China’s GDP growth has been unexpectedly strong this year. But paradoxically, tax revenue has been contracting.
That’s not supposed to happen:
Tax revenue typically falls during a recession, but not when the economy is expanding by more than 5% annually.
In this podcast, Trivium Co-founder Andrew Polk and Dinny McMahon, Trivium’s Head of Markets Research, discuss the reasons behind China’s falling tax revenue, and why it matters – both in the short term and to Beijing’s longer-term economic aspirations.
They then get into what Beijing is doing about it, and whether those efforts are likely to meaningfully boost badly needed tax receipts.
Transcript:
Andrew Polk:
Hi, everybody, and welcome to the latest edition of the Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Cofounder – Andrew Polk. And I am joined today, once again, by Trivium’s Head of China Markets Research, Dinny McMahon. Dinny, how are you doing, brother?
Dinny McMahon:
I’m good here, mate. Great to see you.
Andrew:
Yeah. Good to see you as always. We are going to dig into today a topic which we used to cover quite regularly, and in fact, we probably covered it too many weeks in a row a few months ago, but are now going to dive back into Chinese fiscal issues. I just want to say up top, you know, we spent a lot of time on this because fiscal policy really is the key macro lever that China has to support the economy now. Monetary policy is much less potent. You know, I’m one of those who kind of thinks fiscal policy is not that sexy of a topic, but it’s super important in the China context. So, we’re going to get back into it today. And, specifically, we are going to talk about there’s this paradox that China is facing currently, which basically revolves around the idea that economic growth is quite robust at the moment, actually more robust than a lot of outside observers expected, and arguably even maybe more robust than top government officials themselves would have thought by this point in the year.
But at the same time, China is facing falling tax revenues. So, normally, you’d expect a robust economy to come along with robust tax receipts to help underwrite and finance public works, Social Security, all of those kinds of things. But that’s not happening right now. So we’re going to get into that, that paradox, what’s happening, the dynamics behind it. And then we are going to talk about the steps specifically that the government is taking to address the issues and why it all matters. But before we get into it, got to start, as always, with the customary vibe check. Dinny, how’s your vibe right now?
Dinny:
Yeah, it’s good, mate. I’m very much looking forward to the weekend. My ten-year-old’s soccer season has just started, and he plays on a field right next to the lake. You know, it’s great having an excuse to spend a couple of hours every Saturday morning next to the lake in Chicago as autumn sets in. So yeah, very much looking forward to my Saturday morning tomorrow.
Andrew:
I love it, man. That’s great. And just so people know, the reason we do the vibe checks is sort of just so people know the headspace we’re coming into, into the pods. When you’re doing China analysis every week, it’s easy to kind of get stuck in the weeds. And there’s obviously political dynamics going on both in China and in the U.S. and elsewhere. And so I think it’s important to just understand kind of the headspace that we’re in when we’re coming into these conversations, especially when things are dire, it’s easy to come in, and especially dire, specifically, between the US and China, to come in with kind of a little bit of a pessimistic attitude. Great to hear that you’re upbeat today.
I will say I’m also upbeat. Great weather in D.C. today. I guess my vibe would be having a bone to pick, which is, you know, you just talked about your son playing soccer this weekend. I was telling Dinny, and he’s laughing because he knows that I’m going to say, that I am now coaching my seven — soon to be eight-year-old — daughter’s soccer team. And Dinny just made the assumption, by dint of me being an American, that I had no idea what I was talking about when it comes to soccer. And yet I played soccer all through high school, was on the varsity soccer team, played a little bit in college, just not like for the university, but in some club leagues. And I’m an avid English Premier League and U.S. men’s team follower. So, that’s my bone to pick. I’m just going to pick it publicly. I already had it out with Dinny privately on this, but I think this info and this dynamic needs to be out in the world. So, that’s my vibe. Generally upbeat, but still a little miffed, I guess I would say.
Dinny:
Guys, I consider myself suitably chastised.
