China Tax Take Restrains Fiscal Policy

China cyclical picture looks good in 2023 and 2024 and we recently revised up our forecasts (here), but structural headwinds (slower labor force growth and sluggish productivity growth) will then slow the economy. Can fiscal policy support growth on a structural basis?

Figure 1: General Government Revenue (Pct of GDP) 

Source: IMF

China Fiscal Policy Space Restrained 

China has managed to navigate the 2020 COVID crisis and the last two years by monetary policy support (e.g. reasonable total social financing growth) and fiscal policy relaxation. China authorities have made clear that they will be proactive and targeted in fiscal support in 2023, including support for households. While this is the case for 2023, fiscal policy space in China is shrinking. The official government debt/GDP ratio has increased steadily through the past few years (Figure 2), but the wider IMF augmented government debt is set to surge to 120% of GDP in 2023.

Figure 2: General Government Debt/GDP (Pct of GDP) 

Source: IMF

China has a number of structural fiscal problems

• Local Government. Local government’s own tax revenue excluding land taxes is only half of their outlays, which means resorting to off balance sheet borrowing (one of the main reasons for the difference between the government and augmented government debt/GDP in Figure 2) and central government financing. With the residential property market remaining weak due to poor buyers’ sentiment and the ongoing slow restructuring of property developers, these imbalanced local government finances will likely remain and likely see a push to fiscal policy consolidation in 2024. The idea of a reoccurring property tax rather one off land taxes is seen to be too politically difficult.
• Low tax base and use of tax relief in fiscal policy easing. China general government revenue/GDP (Figure 1) has fallen since 2019 and is not projected to rise on current polices. The use of tax relief and fee rebates during stimulative fiscal policy phases is one reason, with the authorities biased towards this quick stimulus method. China also remains biased towards infrastructure investment as a fiscal policy stabilisation tool, rather than automatic stabilizers that help households. Meanwhile, income tax at 1% of GDP is well below the percentage seen in most other big EM countries, with no active policies planned to significantly widen the income tax take or reduce tax exemptions.
• Health/Unemployment safety nets and household savings/consumption. China authorities are making progress on building out its social security system to provide protection from unemployment/illness and to plan for retirement. However, China households have not been convinced that this is fast enough to reduce high precautionary savings, which could provide a more sustained boost to consumption and GDP growth once the post COVID cyclical upswing runs out of steam. China authorities have no plans to significantly accelerate the improvement in the social security safety net.

China authorities’ strong influence on financial markets means that they can convince banks and other investors to buy central government and local authority bonds, if another negative shock is seen in the future. Outside of a shock the better cyclical growth will likely swing towards 2024 fiscal policy consolidation. China tax revenues are too low and expenditure growth will likely be curtailed to provide multi-year space for fiscal policy.