Richard Herd: No Need To Cut Taxes In China; Instead Raise Government Deficit For Fiscal Stimulus

Summary: In this episode of China Money Podcast, prominent China economist at the Organization for Economic Co-operation and Development (OECD), Richard Herd, takes on China’s tax systems and financial reform. Contrary to popular opinion, Mr. Herd disagrees with policy suggestions to cut taxes as fiscal stimulus. As he sees it, China’s tax burden on companies and individuals is still light. Listen to the podcast or read the excerpt below. Q: In your research report, you pointed out the strong fiscal position of the Chinese government. The government has little net debt, and fiscal revenue has been growing at an average of 1.5 times of nominal GDP. Therefore, some Chinese economists are calling for tax cuts. Do you think that will be a good policy move? A: Over the past 15 years, the growth in tax revenue has been quite rapid. But it was needed and was rooted in the tax reform of the mid 1990s. It lifted, in total with social security, government tax revenue to around 30 percent (of GDP). I think 30 percent, or perhaps 35 percent (of GDP), should be enough to cover most of the governmental expenditure needs. It will allow for a considerable increase in social benefits that’s so badly needed. Beyond that, there is a need to reform taxation so that tax revenue doesn’t grow too rapidly. The disincentive effect is still quite limited because most people still don’t pay income tax. The main problem on incentives with the taxation system is in social security, where social security contribution (by employers) is around 40 percent of a person’s wage, that’s probably too high. Some of that too should be transferred to general taxation so that the incentives for employing labor are not cut too much. As to whether taxes should be cut at this moment, I think that some of the main calls to cut taxes have come from those who think that the Chinese economy is going to a hard landing this year. I don’t think that seems at all likely at the moment. The need to reduce taxes is much less than a trillion Yuan. In fact, the government has announced income tax cuts and also stimulus programs to slightly raising the deficit to around 400-500 billion Yuan. That will go quite a long way to getting the economy going again. Q: The domestic economists are arguing that the tax burden for individuals and companies are too heavy. Sounds like you have a different opinion? A: I think that the tax rate for companies is 25 percent. That’s quite low by international standards. The tax rate for most individuals is, well, only a very small proportion of the Chinese population actually pays income taxes. You could perhaps say that in relation to other transition countries, China’s top tax rate is quite high because it’s at 45 percent. It’s much higher than in Hong Kong for example, which is 15 percent. But on the other hand, China has a bigger social system than Hong Kong. The 45 percent tax rate doesn’t come until someone earns 36 times of the average wage, even then it’s just very few people who pay 45 percent. There is certainly a case for trying to move some of the social security contributions paid by the employer to a more general tax base. Q: You said the government’s increasing the deficit to around 500 billion Yuan is sufficient to stimulate the economy, but of course, you still think that the government should (further) loosen monetary policy, right? A: Yes, indeed. The People’s Bank of China has reduced the reserve requirement ratio (RRR) twice now. That’s had an impact on interbank interest rates. Some more RRR rate cuts is likely in the next few months. Also, the growth of credit has picked up as well. That too should stimulate the economy. Q: Lately, there have been many new policy initiatives in Beijing to reform the financial sector, including an experiment program on private lending in Wenzhou, setting up another offshore RMB center in London, significantly increasing QFII (Qualified Foreign Institutional Investors) quotas.