Andrew:
Okay, good. Good, good. That’s exactly what I was going for. So, with those vibe checks out of the way and you know where our headspace is now, we do have one other thing up at the top, of course, is always the usual housekeeping to go through. First, as always, a quick reminder we’re not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That includes, of course, policy, government policy in China in various areas — tech, autos, net zero, transition energy, renewable energy, all of that stuff — as well as policy towards China out of Western capitals like D.C., London, Brussels and others. So, if you need any help on any of that stuff, please reach out to us at hq@triviumchina.com.
We’d love to have a conversation about how we can support your business or your fund. Otherwise, if you’re interested in receiving more Trivium content, check out our website, triviumchina.com, again, where we have a bunch of different subscription options, both free and paid. You will definitely find the China policy Intel you need on our website. So, check it out. Lastly, as always, and just a clear plug here that we really do mean this — Please do tell your friends and colleagues about Trivium, both about the company and the work we do, as well as the podcast, so we can grow our listenership, grow our profile. The growing listenership for the podcast helps us to widen our footprint, drive more business to the actual consulting that we do, the strategic advisory that we do, and that allows us to continue providing great, free content to everyone who’s interested in knowing, getting smarter about China, and keeping their finger on the pulse of what’s going on there.
So, again, really, please do, do us a favor and just tell a friend or colleague about Trivium. Okay, we’re now going to get into the topic of the day, which, again, is this kind of paradox that China is facing between pretty decent economic growth and weak fiscal revenues, weak tax receipts, weak non-tax receipts as well. So, just to sort of set the stage, economic growth has been quite robust over the past 18 months. China’s official GDP grew 5% on a real basis in 2024, 5.4% in Q1 2025, and 5.2% in Q2 of 2025. Again, these are the official economic numbers. We know there’s some doubt about those numbers out in the world, and that growth likely is somewhat in reality, somewhat lower than that. But we do know that China’s economy has been on the upswing, really compared to last year.
I tend to follow nominal GDP growth, which puts growth at a little bit below 5% because of the deflation that’s going on. But the point still stands that China’s economy is performing better than most people expected at this point and really over the past 18 months. That said, the great irony is that, over the same period, tax revenue has been falling. In 2024, tax revenue fell 3.4%, and in H1 2025, it declined a further 1.2% year on year. That’s really pretty odd because when an economy enters a recession, tax revenue typically contract, but when an economy is growing robustly, it’s the opposite. That’s kind of how things are set up to be. The weaker the economy gets, the more the tax burden on firms and households diminishes.
But as I said, it’s the opposite situation in China right now. GDP’s pretty much cracking along. Again, official numbers about 5% on the real basis, 4.2% on nominal basis. And that’s fast for any economy. It’s not as fast as China used to grow, but it’s a decent growth print. And yet the economy is incapable of generating as much tax as it did a couple of years ago. So, this, of course, begs the question, what’s going on here? And what, if anything, Beijing is looking to do about it? So, Dinny, jump in here for us? Resolve the paradox for us, or at least give us some more context. Why is tax revenue falling despite seemingly robust economic growth?
Dinny:
Well, there’s a few things going on here, but I’ll start with what’s not happening. So, the Ministry of Finance gave a press conference a few weeks ago in which it said, “Oh, look, one of the reasons this is happening is because of pandemic-era tax cuts that we rolled out.” So in 2022, they cut, well, they deferred taxes for certain SMEs. 2023, you know, the pandemic was over by then, but they were still trying to support the economy. 2023 they introduced some modest tax cuts for small firms and also for families as well. But to the extent that those cuts and deferments had an impact on revenue, that was built entirely in 2023 and 2024. The fact that tax revenue generation has still been so weak in 2025 has nothing to do with that.
