China's New Corporate Tax Cuts and Investor Confidence
By Karen Wang, Associate Director Business Development
As its growth stalls and tariffs threaten international trade, China is turning away from the massive government stimulus programs it has implemented over the past decade and trying a more capitalist tack to spur the economy: tax cuts.
At a recent government meeting, Premier Li Keqiang, the country’s second-highest-ranking official after President Xi Jinping, announced a reduction of nearly 2 trillion yuan ($289.28 billion) in business taxes and fees annually for the next three years. The new measure further eases the corporate tax burden for China’s many small businesses, which also received a tax cut last year. In addition, the value-added tax (VAT) rate will be lowered from 16 percent to 13 percent for manufacturers and from 10 percent to 9 percent for the transportation and construction industries. The government also promises to expand tax breaks for venture capital firms that invest in high-tech startups.
China’s standard corporate income tax rate is 25 percent, above the OECD average of 23.5 percent. Its overall tax rate for corporations represents 68 percent of business profits, one of the highest proportions in the world, according to the World Bank.
Small businesses pay a 20 percent tax on some or all of their profits, depending on their size, and now the taxable portions are being further reduced. Lowering taxes could help companies boost employment, productivity and consumption without adding to the debt burden many already face.
Dealing With Debt and Tariffs
Over the past year, China has tightened lending restrictions and shut down projects in an effort to curb the massive amounts of debt that companies and local municipalities owe for large-scale developments in real estate, transportation and other infrastructure that didn’t adequately take into account market demand. But the problem is not easily fixed. An estimated $10 trillion is tied up in risky off-balance-sheet “shadow banking” loans.
The trade war with the U.S. has also affected the economy. Manufacturers and importers have suffered, and in an atmosphere of worsening profits, consumers are spending less. The economy’s growth rate, which slowed last year to 6.5 percent, is expected to remain steady or slide to 6 percent this year. The Chinese stock market has lost nearly $3 trillion in value over the past year, and more than 400 publicly-traded Chinese companies told investors that their results deteriorated in 2018.
Declining profits make foreign investors nervous. A World Bank report entitled Darkening Prospects warned that China’s slowdown could have a negative effect on countries that export to it. A Bloomberg study that analyzed the earnings calls of 195 S&P 500 companies found that 100 of them talked about a slowdown in China.
Tax cuts represent a market-based approach to stimulating growth, allowing businesses to invest more of their own money into capital improvements and innovations rather than relying on the government or unregulated and often unscrupulous private lenders. It’s the kind of move that could raise confidence among multinational investors, especially those outside the auto manufacturing, agricultural and telecommunications sectors, which are disproportionately affected by tariffs.
In addition to lowering taxes, China has pledged to ease restrictions for foreign companies entering its markets and allow more industry sectors to invest without joint-Chinese funding arrangements. "We will strengthen efforts to protect foreign investors' legitimate rights and interests," a new government report says.
The report promised to strengthen intellectual property protections for foreign companies, a sore point among Western companies, which have long complained about technology theft and forced technology transfers. In the report, the government promises to step up intellectual property law enforcement and increase fines for violations.
China also says it plans to bring market-based operations to its large, state-owned, industry-dominating companies, forcing them to be more competitive. It also aims to maintain a more stable renminbi exchange rate.
If China follows through, these reforms combined with the tax cuts could encourage foreign companies to do more business with the country despite its debt load and current international tensions. As China has grown more prosperous and people have migrated en masse to cities over the past decade, internet shopping is exploding and ordinary citizens are craving the trappings multinational companies can provide. Even if trade barriers remain, the prospect of serving 400 million middle-class Chinese consumers is difficult to ignore.