(Bloomberg) -- Xi Jinping’s government has finally outlined its plan to fix a regional fiscal crisis that has weighed on China for years. Economists say it’s not nearly enough.
The ruling Communist Party signaled at a key policy meeting last week that Beijing is willing to share its tax revenue with regional governments while easing their spending burden, one of the country’s biggest tax revamps in decades. A core part of the plan involves passing the proceeds of consumption levies — which currently goes entirely to the central government — to cities and towns.
But the consumption tax generated just 1.6 trillion yuan ($220 billion) last year. That pales in comparison to the record 15 trillion yuan deficit accumulated by provinces, cities, and towns across China last year, with a similarly dire budget shortfall anticipated for 2024.
“The fiscal reform plan reads more like a realistic but marginal remedy with the grip on local government debt still tight,” Citigroup Inc. economists including Yu Xiangrong wrote in a note.
Beijing is under pressure to deleverage local governments that have been hit hard by a property slump and sliding land sales. At the same time, sluggish consumption has weighed on the economy. Giving a larger portion of consumption tax to regions could in theory address both issues by incentivizing local officials to lift consumer spending and offering them a new finance stream.
Yet there’s been no details about expanding the range of products subject to the consumption tax or increasing the tax rate, according to the resolutions announced Sunday after the conclusion of the twice-a-decade Third Plenum.
Beijing will “take steps to move excise tax collection further down the production-to-consumption chain, with the power of collection steadily being passed to local governments,” it said.
What Bloomberg Economics Says ...
“The plenum discussed plans to better align local government spending and resources, particularly at the city and county levels, as expected. This is a welcome sign. Wide budget deficits and heavy debt loads are long-standing issues for local governments – and are impeding growth and undermining financial stability.”
— Chang Shu, Chief Asia Economist
Read the full report here.
Although the fiscal shift will be gradual, a larger share of the consumption levy as well as the value-added tax will be passed onto the local governments, according to Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis SA.
Local governments may also be able to increase the number of products subject to the consumption tax, she said. Among other items, it’s currently levied on luxury goods, alcohol, cigarettes and gasoline.
The VAT yields far more income than the consumption tax. Of the 7 trillion yuan in such revenue last year, half went to local governments.
“While the shared consumption tax may only account for a limited amount of local government income at the beginning, I would expect it to be adjusted to offer more funds to local governments,” said Australia and New Zealand Banking Group economist Xing Zhaopeng.
“The goal would be to keep local government income stable,” Xing said. “I don’t expect significant increases but it would be a way to ensure local government income levels do not drop.”
Other changes outlined in the document may also help to boost local finances, with towns to be allowed some leeway in setting the rate of local surcharges for education and other services, looser rules on spending money from selling special local bonds, and more power over non-tax revenue sources.
The resolutions also doubled down on calls to resolve “hidden debt risks,” which usually refers to borrowing by off-balance sheet entities affiliated with local governments.
The approach marks a continuation of recent policies that have tried to force the authorities to bring more of the borrowing back onto their official balance sheets. If successful, that would raise their debt and repayment burdens.
While China’s attempt to shift revenues and collection to local levels of government is a sensible move, it could be hard to stop tax avoidance with decentralized enforcement, especially from e-commerce, said Bert Hofman, who used to head the World Bank’s office in China.
“This does not increase the pie, but makes spending more efficient if done well,” he said.
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