I mean, that’s already sort of filtered its way through the system. So, what’s really going on is there’s two big things we think are really contributing to this weakness in tax revenue. One is the property sector. So, at its peak back in 2020, the property sector or tax revenues generated by the property sector accounted for about 15% of overall total revenue tax revenue in 2020. And that then fell to about 10% in 2022. We don’t have a figure since then, but we assume it’s been falling since then because, I mean, frankly, the property sector has been going from bad to worse. Prices falling, investment falling, sales falling. So, I mean, unequivocally, the amount of tax revenue being generated by the sector has been declining.
Now, those figures I gave, 15%, 10%. That’s not just the direct taxes generated by the property sector, but it’s also things like the degree to which property sales contribute to VAT as well. So, it really adds up. I mean, the property sector used to be a real contributor to government revenues through various avenues, and that’s kind of clearly taken a hit. And it continues to contract because the property sector really has not turned a corner yet. Now, perhaps the bigger issue, though, is deflation. And so, producer prices, factory gate deflation has been in place now for three years. I mean, it has been just an endemic, intractable decline. And what that does is two main things. So, firstly, it brings down the price that companies can sell their stuff.
And so that has an impact on VAT, you know, taxes generation, the value-added tax. And at the same time, it also squeezes corporate profits. And so that, of course, squeezes corporate income tax as well. And those two things — value-added tax corporate income tax — together, they account for about 60% of all government tax revenue. So, we have this really strange situation at the moment where China’s export machine is going absolutely gangbusters. I mean, that’s really been the big standout and surprise that contributed to the growth this year. I mean, and even last year, exports have really contributed to economic growth to a degree that no one really anticipated. But even though China’s export of manufactured goods has been going so strong, and China’s emerged as a global leader in electric vehicles and batteries, and solar, solar components, and yet so many of these companies aren’t making profits.
I mean, you look at China’s biggest six, I think polysilicon manufacturers, I don’t think any of them were profitable at the end of the first half. And in the cases where companies in these areas are making profits, they’re really operating on pretty thin margins. And so you have this incredible advanced manufacturing machine that China’s really developed over the last few years, and it looks fantastic from the outside. But the consequence of overcapacity and cut-throat competition leading to this endemic deflation means that we have strong economic growth because sales are relatively high. But it’s not translating into taxes because profits have been so weak.
Andrew:
Yeah, and I can say just as a business owner, one of the very, very few and very small positive silver linings of periods when you’re growing with very thin or even negative margins, and your profits not very strong or even negative, is you don’t have to pay taxes, or you don’t have to pay many taxes because you only pay taxes on the profit of the company. Now, you would much rather be in a situation where you have very high profit and have to give a chunk of that over to the government. That’s a much better situation to be in than losing money but not paying taxes. But all that is to say these companies do not want to be in this situation. And while there might be this little silver lining, we have to give the government a little bit less of our revenue, it’s coming from very weak or even negative profits.
And, of course, that’s a problem for the government who has a bunch of things that they need to underwrite. So, walk us through a little bit more of the consequences of these dynamics in the export sector and the deflationary piece in particular. Why does it really matter for the Chinese government?
Dinny:
Well, if they’re not bringing in as much tax revenue, on one level, it just means that Beijing needs to borrow more. Government spending is still going up. I mean, no level of government is reining in its budget. You look at the government’s priorities at the moment, everything from like what the three guarantees of ensuring people’s basic livelihoods to all the additional government support that the state wants to provide to foster the development of high-tech industries and innovation, I mean, the list of government priorities only ever seems to get longer. So, we’re not seeing the government pay back any spending. So, what it really means is that the government has to borrow more just to sort of plug that hole, that funding hole by issuing more bonds. Now, that doesn’t mean that we’ve seen the government issue more bonds, issuing more debt than we would have anticipated.
And that’s because, at the beginning of the year, the central government raised its target budget deficit from 3%, which had been in place for what I think it was about for 30 years, almost annually, every year. It had never exceeded 3%. And this year they raised it to 4%. Now, at the time, we assume that this was all about creating space in the budget to stimulate the Chinese economy. If Trump rolled out tariffs and it had a really crippling effect on the economy, it would be a way to ensure economic stability in the face of a more draconian trade regime. But China’s export machine ended up weathering that far better than anybody anticipated. And so, this extra-budgetary space they created at the beginning of the year has really given Beijing the space to kind of cover the tax gap.
