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China’s ‘Common Prosperity’ Campaign is Going to Be Tough Going

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China’s ‘Common Prosperity’ Campaign is Going to Be Tough Going

Fixing inequality would require fundamental change in China’s tax structure and state system – reforms highly unlikely under the current political system.

China’s ‘Common Prosperity’ Campaign is Going to Be Tough Going
Credit: Depositphotos

Chinese leader Xi Jinping has declared war on rich capitalists in a program grandly titled “common prosperity.” Given the challenges of China’s economy, he is going to have a tough time getting it off the ground.

The leadership in Beijing is attacking large companies but lacks the power or interest to alter the country’s underlying economic structure in ways that could significantly improve China’s significant income equality.

What exactly is common prosperity? Han Wenxiu, a top official in the Central Finance Office, called it doing “a good job of making the cake bigger and dividing the cake well.” The country’s new five-year plan is pushing for greater regulation of the economy, including the large tech firms like Alibaba and Tencent that have huge market power. Xinhua News Service also pointedly noted that China “must clean up and standardize unreasonable income, rectify the order of income distribution, and resolutely ban illegal income.”

The question is – how? Simply attacking tech moguls like Alibaba’s Jack Ma won’t do the trick. And forcing these companies to contribute billions to charity, which is a key aspect of the policy announcements, won’t make much of a dent in income inequality, which many agree has become a serious problem in China. China’s top 1 percent has more wealth than the bottom 50 percent, and its Gini coefficient of 0.47 ranks among the most unequal in the world, according to political scientist Elizabeth Economy.

The problem is that fixing this inequality would require the Chinese state to tackle fundamental change in its tax structure and state system – reforms highly unlikely under China’s current political system. The structure of the economy does not allow for easy fixes.

One of the major shortcomings is the lack of tax revenue. China’s share of tax revenue is 28.2 percent of GDP, compared with 31.8 percent in the U.S. and 40.3 percent for OECD countries, according to the IMF. Personal income taxes are a paltry 1.2 percent of GDP compared with 8.4 percent in the OECD. Public spending on health is relatively low at 2.5 percent of GDP. Tax rates are high, but the number of people paying is small and compliance is inadequate. As a result, fiscal policy has played only a limited role in “moderating income inequality in China to date,” the IMF noted.

Meanwhile, the bulk of responsibility for social services lies with the subnational governments, including provinces, cities, counties (very important), and cities. China is actually one of the most decentralized countries in the world – surprising, considering the authoritarian political system. Including local government companies, local governments account for a whopping 89 percent of total government spending. They are largely responsible for public service delivery and managing and financing the social safety net. China is unique in having both its public pension system and unemployment insurance managed locally, according to the World Bank.

So, with all these responsibilities for social welfare, how are the local governments doing? Some quite well, others a lot worse. Among China’s 31 provinces and provincial-level municipalities, 27 reported first half economic results as of July 23. Hubei, the center of China’s COVID-19 outbreak last year, achieved the highest year-over-year growth at 28.5 percent, triple the 9.1 percent expansion recorded by the landlocked northwestern province of Qinghai, which registered the lowest, according to Caixin Magazine. Based on a two-year average, Hubei and the northeastern province of Liaoning had the slowest growth at less than 3 percent while the island province of Hainan had the highest at 7 percent, beating the national average of 5.3 percent.

Historically, consumption has been relatively consistent across provinces. No longer. Before the pandemic, the biggest gap between the highest and lowest consumption growth among provinces was only 10 percent, according to Bloomberg data. In 2020, this gap expanded to 26 percent this year. COVID-19 just accelerated the widening consumption gap.

What can the government do? First, institute a property tax. Two cities, Shanghai and Chongqing, have been trialing this. The tax rate in Shanghai is set between 0.4 percent to 0.6 percent of the last-sale price, according to Bloomberg. (In the U.S., such levies can reach as high as 2.13 percent in places like New Jersey.)

However, there is little interest in instituting a national property tax because it could hurt local government’s biggest source of revenue – land. Last year, local governments raised 8.4 trillion renminbi (RMB) from land sales, almost as much as the 10.1 trillion RMB raised from other sources including sales taxes and personal and corporate income taxes.

Likewise, Chinese banks have loaned the real estate industry 50 trillion RMB, more than any other industry, accounting for about 28 percent of all loans. About 35.7 trillion RMB were mortgage loans to households and 12.4 trillion RMB were for property development. A shaky property market could impact the stability of the financial system.

Meanwhile, China has a woefully inadequate personal income tax, with high official rates but little compliance. Personal income taxes raise only 1.2 percent of GDP in revenues, compared to around 10 percent of GDP in many advanced economies and an OECD average of 8.4 percent of GDP. Revenues from social security contributions are much higher at 6.5 percent of GDP, but are nevertheless below the OECD average of 9 percent.

Even worse, most of the current tax is aimed at high spenders, many of whom evade taxes. Enforcing compliance would not be easy. And expanding the tax system into lower income groups would attack the very people Xi Jinping is trying to help.

Another possible reform is improving the country’s regressive consumption tax. Last year, personal consumption in China was $5.8 trillion compared, with personal consumption of luxury goods of $250 billion. However, increasing the tax on high end goods – such as elite clubs and aircraft – would be unlikely to compensate for lowering the consumption tax on lower-end goods.

Thus, Beijing policymakers are stuck with ad hoc campaigns against the technology companies, demands that CEOs contribute to charity, and calls for redistribution of income – but no fundamental restructuring of the tax base, fiscal system, or the state firms that grab a big chunk of national capital. Fundamental reforms are a lot harder than bold policy pronouncements.