US Tax Bill Spillover :
High-profile cuts to US company tax rates have Chinese experts debating the best way to prevent commensurate capital flow
Rules of Attraction
The tax cut legislation that has dominated the US domestic policy agenda in recent months has been debated just as hotly in China. For Chinese political analysts, the issue has shed new light on the profound social and political changes taking place in the US. Meanwhile, Chinese economists have focused on whether China should follow suit. Unsurprisingly, as is the case in the US, most attention has focused on the latter. After all, taxation affects everyone.
In China, the issue of how to reform corporate and personal taxation has proved controversial. Chinese companies lobby against heavy taxes, citing these as a reason why they move to other markets – including the US. Chinese households want higher tax thresholds to keep more spending money in their pockets. These voices have grown in strength recently as China's growth, though still the fastest of all major economies, faces shrinking private investment and consumption, com- pounded by mounting pressure from capital flight. Once the US lowers taxes on business and increases its interest rates, money will be even more motivated to flow to the US to chase higher returns, whether from direct or portfolio investments.
China has reformed corporate taxation in recent years to encourage investment. And Chinese economists, and even top official media, have apparently reached a consensus that China must take non-tax burdens more seriously if it hopes to win the hearts (and wallets) of investors.
Shock Waves
Andrew Choy, the international tax services leader at Ernst and Young Greater China, told Newschina the company has had plenty of recent inquiries from Chinese clients – USinvested and domestic – about the US tax bill approved by Congress. Choy explained how the bill, once implemented, could af- fect capital flows. First, US companies will not have to pay the difference between the higher US tax and lower tax in foreign markets when they transfer profits back to their US shareholders. The bigger the difference is, the more tax savings US companies may achieve. Under the existing tax system, some US companies with global reach prefer not to transfer their overseas profits to fund US projects because of potential tax costs. In China, the difference is particularly high for companies officially certified as hi-tech firms enjoying China's preferable corporate income tax. Secondly, companies in the US will be able to have immediate deductions for their expenditure on qualified property. These measures, combined with lower corporate income taxes, are designed to encourage US companies to recover their overseas earnings and all companies in the US to invest in jobcreating projects in the US.
If the tax cut bill further boosts US growth,
the US dollar will be strengthened, and the US Fed will accelerate the pace of interest rate rises. This will reinforce the effect of siphoning capital to the US from other markets. For China, there is widespread concern over the resurging pressure of the depreciation of the yuan. Some analysts have already attributed the recent devaluation of the yuan's official parity price for 11 trading days in a row to the impact of the US tax bill legislation.
China's recent response to the US tax bill appears more moderate than it was a few months ago. In an April editorial, Party mouthpiece the People’s Daily labeled the proposed tax bill a “tax war” which would “disturb the global order of taxation” and “hurt the interests of export-oriented countries which are not able to join tax competition.” By contrast, after the Senate passed the bill in early December, a report in the overseas edition of the People’s Daily said the US action was designed to improve its own interna- tional competitiveness, and thus should not be regarded as a “provocation” or a “war.” The report even noted that the tax cut, if successful in boosting the US and global economies, would also benefit China.
Chinese analysts also have deep doubts over the effect of the tax cuts, even if they are implemented. At a forum in Beijing on December 7 sponsored by the Beijing-based think tank the Center for China and Globalization, Huo Jianguo, a CCG researcher and former president of the Chinese Academy of International Trade and Economic Cooperation, stressed that it was largely the information technology revolution, not the tax cuts of the Reagan administration, that underwrote the US economy's recovery and boom from the 1980s. Also, companies have to take other factors into their investment decisions, including the availability of a local supply chain and markets for their products and services. Huo concluded that the US tax cuts might not affect China's capital flow as much as expected, at least in the short term.
“We expect continued US investment in China even with tax reform in the US,” Kenneth Jarrett, president of the American Chamber of Commerce in Shanghai told the Global Times.
Internal Repercussions
This does not mean China can just wait to reap whatever benefits are brought either by the success, weaknesses or failures of the US tax cuts. Foreign companies in China pay tax to China when they send their profits back to their overseas shareholders. China's State Council decided it will annul this tax on the condition companies reinvest the money in China. The implementation rules are yet to be formulated.
The bill has also fueled long debates over whether China should lower company taxes further. At a press conference in Beijing on
December 14, Mao Shengyong of the National Bureau of Statistics of China called on the nation to further reduce taxes and charges to ease the burden for businesses.