But there’s another issue going on here. So that’s kind of the immediate one, what it means for the debt and bond issuance and whatnot. But there’s a bigger issue here. And that’s at this point in development, what Beijing really wants to see is, of course, not tax revenues falling, but tax revenues increasing relative to the size of the economy. So, what I mean by that is not only not just that tax revenues are increasing in line with economic growth. So, that’s not just that. It’s growing 5% each year. But, ideally, what they’d like to be saying is for tax revenues to be growing at 6% or 7% or 8%. And that’s because countries or economies at kind of China’s level of development, so upper middle-income economies, once they get to that stage of development, and as they segue into becoming rich countries, the tax to GDP ratio typically expands. And that’s really important because it gives the state the capacity to do a whole lot of stuff that they want, but hitherto haven’t been able to do. And, specifically, what that usually translates into is being able to provide a more robust health care system or a better social safety net, higher spending on education, all that sort of stuff.
So, to give you an example, you take Korea’s experience, in the decade from 2013 to 2023, the Korean GDP per capita went up 20%. And in that period, the tax-to-GDP ratio of the Korean government went from 23% to 29%. So, a six percentage point increase in terms of the amount of tax revenue the Korean government was generating each year relative to the size of the economy. If that ratio had stayed 23% for that entire decade, the Korean government would be bringing in a lot more money, because over that period, the economy expanded 20%. But not only did that happen, but the amount that they were collecting relative to the size of the economy increased as well. So, that gave them a huge increase in spending capacity.
And ultimately, that’s what Beijing is looking for as well. At the moment, China’s tax-to-GDP ratio is really low by global standards. It’s only about 20%. They’ve always had a struggle raising it. And part of the motivation behind sort of force marching the economy into more innovative technologies and forcing the industrial upgrading of the manufacturing sector is to raise productivity levels. And what that really means in real terms is that you’re creating more profitable firms, that profit margins go up. And company profit margins go up isn’t some sort of abstract idea. Wouldn’t it be nice? It’d be great. We’ve got more profitable companies. Fantastic. What that translates to in real terms is people are able to get higher incomes, those companies are able to give bonuses.
And, ultimately, as well, those companies are able to pay higher taxes. And the government can then redistribute that wealth in ways that it sees as being important. So, we’re in this situation at the moment where China is starting to see the development of the sort of economy that Beijing wants with the emergence of these world-beating electric vehicle companies and sort of global dominance of China’s big, innovative battery companies and whatnot. But they’re not reaping the benefits of that transformation yet because it’s not turning into profit. And until it turns into profits, the government’s not going to see that sort of increase in tax revenue that it really wants to then be able to have the discretion to be able to provide greater support to a rapidly aging population and provide the additional support to the sort of pro-fertility policies that it wants to roll out to support, to try and boost family size and whatnot.
So, that’s kind of the bigger picture here. The economy growing at 5% is clearly what Beijing wants, but they’re just not reaping the benefits of that growth at the moment because it’s just not translating into tax revenue.
Andrew:
Yeah, we’ve talked about this in various contexts on the pod and elsewhere that the structure of the economy is not what Beijing wants. There’s a big mismatch between supply and demand. There’s too much supply and not enough demand, or at least not enough domestic demand that ultimately results in shipping a bunch of goods overseas. So, you have these big exports, which then, of course, creates trade tensions. But, more generally, this isn’t a 1:1 equation, but basically, the more productively companies are performing, the more profit they’re generating, as you said, and so the more taxes they’re paying. So 5% gross, you know, there’s different ways to achieve 5% growth. There’s healthy ways and unhealthy ways. And, currently, we’d say that China’s growing in a pretty unhealthy, unsustainable way.
