Amid talk of presidential term limits, growth targets and combating pollution and corruption, taxes have quietly emerged as a key issue for China's National People's Congress.
Premier Li Keqiang promised on Monday to cut taxes and fees for businesses. This could provide an important source of economic stimulus at a time when overcapacity reductions, deleveraging and measures to reduce financial risk are weighing on growth. Yet Beijing cannot just slash taxes. To put the real estate market on a sounder footing, it is also vital that officials move ahead with implementing a property tax after years of inconclusive discussion.
Li's pledge on business taxes was partly prompted by the recent reduction in the U.S. corporate income tax rate to 21% from 35%. In China, the standard corporate tax rate is 25% but that is compounded by value-added taxes of up to 17%.
While headline tax rates for Chinese companies may not appear too far out of line, World Bank statistics show that some 67.3% of Chinese corporate profits go to taxes. This compares with 48.3% in the U.S. and a global average of 40.5%. The heavy burden on the Chinese corporate sector is mainly due to mandatory employer contributions for employee pension funds, housing support and medical, unemployment and disability insurance.
Until now, repeated pledges to lower the tax burden have had little impact. The authorities last year promised to cut the tax burden on corporations by 1 trillion yuan, mainly through VAT reform, but VAT revenues actually rose 8%.
Li said in his address to the congress that China's three VAT brackets will be consolidated into two, with the manufacturing and transportation sectors in particular in line for cuts. He added that mandatory employer contributions will be reduced too.
While their heavy tax burden handicaps the competitiveness of Chinese companies in the global market, government subsidies complicate the picture. State-owned enterprises in particular receive large subsidies from every level of the Chinese government in the name of industrial policy. This support has prompted growing complaints from trade partners, including anti-dumping and anti-subsidy investigations by the U.S.
Beijing should consider scaling back industrial subsidies to ease trade tensions. While the details of Li's tax cut plan are unclear, the authorities should look at giving relief to all companies by lowering the top VAT rate to 13% from 17% and trimming overall mandatory employer contributions to around 30% of employee salaries from above 40% over several years. Cutting business taxes and subsidies at the same time would minimize the impact on the country's fiscal balance.
As with reduced corporate rates, the introduction of a national property tax system has long been on the official agenda. Since 2011, the cities of Shanghai and Chongqing have been collecting property taxes in pilot tests. Shanghai's tax applies to second-home purchases while Chongqing's covers just high-end residences.
Following remarks by President Xi Jinping at the Communist Party Congress in October that "houses are for living in, not for speculation," Finance Minister Xiao Jie a month later said that the government aimed to push through property tax legislation by 2019. Premier Li affirmed on Monday that a law is under preparation.
Ballooning prices have pushed China's largest cities to the bottom of global rankings of housing affordability. Yet government resolve to tame prices has been tempered by the official obsession with economic growth, in that the property sector and related industries contribute as much as a quarter of gross domestic product.
Until now, Chinese investors have correctly bet that the authorities would not hold to tightened housing policy for too long amid slowing growth momentum. The policy pendulum has thus swung between overtightening and excessive loosening. This oscillation has encouraged, rather than dampened, speculative demand and all along, house prices have kept rising.
Past cooling measures, including direct home purchase restrictions and tightened mortgage rules, have not proved very effective. Such measures blindly impact all demand, whether from would-be occupants or speculators. Even the fine-tuning of such measures can lead to increased market volatility, given that limited supply in top markets cannot meet both the long-repressed demand of real users and the unbridled appetites of speculators.
A property tax would help to better balance end-user demand and supply. Even a flat tax on property holdings tends to exert a larger financial burden on speculators as they tend to hold more property than real users.
Many Chinese investors lock up acquired units, holding them purely for long-term capital gain and not renting them out regardless of demand. As such, a well-designed property tax should drive many such speculators to release some of their holdings onto the market, increasing effective housing supply and relieving some pressure on prices.
Although property taxes look like a good weapon to prick China's housing bubble and ensure the sustainable development of the housing market in the long run, local governments have so far strongly resisted the notion as their fiscal revenues now hinge on land sales. The worry is that implementation of a property tax could lead to large-scale market corrections, squeezing local government land revenues in the short term even though the tax should be a good source of revenue for them in the long run.
The central government seems to be signaling determination to set aside such objections and press ahead with a property tax. This is definitely a welcome step. However, many uncertainties remain. The authorities have not revealed whether the national tax system will follow the Shanghai or Chongqing models or a new one.
To meet the timetable of finishing legislative procedures in 2019, the authorities should unveil the outlines of the tax system at the NPC. This would give adequate time for the market to absorb the changes. A nationwide property tax seems to be in the works at last. The market needs to be prepared for it.
Xia Le is chief economist for Asia at BBVA Research. He is also a research fellow with the International Monetary Institute at Renmin University of China.