China’s Tax Revenues: An Embarrassment of Riches

You’ve got to love the timing. With U.S. mired in a debt and spending crisis, with tax revenues stagnant and its government about to run out of borrowed money to spend, the Chinese government just announced that its fiscal revenues during the first half of 2011 rose by 29.6% compared to a year earlier. One country is a fiscal train-wreck, the other a fiscal gusher.

China’s tax revenues are surging for a host of reasons that set it apart from the US – the economy is booming, and in particular, businesses are thriving. According to the Chinese Ministry of Finance, profit taxes are growing especially quickly. Income and corporate tax rates are stable, at rates far lower than the US. China levies a nationwide VAT, while most of the US charges sales tax. Consumer spending is growing by over 20% in China, while it’s basically flat in the US.

To all these must be added another crucial difference: China is modernizing so quickly, that every year money pours in from new sources. China doesn’t need to raise tax rates to increase tax revenue. It just allows its citizens to get on with their lives.

Take auto sales. A decade ago, China produced and sold about two million cars. This year, it will sell about 20 million. China passed the US two years ago to become the world’s largest auto market. Since then, sales have grown by a further 40%.

Along with creating some of the world’s worst traffic congestion, all these new car sales do wonders for the country’s fiscal situation.  Start with the fact that every car sold in China has not just a 17% VAT built into its price, but a host of other taxes and levies. A consumption tax adds as much as 40% more to the sticker price depending on the size of the engine. Customs duties are also levied on imports.

These all add up fast. The government’s tax take from the sale of a single Mercedes-Benz can easily top Rmb325,000 (US$50,000). Last year alone, sales of Mercedes-Benz in China doubled. This year, Mercedes will sell about 180,000 cars in China. Total tax take: about USD$1 billion. Keep in mind that Mercedes-Benz has less than 1% of the Chinese market. BWM, Porsche and Lexus are also doing great in China. While they are all doing well, the Chinese government does even better. The government earns far more on the sale of every luxury car than the manufacturers do.

The sales and consumption taxes are just the start. Most news cars in China are sold to new drivers. That means, every year, there’s a significant net increase in the consumption of gasoline. Each liter of gasoline also carries a variety of different taxes – VAT, consumption tax, resource tax. Plus, almost every gas station and refiner in China is owned by companies majority-owned by the Chinese government. So, profits at the pump flow back to the government.

At the moment, the gasoline price in China is about Rmb7.5 per liter,  or Rmb30 ($4.60) per gallon. Figure the Chinese government is making about Rmb10 ($1.50) per gallon sold in tax. Each new car sold this year will likely contribute an additional $500-$600 in fuel taxes, or about Rmb100 billion in total. Again, a big chunk of that will be a net increase in fiscal revenues, since there are so many new drivers each year.

Think the same for sales of new apartments, air-conditioners, iPads and iPhones, plane and high-speed train tickets. Each one has all sorts of taxes built into its sales price, and then an annuity of future tax revenues from energy taxes, fees and assessments.

In the US, taxes and spending are so high, people grow more and more reluctant to spend. Huge budget deficits today, as Milton Friedman long ago established,  creates the expectation of tax increases tomorrow. Americans adjust their spending accordingly. Not so in China. Chinese keep spending and the government reaps the bounty.

As flush as the Chinese fisc now is, tax revenues represent only one part of the government’s huge cash hoard. To begin with, there is the over $3 trillion in official foreign exchange reserves. This money contributes little to no benefit to the economy as a whole, except bottling up pressure on the Renminbi to appreciate against the dollar. It’s basically money buried in the backyard.

The government also owns significant – often controlling — shares the country’s biggest and most profitable companies, including SinoPec, China Mobile, China Telecom.

Net profits at the 120 biggest centrally-controlled Chinese SOEs rose by 14.6% year-on-year during the first half of 2011, reaching Rmb457.17 billion yuan ($71 billion) . These 120 SOEs are meant to pay taxes and levies of almost twice that, Rmb850 billion, up 26.4% from 2010. No one quite knows how much of that money actually reaches the Chinese Treasury. But, of course,  the money is there, should it be needed – in a way the US Social Security “Trust Fund” most assuredly is not.