Now, how long it takes for that paradox of unsustainability to be resolved, it can take a long time. But the main point is we’re not just banging on and on about profit. But profit is reflective of a really well-functioning, highly productive economy, and within that, high functioning, highly productive companies. Right? And so, it’s not to say that Chinese companies aren’t innovative, but they certainly aren’t showing, across the board, at least high productivity and improvements in productivity, which is really what classic economics, which I’m sure plenty of listeners will have issues with, but says that the only way to sustainably grow an economy is through ongoing productivity gains.
It’s not through having consumers be the driver of growth or investment or anything. It’s ongoing, incremental, and sustained increases in productivity that then is reflected in profitability and increasing government receipts. I really like that example you gave of Korea because it shows, like you said, like tax receipts for the government would be increasing just simply by the economy growing as long as the percentage of tax receipts or the amount of tax receipts as a percentage of GDP if it remains stable. But if you’ve got a growing economy and even increasing tax receipts as a percentage of GDP, then it can really help to build a sustainable way to grow public sector funded social security net. We’re not just saying, hey, the government needs more money, but the government then, in theory, is to use that money to put to either productive uses through public works or to support people in their old age, young people, improve health care outcomes, all that kind of thing.
Dinny:
And the thing that I didn’t mention is perhaps deal with a significant debt overhang.
Andrew:
Yes, exactly. Well, and it’s a bummer when your productivity is just going towards paying previous liabilities that you have built up. But that also is important in China’s case. And another thing that’s really important and unique in China’s case is kind of how local governments all fit in. A country like Korea wouldn’t have as much of an issue here. China has a really unique, again, an issue we’ve talked a lot about on the pod, you know, the key dynamics there. But just talk to us a little bit about how the local government dynamic fits into all this in the China context.
Dinny:
Yeah. For local governments, it gets a little bit more complicated because they’ve unequivocally been hit by a lower tax revenue. I mean, some of these taxes, particularly in the property sector, for example, I mean, they were going directly to local authorities. But it gets complicated because Beijing’s tried to make up for that shortfall by significantly increasing direct transfers. And I mean, that’s always been a big part of local government revenue, you know, the amount that comes directly from Beijing. A couple of years ago, Beijing massively ramp that up to take into account the drop-off in tax revenue, partly because of COVID, partly because of the property sector downturn. But things get really complicated with the local governments because, other than tax revenue, the bigger problem here is the collapse in land sales.
And it’s because local governments use this not only to pay the interest payments on the debt, like the huge amounts of debts that they accumulated, but also a pretty significant amount of land sale revenue also went directly to their ordinary budgets. I mean, they use this money to supplement spending on education, and health, and whatnot. And that has massively dried up. I mean, it’s dropped precipitously. And so, the bigger issue here for the local governments at least is how they deal with the collapse in local government financing. And, frankly, there just hasn’t been a solution here as yet. And the way local governments are dealing with it ultimately is by imposing austerity policies. Their budgets haven’t declined. As I said earlier, they’re still getting all this pressure from Beijing to spend on an ever-increasing list of government priorities. So, their formal budgets typically haven’t declined. So, they’re expected to come up with more money.
So, you’ve had things like they’ve been trying to make up the shortfall with non-tax revenue, which is effectively code for things like fees and fines. And they’ve also been selling government assets in some instances to sort of make up the shortfall. Non-Tax revenue was up 25% last year, which kind of speaks volumes. I mean, this was a major tool for trying to plug the budget shortfall. It’s come off the boil a little bit this year. It increased 9% in the first quarter and then dropped 2% in the second quarter. But other than that, so there’s kind of been this effort to sort of just come up with new revenue wherever they can find it. But in addition to that, the local governments have tried to defer paying out cash for various expenses whenever possible. So, they’ve done things like, in some instances in some cities, they haven’t been paying various state employees.