In reality, there's probably not much China needs to do, or even can do in this regard. A public relations director of an Internet company in Beijing with branches in the US, who spoke to Newschina on condition of anonymity, said the US cuts would make it a more attractive destination for China's Internet companies (many of which already have US operations). But he doubts whether the cuts will last long, and says it depends on how effectively they boost growth, and whether US President Donald Trump and the Republican Party win the 2020 election.
Huang Xiaojun, managing director and head of strategy and research at the Bank of China, New York, does not think the tax cuts will immediately trigger a surge of Chinese investment in the US. Generally, he says, they will help improve the profitability of Chinese companies there and boost US consumer demand for Chinese products. However, this impact may be offset by Trump's “America First” strategy and stricter scrutiny of mergers and acquisitions and foreign investment in the US. In addition, specific terms in the bill are subject to debate by US legislators. Finally, complying with the new rules will mean adjusting tax management, cash flow, investment and finance decisions and valuation for all companies. He said Chinese companies should observe the US tax bill carefully.
So far, the consensus among analysts and officials seems to be that China needs to restructure its tax system, rather than taking the US approach of lowering corporate income tax. Currently, China's corporate tax rate sits at 25 percent, not much higher than the 21 percent in the US tax bill. Small businesses and hi-tech companies enjoy lower taxes than this, which saved them around US$55 billion over the first three quarters of 2017, according to China's State Administration of Taxation. Besides, replacing business operation tax with value-added tax to eliminate dual taxation reduced corporate tax bills by more than US$170 billion over the 14 months to the end of September 2017. Choy does not think the cost of operating a business in China is much higher than in the US if both taxes and labor welfare are taken into account. In a recent article, Chinese Finance Minister Xiao Jie disclosed that taxation reform would focus on distribution and types of taxes.
There are also fiscal constraints preventing China from lowering its corporate taxes. According to Chen Gong, chief analyst with Anbound, a think tank in Beijing, these constraints include more government spending to deal with the pressure from a growth slowdown, social security deficit, demand for investment in poverty alleviation, and the economy's already high debt ratio. He predicted that China would impose longawaited taxes on homeowners sooner than expected.
Outside the Tax Bill
“Tax cuts in China are not the once-andfor-all solution to business burdens in China; they are not even the solution to the biggest burdens on business in China,” writes Jia Kang, former chief of the Chinese Academy of Fiscal Sciences, in a recent article for the Chinese Cadres Tribune co-authored with Dr Ou Chunzhi, also of the institute.
There are calls to address issues other than tax to attract investment from both foreign and Chinese sources. In the first 10 months of 2017, foreign direct investment from the top 10 sources to China was down by 2.7 percent over the same period of 2016.
Investment from the US and the EU declined by 19 percent and 9 percent respectively. Huo said that this was because foreign companies, including those from the US, had already begun sending their profits back home, rather than reinvesting in China. He argues that the key to stabilizing FDI in China is to open further the high-end manu- facturing and service sector, where there are new profit-making opportunities for foreign companies and unsatisfied demands from Chinese consumers. In addition, China needs to define what a good business environment means. For example, it may include transparent policy-making processes.
He Ning, also a CCG researcher and former director-general of the Department of American and Oceanian Affairs under the Ministry of Commerce, agrees. He told the CCG forum that China's business environment must improve if it is to retain both Chinese and foreign companies.
US and European companies in China have been complaining that they feel less welcome. He thinks this is partly because of the fiercer market competition in China, but also partly because of problems in the business environment. He warned that US tax cuts might make them less willing to accept the existing state of affairs. Indeed, tax differences have not been a major concern of US or European companies in China in their annual surveys. Their main gripe has been with what they see as the slower-than-expected implementation of market-oriented reform.
Private Chinese companies have also reduced their investment in China. Over the first 10 months of the year, private investment in fixed assets grew slower than total fixed asset investment in China. Many guidelines have been issued in the past few years to reverse the trend.
As Jia Kang stressed, competition for production resources between China and the US beyond tax includes “a high standard rule-based business environment.” He Ning said several Chinese companies involved in conventional manufacturing, like textiles and plastics films, told him they went to the US for a more predictable regulatory environment and more stable electric power supply.
A better business environment will serve as a sufficient “hedge” against the impact of the US tax cuts, Huo concluded.