Why Is China Booming? Surprise, It’s Not the Stimulus

China First Capital blog post -- Qing Dynasty stupa

Launched amid much worldwide rejoicing when the financial crisis struck last year, China’s Rmb 4 trillion ($585 billion) stimulus package is given much of the credit for China’s continued strong economic performance this year. China’s GDP growth is likely to exceed 8%, and the domestic stock market is up by over 70% since the start of the year. 

A Keynesian miracle? To read a lot of the financial commentary on China, you might well conclude this is so, that government spending has single-handedly kept the economy jaunty, while both firms and consumers sank into a deep funk. It’s a great story, and provides a simple explanation for how China dodged the bullets that struck all other major economies. Other countries looked on enviously, and urged China to continue the fiscal pump-priming to help out the overall world economy. 

Problem is, the analysis is flawed. China’s stimulus plan is not all it’s cracked up to be. While the additional government spending has clearly played a part, it is not the only reason why China’s economy has remained so sound this year. The unsung heroes of China’s economic success this year are its ordinary consumers. It’s their continued confidence and increased spending that have really made the difference. 

Economic statistics are notoriously iffy in China. The further one gets from the economic lever-pullers in Beijing, the harder it becomes to track economic activity. That’s another reason why the stimulus plan was so often singled out as the main spur to China’s growth. It’s easier to calculate how much additional the Chinese government is spending building expressways than it is to see how many pairs of socks or bowls of noodles Chinese are buying. 

Another reason: a lot of the economic commentary comes from folks who believe that governments really are responsible for what happens, good and bad, in an economy. Again, it’s just so much simpler to view things this way, that powerful government men can pull out their checkbooks and spend their way to national prosperity. These are often the same people who will tell you, wrongly, that Roosevelt’s New Deal spending lifted the US out of Depression.

China’s supporters and detractors both give the government too much credit. There are those who are convinced China’s economic growth is all some kind of fraud, cooked up by the central government, and that once the extra government spending is dialed down, the economy is certain to crash. 

Again, pure hogwash. 

In China, the government rightly deserves credit for excellent economic management, for creating the circumstances, both marco and micro,  that allow the Chinese economy to continue to thrive. I’ve said it frequently, including in public forums: China is the best-managed major economy in the world. 

But, again, let’s also commend the country’s one-billion-plus consumers, too often seem as miserly skinflints, saving up all their money for their great-grandchildren’s rainy days. It just ain’t so. China’s consumers, with an ever-increasing choice of products, services and shops, are spending ever-increasing sums on improving the quality of their lives. Newer and better housing. New cars. Holidays. New wardrobes. You name it. 

I see it every day here, the untethered exuberance of the Chinese consumer. It’s true that in the early part of this year, there was a relative lull. Back then, shops were working harder to attract customers, by putting a lot of their goods on sale at steep discounts. About four months ago, the situation began to change markedly. No more major knockdowns. Prices now all seem to carry list price, and the prices for many common consumer products are as high, or higher, than in the US. 

Not much of this, it goes without saying, gets noticed by the world’s financial commentariat. Car sales in China are at an all-time high, and China is now the world’s largest car market. But, listen to the commentators, and they’ll tell you it’s the result of some small government tax breaks on new car purchases. Helpful, yes. The main spur? No. Car prices in China are still, in dollar terms, generally much higher than in the US. Based on a percentage of average disposable income, car prices in China are probably among the most expensive in the world. Same goes for property prices. Yet, Chinese keep buying. 

They will keep buying, at or near this record pace, long after any tax breaks phase out.  Chinese want the new cars to drive on the new expressways to carry them to the new shopping malls to buy the new furniture for their new apartments. 

