Fiscal policy reform is on China’s agenda again. Its structure—both for taxation and public spending—was established in 1994, when economic records were still on the horizon and entry into the WTO was an improbable chimera. Not by chance, it was Lou Ji Wei, chief negotiator for Beijing’s entry in 2001, ex-head of the China Investment Corporation, and the current Minister of Finance, who labored for elusive reforms. The political means were provided at the CPC’s third plenum last December. The ambitions are two-fold: reform fiscal policy and rebalance the economy. Typical in China, each step is instrumental for the successive, more important steps. There’s the urgency to intervene because the country is big, powerful, and rich, but simultaneously harder to manage. Twenty years ago, the first structural reform in China’s history tried to find a middle ground between entrepreneurial exuberance and the need to maintain social order. The industry’s priority put a base level of pressure on businesses, especially because they wanted to attract foreign capital necessary for growth. A series of tax burdens were collected with not always legal ploys. Beijing’s demands were superimposed on local—and certainly less stringent—regulations, and created an undefined and misguided situation. A recent report by the US-China Economic and Security Review Commission describes the situation like a “balkanized system.” At the same time, the great majority of the population doesn’t pay income taxes because it doesn’t fall within existing limits. In general, China has one of the lowest ratios between its GDP and taxes; furthermore, only 8% of Chinese families are subject to income tax. Even in this case the attempt to promote investments while protecting the lowest strata of the population is evident. The annual wealth growth has made this operation impossible. On the other hand, consumption of imports was penalized by high duties, while the nascent service economy didn’t receive the same benevolent treatment as the industrial economy. The system’s opacity was then inserted/ into this regulatory framework: preference reserved for industrial businesses, difficulties collecting taxes, corruption, and local governments’ impatience for Beijing.
Now, remedying strong imbalances is necessary. China can accomplish this because it has a public debt of only 2.9%—which is absolutely tolerable—while the value of the public debt is unknown, especially due to the difficulty quantifying local debt. The first reform on the table is the substitution of the business tax—that primarily affected services—with a VAT applied to all sectors. It should produce equal and diffuse treatment that takes the country’s changes into account. Manufacturing’s priorities and privileges (which are now flanked by banks, railways, and IT) will be relegated to history, and it tries to cast light on the shadows state-owned enterprises have created. Paying fewer taxes allowed them to accumulate enormous reserves that favored personal channels and not common interests. Furthermore, the responsibilities of polluting businesses will be increased and those that continue to burn coal. Environmental violations have become intolerable, just like the un-breathable air experienced in Beijing today. New and likely heavy taxes will accompany real estate, personal wealth, and luxury purchases. The inteded motive is to intervene in an administrative manner to reduce the growing and dangerous social disparity. When it comes to spending, the government will continues its expansion cautiously, in line with the growth of a no-longer-developing country. Therefore, Keynesian attempts to conjugate support and public spending to a leveling property tax will likely characterize China’s future moves. It means that the other solutions—wild industrial liberalism and severe policy control—while effective certainly need to be reexamined.