Otherwise, some state employees have found themselves having to accept pay cuts. In other instances, they’ve had the government stopped making Social Security payments for a period of time. And then, on top of that, there’s this huge, massive backlog of arrears of local governments’ unpaid bills to contractors and suppliers, which is something Beijing… I mean, this has been an issue for years and years and years, and Beijing routinely complains about it, but it’s taken on an order of magnitude since the collapse of the housing market, which is a real drag on the economy at this point, companies out there that have done business with the government and they’re just not sure if they ever going to get paid.
There was a recent story, just, I think yesterday, in Bloomberg saying, look, Beijing is going to push big commercial banks in the policy banks to actually lend to governments so that they can take these bank loans and then pay down what they owe to suppliers and contractors. But Bloomberg said that Beijing is talking about an upper limit of about a 1 trillion renminbi, whereas one of China’s leading economists and government advisers, Li Daokui, thinks that the amount of arrears outstanding is closer to 10 trillion. So, I mean, this is a real problem, but it speaks to this kind of funding shortfall problem that local governments are dealing with, and they’re really managing it with just straight-up Chinese-style austerity policies.
But, as I said, the real problem here is the collapse in land revenue and this overhang of debt payments. Clearly, the tax revenue issue exacerbates things at the margin. But even if tax revenue started growing at 5% annually in line with economic growth, the underlying challenges facing local governments fundamentally aren’t going to change in a hurry.
Andrew:
Yeah. So, I want to get into some of the things Beijing’s doing to address some of the issues. But actually, I just want to make one comment and then I want to follow up on what you just said on the arrears piece. So, the comment is that, especially at the local level, as you said, basically local governments, while the central government fiscal imprint is relatively expansionary this year compared to last year, you said they increase the budget deficit to 4% of GDP from 3% of GDP last year. That’s largely going to fill a hole, which is the local governments imposing this austerity, really shaking down effectively companies for fees and fines and back taxes and all that stuff. And so, what’s interesting to me on that side is that China’s economy is growing pretty robustly in the context of, actually, what you’d say a pretty tight fiscal environment when you factor in the local government kind of context, the local government approach to these non-tax revenue generation.
And just imagine how the economy would be doing if you took the fiscal headwinds away. Right? So, the economy, which is already performing really well in the face of this kind of drag from local government fiscal austerity, would be doing even better. And this is where I think the arrears piece really is interesting because, as you said, if Bloomberg reporting is correct and they are going to put in 1 trillion through the banks to pay arrears, I mean, even if it’s one tenth of what is actually owed, that’s still a pretty decent windfall. As I’ve argued for, I don’t know, a year now, if you’re a business who hasn’t gotten paid by the government in 12 months or six months or 18 months, you may be basically writing off that revenue at this point.
But if the government comes and says, “Well, hey, we’re going to pay you even 10% of what we owe you,” they’ll pay 10% of the people 100% of what they owe those contractors, that’s still like a fiscal infusion and does go some way, it’s like a one-off sort of stimulus because it’s like money in your pocket as a business that you didn’t necessarily think was there. So, they’ve been talking about this for a while. I’ve been waiting to see any real movement on it. It would be really good, in my view, if the Bloomberg reporting is correct, and they are, even if they’re just at a start doing 1 trillion, paying arrears could be really a significant boost to confidence. Do you agree with that or no?
Dinny:
Yeah, absolutely. Because the thing about paying arrears is that it’s not just the government handing over money to a contractor, and it’s like, oh, end of transaction. Usually, the way this works is, well, the government pays off the contractor and the contractor pays off his or her suppliers, and then the suppliers high of whatever the bills that they owed. There’s a real trickle-down effect throughout the economy. It’s kind of a velocity of money sort of thing. Once the government hands over the cash, it will pass from person to person-to-person, and the impact will be far greater than the sort of the headline amount of 1 trillion a day. That said, there are consequences to doing this.
