Bigger Tax Cuts Make for Smart Policy

In recent months, China has launched a series of measures to deal with sustained pressure on its economy posed by escalating trade disputes with the US. On October 7, China's central bank announced a cut to the reserve requirement ratio (RRR) of banks. This aims to lower financial costs and spur economic growth. Meanwhile China's Ministry of Finance pledged it would aim to cut 1.3 trillion yuan (US$187B) in taxes and fees by the end of the year.

For much of the year, trade disputes with the US and the resulting uncertainty have posed a major threat to China's economy. With such disputes set to continue, China should not adopt a tit-for-tat approach in response to US unilateralism. Instead, China should focus on pushing its internal economic reform and promoting the competence and efficiency of its economy.

A key aspect of the reform is realigning the relationship between the government and companies. In the past year, this has been characterized by increasing government revenue that has outstripped GDP growth – typically at twice the rate – meaning the tax burden has steadily increased in past years despite tax cut moves.

A major reason behind this is the desire of governments at all levels to take control of the economy. As a result, the relationship between the government and the business world, especially in the private sector, has often been competitive in nature, with the government often directly intervening in the economy.

Another reason is the rapid increase in the government's tax administration capabilities. China's high tax rate was in some ways a function of its inability to collect tax effectively. But as technology has advanced and tax collection has become more efficient, China has become one of the world's most taxed economies, with this regime becoming detrimental to the economy.

These issues are particularly important because the world's major economies have been enacting tax cuts. In late 2017, the US launched a new tax plan to simplify personal income tax and cut corporate tax from 35 percent to 21 percent. Japan approved a plan to lower its corporate tax rate from 30 percent to 20 percent. And the UK pledged to lower its already low corporate rate from 19 percent to 17 percent in 2020. More recently, the French government said it would roll out 20 billion euros (US$23.5B) in tax cuts for business and six billion euros (US$6.8B) for households in 2019.

While China has also launched tax reforms in the past few years, none have created a significant drop in the overall tax burden. In the first half of 2018, total government revenue increased 10.6 percent on the same period last year – considerably higher than the 6.8 percent increase in GDP for the same period. Even after recent reforms to personal income tax, the highest tax rate for personal income remains at 45 percent, higher than many other countries.

To deal with the threat of an economic downturn, China should adopt more drastic tax cut measures to inject new vitality into the economy. Tax cuts are the most direct way to attract investment and talent. With an overall tax burden that is one of the highest in the world, China has ample room to do that. To boost domestic consumption, China can cut the consumption tax. Only by revitalizing its economy can China deal effectively with the various challenges ahead.

China should not adopt a tit-fortat approach in response to US unilateralism. Instead, China should focus on pushing its internal economic reform and promoting the competence and efficiency of its economy