SinoInsight 1
On Oct. 9, the PRC State Council published a plan for further tax and fee reductions. Part of the plan involves central and local governments each getting 50 percent of value-added taxes. Adjustments would also be made to improve tax sharing among local governments.
On Oct. 16, PRC premier Li Keqiang convened a State Council executive meeting where he stressed that the government must “persevere in ‘tough days’ ahead” and ensure that “cutting taxes and fees must be implemented properly.” According to a State Council press release of the meeting, tax and fee cuts in the first eight months of 2019 exceeded 1.5 trillion yuan, and estimated total tax and fee cuts will exceed 2 trillion yuan by the end of the year.
OUR TAKE
1. Li Keqiang’s latest call for local government to ensure that “cutting taxes and fees must be implemented properly” indicates that the central government’s orders are not passing the gates of Zhongnanhai (政令不出中南海), i.e. local governments are not following orders.
While Li’s 2018 government work report calls for “cutting taxes and fees,” the central government had to keep repeating that point in several meetings and dispatched supervision groups to the provinces to see that the task was “implemented properly”; the central government’s efforts, however, met with limited success. Concurrently, the central government sought to tighten its control over local government finances by merging state taxation agencies at the provincial level governments and below were.
Li’s 2019 government work report proposed a 2 trillion cut in corporate taxes and fees. The report also called on local governments to take the lead in saving money and find ways to raise funds, but did not provide any solutions. However, local governments still saw significant reductions in local government revenue due to a rapidly slowing Chinese economy that was further impacted by the Sino-U.S. trade war; local government revenue grew 0.1 percent year-on-year for the period between January to August 2019 while fiscal deficits reached a high of 1.6 trillion yuan in the same period (105.1 percent increase YoY). At the same time, local government revenue from land sales decreased sharply in the January-August period (4.7 percent growth YoY as compared to over 30 percent YoY growth in 2017 and 2018) and the local government funds budget incurred a nearly 800 billion yuan deficit.
Meanwhile, the “cutting taxes and fees” move became a financial burden for corporations because the CCP did not layoff much staff despite carrying out sweeping Party and state institutional reforms, likely due to concerns that mass layoffs would threaten its political power. To generate more income, local governments found other ways to boost their non-tax revenue (administrative fees, fines, etc.); local government non-tax revenue for the January-August period ended up growing by 27.3 percent (as compared to up o.1 percent YoY in 2017 and up 13.1 percent YoY in 2018).
2. By clarifying that the central and local governments would each get 50 percent of value-added taxes, the central government is likely meaning for local governments to boost their revenue and reduce their dependence on the private sector (and thus giving enterprises breathing room to grow). With more VAT revenue, local governments are also encouraged to not push up land prices.
The VAT split will likely translate into increased income for the wealthy provinces but will not make a big difference to poorer provinces that have been relying on central government funding and support. Conversely, the bulk of the poorer provinces will still be reliant on subsidies from the central government, while the richer provinces will remit less money to the central government. To make up for this deficit, the central government may have to source additional funding to bear the burden from state-owned enterprises or by issuing more bonds. This would inevitably lead to a depreciation in the renminbi and rising consumer prices.
The RMB could be devalued come December if China and the U.S. cannot reach a trade agreement or trade talks break down again, and China’s economy will be hugely affected.
SinoInsight 2
On Oct. 18, the PRC’s National Bureau of Statistics announced that China’s GDP grew by 6 percent year-on-year in the third quarter of 2019. The figure was lower than the 6.1 percent expected by observers, and was the lowest quarterly growth since quarterly GDP growth was recorded in 1992.
Xiang Songzuo, an economics professor at Renmin University of China, cast doubt on the official GDP figure on his WeChat account, noting that it was “obviously overestimated.” Xiang said that national fiscal revenue saw negative growth from May to September 2019; corporate profits had been sharply falling in the same period; individual income was not growing rapidly; and the individual tax revenue had dropped by nearly 30 percent in the previous three quarters. Given that the aforementioned indicators made up the GDP and were mostly declining or showed slower growth, Xiang asked, how was it possible to get GDP growth of 6 percent?
OUR TAKE
1. Xiang Songzuo’s skepticism is warranted. The CCP has long engaged in data fraud to show the world that the Chinese economy is going “full steam ahead” (形勢一片大好), has “resilience,” and can withstand a trade war. Meanwhile, local officials commit data fraud to secure political capital or demand more subsidies from the central government. For example, in early 2018, many provinces and regions suddenly admitted to data fraud in 2016 (as much as 30 percent variance) as they were preparing to release their 2017 GDP figures.
In 2018, we analyzed several instances where the CCP engaged in data falsification. For example, both the central and local governments stopped issuing data for fixed asset investment, economic benefit of enterprises, and other key economic indicators, but instead provided an unverifiable percentage growth figure. The unconvincing level of data falsification suggests that China’s economy is in a very bad state.
In December 2018, Xiang Songzuo openly questioned the official GDP figure of 6.5 percent at a public forum. He noted that an internal report by a research group of a very important institution estimated that China’s GDP had grown by either only 1.67 percent or is in negative figures.
2. China’s data fraud affirms our April 2018 analysis on why China cannot withstand a trade war with America:
“Should the CCP decide to go ‘all the way’ against America, it faces a tsunami of problems that could lead to regime collapse. Chinese exports would be hit hard, foreign investment would withdraw from the mainland, the manufacturing sector would go under, and unemployment would skyrocket, and Beijing’s fiscal deficit would be even more severe.
“As China’s foreign exchange earning capacity decreases, its foreign-exchange reserves would be reduced. And if the RMB exchange rate doesn’t have foreign exchange support, the yuan would depreciate and capital outflow would expedite. To repay foreign debt, Beijing would have to keep printing money, and banks would increase interest rates when confidence in the RMB falls. The devaluation of the RMB technically should promote exports, but it is unlikely that the depreciation would reach a stage where China can offset the additional costs of the 25 percent tariffs levied by the U.S.”
3. We believe that Sino-U.S. trade tensions will inevitably flare up again as factional struggle in the CCP prevents the Xi leadership from signing a trade deal with America. And a full-blown trade war would be disastrous for the Chinese economy. Businesses, investors, and governments must track the CCP factional struggle to better gauge China’s political risks and make advance preparations.