And that is it’s great for firms, but it will mean that the burden on local governments will go up because at the moment, not paying arrears is effectively having taken out an interest-free loan from your suppliers and contractors. It’s free debt. Now, if you replace that free debt with real debt from a bank, which is charging you an interest rate. All of a sudden, you’ve gone from having a loan where you’re not paying any interest to a real explicit loan, where you are paying interest. Now, in this environment where interest rates are so low already, maybe the issue is negligible. I mean, presumably, if interest rates fall even further, then the difference will be even more negligible. So, I mean, it’s hard to say how much an issue it is, but given how overstretched local governments are at the moment, this would increase their costs. And that is something I think the authorities really have to think about. And it’s probably one of the reasons why they’re limiting this thing to 1 trillion renminbi.
Andrew:
Yeah, that’s a good point. I mean, no options here are cost-free, none are easy, otherwise, they would already have moved on to an easy option. And it reminds me I owe you, I think, three months of salary. I’m good for that. So, don’t worry. That’s coming. That’s coming. So, back to the issue at hand, okay, so we talked about the arrears piece. But what else more broadly, again, I will say I think watching what happens on the financing of arrears payments is going to be really something to watch. But beyond that, what else is Beijing doing? Because in this environment, it doesn’t seem like you can raise tax rates overall. So, that’s kind of off the table. But what is on the table?
Dinny:
Well, they’re trying to boost tax revenue in ways that they think they can get away with without there being sort of meaningful pushback from the government. So, I think a really good example of that is at the beginning of this year, they started going after the undeclared income from Chinese citizens’ offshore financial assets. So, this particular tax, this rule has been on the books for years, but it’s never really been enforced. If you a Chinese citizen, if you’ve got assets overseas invested in whatever stock market, and you’re earning returns, or capital gains on those investments, the Chinese government now expects you to hand over a percentage of that. So, this is a sort of thing whereby, as I was saying, there’s minimal public pushback. It’s already a law on the books.
It’s just about enforcement. Most Chinese people will be like, “If you’ve you got enough money to be investing overseas, then it doesn’t bother me that we expected to hand over some of it to the Chinese, you know, to the government.” And even for the people who are expected to pay taxes, no doubt some of them are going to try and get around it. But at the end of the day, they’re like, “Well, you know, this isn’t exactly a new tax. It’s just being enforced.” So, it’s one of those things where people might not be happy about it, but there’s limited scope to complain. Then they’ve done other stuff as well. So, they have phased out existing tax exemptions. So, for example, for a long time, interest earned on government bonds and financial bonds, so bonds issued by the policy banks, they were exempt from VAT.
Now, that exemption is being phased out. Also they’re expanding the scope of some major taxes. So, for example, extending the luxury car consumption tax to electric vehicles. So, originally electric vehicles were exempt from luxury car tax, this being part of government efforts to sort of help support the EV industry. Now that’s changing. If you’re selling a luxury EV, that is going to be subject to a tax. Again, this is kind of you know, it’s not quite to suck the rich, but it’s an area where the public’s not going to be too miffed about this. It’s going to affect a minority of people. There’s not going to be a huge pushback on this. And they’re also scaling back some of the broad VAT fund relief schemes that they rolled out during the pandemic.
So, some of the relief from a few years ago is sort of being rolled back. And I think also the most recent measure, I think, they’re broadening the scope of the environmental tax. We covered this in our daily yesterday to cover a whole lot of volatile chemicals, organic chemicals that previously hadn’t been affected by the tax. Again, sort of something that aligns. It’s not purely about raising revenue here. It is clearly something that aligns with the government’s priorities about creating a cleaner greener China. But the upside is in this environment of constrained tax revenue, it’s another source of incremental tax revenue. So, yeah, this is kind of the stuff we’re seeing a lot of small move, stuff that’s not going to get a lot of pushback, the sort of stuff that most people in China will probably sort of nod in agreement at.
The general public isn’t getting burnt by it. It’s not going to have a huge impact on the economy. It’s stuff that’s going to raise a little bit more money without really causing a stink or having a real impact on growth.