Of all the economic statistics I’ve seen lately, the one that best captures what is going on now in China is this: revenues in China’s restaurant industry were up 18% during the first half of 2009, to over $120 billion. That’s not due to stimulus, or bank loans, or tax concessions, or a government mandate to entertain more. It’s largely because Chinese are out having a good time, more often, and spending a lot more doing so than they did a year ago. 

It’s one of the best barometers of a nation’s mood, restaurant spending. In China, the mood is buoyant, the outlook bright, and the woks are working overtime.



The Closing of the American Mind: Seeing China As It Was, Not As It Is

China First Capital blog post -- Qing Dynasty dragon plate

I recently returned from a two-week stay in the US. I was very busy seeing friends and business colleagues, which means I was also very busy answering questions about China. 

China occupies a very special place in the minds of many Americans, including many who’ve never been. The level of curiosity in America about China is enormous. This contrasts notably with the indifference with which many Americans view the world abroad. For example, during the 14 years I spent in London, I never found my American friends to be very interested in what life was like in England. Not so China. 

But, this intense curiosity is not matched by a deep knowledge among Americans about the current situation in China. In fact, even among the most well-read and worldly-wise of my friends, the level of ignorance about today’s China is high. That’s largely because the American media, for the most part, does an execrable job covering China. The result is that most Americans have an excessive focus on what’s perceived to be “human rights problems” in China, and a vast under-appreciation of the monumental, positive changes that China is now undergoing. 

My local shoe repair guy in Shenzhen has a more nuanced understanding of the US than most educated Americans have about China. Every time I get my shoes polished, I end up discussing the genesis of the American credit crisis and the challenges President Obama faces in trying to change America’s health care system. In the US, the main topics of discussion about China reflect an exaggerated negative view of what’s going on. Nine times out of ten, people want to comment on pollution and product quality, as if China was one large Satanic mill turning out killer toys. 

Of course, the speed and scope of all the positive changes in China are so awesome it’s difficult for anyone, including Chinese, to fully appreciate just how far the country has come in a short time. But, in my experience, the American misapprehensions about China have a stale, time-worn quality about them, as if America’s view of China stop evolving about five years ago. 

A friend of mine, for example, writes about Chinese-American relations for a leading US publication. He talked about the issues he’s most busy writing about and what is of greatest concern to the Americans now guiding policy toward China. North Korea and Iran figured prominently in the discussion, and he relayed the US strategy to win China’s backing for the American position.

There was lots of talk of high-level diplomatic meetings and various quids-pro-quo. While all this is no doubt important to the safety of the world,  I couldn’t help feeling that it also demonstrated a lot of wishful thinking on America’s part, that China would still be, as it often once was,  highly responsive to America’s strategic needs. 

The US has long commanded significant leverage over China. But, that leverage is lessening by the day. One reason, of course, is China’s own rising economic and military power. But, less noticed and perhaps even more important is that China is less and less reliant on access to the US market to sustain its own economy.

China’s economy is increasingly driven by its own domestic market, rather than exports. This is why China could absorb without much dislocation the sharp fall in exports to the US over the last year. Exports will continue to play a larger role in China’s economy than in America’s. But, its economy is changing, and growing far more balanced. 

China will more and more resemble the US — a large, continent-sized economy that grows by meeting the needs of its own citizens, and providing a stable environment for business to invest. This change has many more years to run. The simple formula: China can listen less to what the US wants because it needs less of what the US has to offer in return. 

This, too, is a change that seems to have escaped the notice of most Americans, including those in a policy-making position. China isn’t simply being difficult or stubborn by failing to tow a US line. It’s also less concerned about calibrating its own policies to expand the markets for its exports to the US. The last time the US was in recession, China’s economy was also badly bruised. Not so this time. OEM exporters have suffered, but not the businesses that focus on selling to Chinese consumers. They’ve played a key role in keeping China’s economy healthy, while the US has faltered. 

Americans need to see China for what it is, not what it was. It’s a better, richer, cleaner, freer place than they think. Americans may just learn to like what they see..