What could Beijing do to offset the adverse impact of the escalating US-China trade war?
Fighting back with tariff hikes or limiting the damage by further depreciating the renminbi may not work well. I believe cutting taxes to stimulate domestic demand is the best way.
China’s economy has three main engines: infrastructure investment, exports and consumption.
Infrastructure spending has proved to be rather ineffective, as shown by numerous white elephant projects scattered across the country.
Export growth has long decelerated. Given the current US-China trade war and the prospects of new regional trade partnerships among Europe, the United States and Japan, China cannot reasonably hope to see any breakthroughs in its trade volume.
However, massive tax cuts – not only personal income tax but also corporate tax – will make a big difference.
Just look at the US. Its Congress passed the biggest tax reform in three decades last year. Business tax has been slashed from 35 percent to 20 percent. As a result, GDP growth hit 4.1 percent in the first quarter while retail growth rose by over 4 percent. The unemployment rate also tumbled to a record low, while the stock market continued to set new highs.
China also launched various tax cuts at the beginning of this year. But the government’s tax revenue still recorded growth in the first half.
China’s business tax rate exceeds that of the US. Along with other operating expenses, taxes have put considerable pressure on the business sector.
A mainland glass tycoon decided to open a factory in the US last year, citing lower costs in land, energy and taxes.
What he didn’t mention is the cost of funding, often ranging between 6 and 8 percent, which may rise further against the backdrop of financial deleveraging.
Meanwhile, Chinese companies may soon encounter another round of surging costs. Starting from Jan. 1, 2019, tax authorities will collect various social security fund contributions that cover benefits like medical and unemployment insurance, directly from companies.
Currently, many companies have not paid full social welfare benefits to their employees, but the malpractice may end soon.
If business owners are struggling with heavy taxes and other costs, how could they invest in innovation or offer pay rises to their employees?
Tax cuts are the most efficient way to boost consumption and the economy as a whole.
China’s trade surplus with the US accounts for less than 3 percent of the GDP. A pickup in domestic consumption can easily offset the impact of a trade war.
This article appeared in the Hong Kong Economic Journal on Aug 13
Translation by Julie Zhu
[Chinese version 中文版]
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