent in the US.
The biggest complaint is against the wide seven-bracket system, in which the highest marginal tax rate is set at 45 per cent. The high rates have caused the country’s wealthy to shield themselves by drawing low salaries and relying more on stock investments and company dividends which attract much lower taxes.
As the tax officials can only track those wage earners through their payrolls, the tax has lost its redistributive purpose. Even worse, many of those people currently heavily taxed are professional managers and talents the Chinese government has been trying to attract and groom as it develops an innovation driven economy.
For years, there have been consistent calls for lowering the top bracket of individual income tax to 25 per cent to help the middle class grow but the government has steadfastly refused, publicly arguing any reduction would benefit the rich and completely ignoring the fact the rich pay little in this category.
Despite their public arguments, the central government has long studied ways to further lower both corporate and individual corporate taxes as well as VAT but has fretted about the political and economic implications of overhauling the tax code.
Trump’s tax cuts should serve as a wake-up call and China should react more proactively to the impact instead of complaining and merely thinking about tinkering with the tax system. ■
Wang Xiangwei is the former editor-in-chief of the South China Morning Post. He is now based in Beijing as editorial adviser to the paper