Andrew:
Well, thanks for laying those things out. But I mean, they all seem like they’re pretty small in the scheme of things. As you said, incremental is maybe even a generous word, right? We’re talking about most of these not even being a single percentage point of overall tax receipts. Right? Often like a quarter of a percentage point or less. So, put them all together, do they start to add up? How much will they really impact government revenue flows and, more generally, like what is the expectation for these measures in terms of supporting tax revenue growth and fiscal receipts, say over the rest of the year?
Dinny:
Yeah, we think they will. I mean, as you pointed out, every one of these individually is not a game changer. I mean, every time we’ve covered one of these things in our dailies, we always make the point. It’s like this is small. The amount of revenue it’s going to generate isn’t huge. It’s fine. But the thing is taken all together, they start adding up a little bit. And we estimate that you put it all together, this could boost revenue by several hundred billion renminbi this year if they’re effectively enforced. And we might already be seeing some early results. So, hiking tax revenue from one single month is not a great idea because there’s huge volatility in China’s tax revenues even in a normal year.
But in July, tax revenue grew 5%. Now that’s encouraging, given that, as we said, over the first six months of the year that it contracted, I think 1.2%. But in July, that grew 5% year on year. And that was largely driven by a 14% increase in individual income tax. And we think part of that, at least, has been a consequence of the government going after individuals overseas investment income, which kind of falls under that category. So, what we think is, assuming all these policies are implemented effectively, by the end of the year, we could really see full-year tax revenue finally turn positive, and maybe even come close to Beijing realizing its revenue growth target of 3.7%.
Now, there’s a lot of ifs and buts and maybes in there, but it kind of feels like this strategy kind of puts them on the track to kind of incrementally increasing tax revenue on a scale, which kind of helps put them back in black.
Andrew:
And just to clarify, that 3.7% is revenue growth, both tax and non-tax, over 2024?
Dinny:
Oh, sorry, I thought that was just tax, but I’d have to double-check that.
Andrew:
But either way, I guess the point here is that’s still below what’s likely to be nominal GDP growth of 4% to 4.5%. Right? So, they’re still deteriorating the overall amount of tax revenue as a percent of GDP. So, it might be a move in the right direction, but it doesn’t, by any means, put them on a fully solid footing.
Dinny:
No, no, that’s a really good observation. They’re still behind the eight ball on this.
Andrew:
Well, so this one will be one we’re tracking. I think this hopefully does a good job of showing some of our listeners what we do at Trivium, which is to really track very granular developments in policy that often kind of work together to actually make a dent on the macro environment or a certain industry. But we’ve kind of had to very meticulously put these very small moves that are happening together to say, “Okay, this seems like it’s actually going to add up.” And I think this one, because none of these things are particularly headline grabbing and they’re actually meant to not impact one constituency to aggressively or too onerously, that a lot of people can miss them. And so we thought this would be a good time to sort of put out what we’ve been seeing on the tax-raising side on the overall fiscal picture. Because, as I said, at the top, fiscal policy and fiscal dynamics are not very sexy, but they are super important for Beijing’s ability to grow the economy sustainably and, even more importantly, to underwrite a growing social safety net on a sustainable basis.
So, it’s a big issue that officials need to get right. They’ve talked about it in the third plenum last year, the need to undergo fiscal reform. Everyone’s sort of been like, if this is so dire, why aren’t you doing it? And we would just say they’re not attacking it as aggressively as we had hoped, but they actually are very much kind of under the radar making some moves. So, one to watch, one to continue tracking. Dinny, really appreciate you walking us through all of that. And we’ll see kind of how things play out on this front over the course the rest of the year, but then beyond that as well. So, thanks a bunch for the time, man. Really appreciate it.
Dinny:
No worries, mate. Pleasure as always.
Andrew:
And, as always, thanks, everybody, for listening. We will see you next time. Bye, everybody.
