China needs to revamp its tax system in order to stimulate consumer spending
In a recent article published by the China Chief Economist Forum think tank, economists have proposed a significant revamp of the Value-Added Tax (VAT) system in China. The aim is to direct more tax revenue to locations where consumption occurs, rather than where production takes place [1].
The current VAT system, which is the country's largest source of tax revenue, has been criticized for undermining efforts to develop a consumption-driven economy. The system's focus on production locations has led to regional competition centered on attracting factories and investment, which exacerbates overcapacity issues and slows economic transformation [1].
The proposed reforms include revising the VAT revenue sharing formula so that local authorities receive more tax revenue based on where consumers purchase goods and services, rather than where these goods are manufactured [1]. This change would encourage local officials to promote consumption-driven growth, aligning with Beijing's strategic goal to rebalance the economy away from investment-heavy and industrial overcapacity models towards stronger domestic demand [1].
By linking fiscal incentives to consumption, local governments would have greater motivation to improve retail, services, and overall consumer market conditions, helping to address the current imbalance where industrial expansion is prioritized due to fiscal reward structures [1].
The paper, co-authored by Sheng Songcheng, a former head of statistics at China's central bank, and two researchers at the CEIBS Lujiazui International Institute of Finance, presents these criticisms and suggestions [1]. The economists urge the government to introduce more radical reforms to give local authorities stronger incentives to spur consumption.
The VAT policy's effectiveness in supporting local government finances during an earlier period in China's development has become less apparent. The policy encourages a local development model that prioritizes investment over consumption, which has become a drawback as consumption emerges as the main growth driver [1].
The VAT law recently passed by China is the focus of public feedback, and its implementation is being evaluated for potential improvements to address the issues highlighted in the article [1]. The reforms, if implemented, could help China transition towards a healthier, consumption-led growth model by realigning local government incentives with consumption growth rather than industrial output.
[1] Sheng Songcheng, et al. (2022). Revamping China's VAT Allocation System: Incentivizing Consumption-Driven Growth. China Chief Economist Forum.
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