Chinese policymakers have long been aware of the unbalanced, unsustainable and uneven nature of the country's debt-driven and investment-reliant growth model.
Yet whenever economic growth momentum has slowed over the past decade, the authorities have chosen to prioritize short-term growth. In 2009 and 2016, this resulted in bursts of credit-backed infrastructure stimulus which only exacerbated the country's debt problem.
Beijing, however, has taken a different approach since signs of a slowdown emerged last spring. This time, reducing the fiscal burden of the private sector has become a top priority, with taxes and fees equivalent to 1.4% of gross domestic product eliminated.
As the nation's top policymakers gather this week for the Central Economic Work Conference in Beijing, more business tax cuts should be on the agenda.
In the coming year, the authorities should further lighten the fiscal burden of the corporate sector by reducing value-added and corporate income taxes as well as other government fees. Employer levies for social welfare programs should be lowered to offset an expected rise in the actual burden as collection enforcement is strengthened.
Stepped up tax cuts should lead to a more efficient allocation of economic resources in China. This in turn would provide a boost to long-term productivity and debt sustainability. It could also help to spur consumption and create more room for the expansion of the innovative private sector, long the country's leading generator of new jobs.
Notably, the fiscal burden of Chinese companies is higher than that seen in most emerging economies. While tax revenues still amount to less than 20% of China's GDP, the total fiscal burden for business exceeds 35% of output.
This is nearly on par with the 40% average of the advanced nations in the Organization for Economic Cooperation and Development. Indeed, the World Bank's last annual "Doing Business" survey found that China's overall tax rate for corporations represented 68% of business profits, one of the highest proportions in the world.
There is scope, moreover, for tax simplification. China's many-tiered VAT system has high administrative costs and tempts gaming by companies seeking entry to lower rate levels. At the least, the highest-tier rate, which applies to manufacturing, should be trimmed next year to 14% from 16%.
China's base corporate income tax rate of 25% is high, topping the OECD average of 23.5%. It should at least be cut to that level but policymakers should also consider tax exemptions for small and medium-sized companies and other and targeted businesses.
If trade tensions with Washington resume, policymakers could look at further increasing tax rebate rates for exporters. The employer levy for social welfare programs, equivalent to as much as 35% of a worker's salary, should be trimmed too as it is significantly higher than OECD levels.
These kinds of tax cuts can give China's economy more of a boost in the medium-to-long term than spending the equivalent funds on public infrastructure. China's public capital stock per capita is already on par with that of OECD economies and returns on these investments have declined notably in the past decade. The country's private capital stock per capita, by contrast, remains low.
To facilitate tax cuts, the central government should allow its budget deficit to rise as high as 3.5% of GDP next year. This would compare with this year's 2.6% target.
The central government is arguably the only sector in China with space to step up leverage to help juice up growth. Corporate debt remains excessively high and household debt has ballooned rapidly over the last few years with the run-up in mortgage borrowing.
Local governments are cash-strapped with the costs of cleaning up shadow banking debt and could see a plunge in land sale revenues if there is a housing slowdown. So the central government needs to make sure it shares enough tax revenue with local governments who otherwise might be disinclined to fully implement national corporate tax cuts.
Now that Beijing has started down the track of tax cuts, it should stick to it. The impact of announced and suggested tax cuts could boost real GDP growth by around half a percentage point next year, potentially enough to offset the impact of the U.S. tariffs implemented so far.
More benefits would come later as companies spot opportunities to deploy their tax savings and begin to generate returns from their investments. Letting the market work in this way may not give the economy as quick a stimulus as higher infrastructure spending, but it will be much more meaningful for long-term growth.
Wei Yao is chief China economist and lead Asia economist for Societe Generale. Michelle Lam is the bank's greater China economist.