china has a major tax problem or actually china has a few major tax problems and
most of them stem from the fact that china is both the second largest economy in the world
with advanced financial systems and international trade networks while also still being a largely
informal economy china's large economy demands a level of government spending which requires
a large and broad tax base to fund unfortunately the country does not have that the united states
china's closest peer and economic size has federal tax revenues of around 17 percent of gdp
or around 25 percent when you include all local and state revenues china by comparison
has revenues of nine percent now this video isn't to argue for lower taxes or higher taxes
it is instead to look at the systemic issues that china will have to overcome to stop living
on borrowed time and create a sustainable system to fund its government's activities but to truly
understand this problem we are as always going to need to look at some specific issues why has china
been unable to raise more taxes from its economy is this low tax revenue actually going to hurt its
economy and finally is there anything that they can do to fix this issue once we have done all of
this we can put china the second largest economy in the world on the economics explained national
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free so china's tax collection problem is really three problems they can't collect taxes from most
people the people they can collect taxes from do a really good job of avoiding those taxes and the
taxes they do collect don't always go where they need to china operates off a central authority but
no single man or even a single institution can oversee the operations of 1.4 billion people
in one of the lightest countries in the world by basically every metric that's why the government
authority is shared amongst provinces with their own subprovincial regions and cities within those
regions all of these local authorities are in charge of certain government functions that are
too small or regionally specific to be controlled by the government organizations above them
it doesn't make sense for the people's party congress to be managing the trash collection
schedule of hangzhou so they delegate that down to the provincial government body who will probably
delegate it down to a city council so far this is not that unusual it's basically exactly the
same system that i'm sure most of your own governments use to perform their functions
the big difference is in the way that they get their funding in most developed economies local
governments get their funding primarily through a combination of property taxes and money coming
from a more senior level of government the federal government gives money to the states and states
give money to their local governments they may also have alternative revenue sources from things
like parking tickets or business fees but those are pretty much irrelevant compared to these two
china's local governments are a little bit different in that they make most of their
money by taxing businesses and selling off 20 to 70 year leases on their land holdings in china no
private company or citizen can own urban land so renting it out for 70 years is the next best thing
60 of whatever these local governments make from businesses needs to be returned to the central
government but the land revenues are all theirs this is a very significant revenue source because
the real estate market in china is absolutely massive we made a video a few months ago about
the real estate debt crisis the country had got itself into to prop up this market a video that
i'm just saying we released just a month before the news broke about the financial troubles of the
evergreen property development group now the thing about land lease revenues is that they only work
if the land is worth developing land is only worth developing if there's some kind of infrastructure
in place to support the people that will be living in these new developments the solution to this is
that provincial governments are consistently in an arms race against one another to build out
more infrastructure so they can make themselves economic hubs so they can sell off land rights
so that they can fund more infrastructure so that they can make themselves economic hubs
this game of chicken and egg does two things the first is that it creates a glut of infrastructure
ghost cities and railways that carry no passengers are not uncommon sights in china
again we did a video about exactly this the second thing it does is necessitate a lot of upfront
investment by these provincial governments the problem is that these governments are not allowed
to issue bonds and they don't start making land revenues until they sell off their land holdings
so they need to get creative they have come up with what is called a local government financing
platform and it's pretty much exactly as dodgy as it sounds what these local governments do is set
up a private company and then give that company some of their state assets this can be cash shares
and state enterprises or the land rights that they are trying to sell off this supposedly private
company can then go to the bank and use all of these assets as collateral to get a loan the
local government can then use this cash to fund whatever infrastructure projects it wants and the
banks can bundle these loans up and sell them as bonds on the open market in 2019 local government
financing bonds constituted 39 of all outstanding bonds in china's domestic market the other 60 was
up until recently mostly made up of real estate bonds sold by the development companies that
needed funding to build on the land that was being leased out to them by these local governments
these local government financing platform bonds are deemed to be quite safe because they
indirectly have the backing of the communist party and it's unthinkable for many chinese investors
that the government would default on their debts this also has the benefit of pushing government
debt into the private sector so national debt to gdp figures look better than they really should
of course the problem is that these are local governments not the national government and
they have every chance of going bankrupt because they are limited in how they can raise revenue so
far this whole system hasn't been an issue because the real estate market has appreciated in value so
relentlessly that even the most reckless borrowing practices can be wiped away with the money that is
made by leasing out this land but this precarious status quo is starting to come undone for starters
china is still practicing strict lockdowns to stop the spread of covert the government has adopted a
zero case policy which means even entire cities as large as shanghai will go into complete lockdown
should any cases be detected these lockdowns have banned people from leaving their house for any
reason outside of getting groceries so businesses are obviously suffering a lack of business
activity has cut off a major source of revenue for local chinese governments and that's before
we get into the problems in the real estate sector the unwavering confidence the chinese people once
had in real estate is will wavering off the back of high profile property development bankruptcies
this has meant that less people want to invest in properties which means less are getting built less
getting built means that local governments gain less revenue from renting out their land holdings
it also means that banks are no longer interested in accepting these land holdings as collateral to
underwrite the bonds for these local government financing platforms to make this all worse the
chinese central government has started issuing tax returns to compensate citizens from being locked
into their homes while simultaneously pushing for more infrastructure projects to offset the
economic impacts that the lockdowns caused in the first place this means less money coming
in more money going out and less options to raise money to bridge the financing gap in the meantime
now if highly speculative financial assets that are deemed too safe to fail because they are
backed by real estate in the market that has been booming sounds familiar to you then this should
probably make you a little bit worried to top this all off almost all bonds issued in china are rated
at least double a and local government financing bonds are almost exclusively rated at aaa
which suggests to investors that these are the safest possible investment when the reality is
anything but this is a 19 trillion dollar bond market that is based on a system that requires
perpetual growth you might have been thinking this entire time that should this market implode
spectacularly well that would be bad but the central national government would step in to bail
these local governments out if for no other reason than to save the reputation of their own party
but they might not be able to the chinese bond market is massive the total value of the
global mortgage-backed securities market is 11 trillion dollars and in many ways that market
was probably better regulated this is a market significantly larger than china's entire gdp
and this is all to say nothing of the other big problem with how the chinese government handles
land 20 to 70 year leases eventually come to an end and some of those shorter leases have
now started to expire which is presenting the government with a problem what do they do with
that land now the traditional agreement was that this land would go back to the government but
obviously that idea is very unpopular amongst the people that will be kicked out of their homes and
stripped of their largest investment a widespread belief has grown amongst chinese citizens that
the land will never be taken back off them once these leases expire because it would simply be too
politically unpopular the real estate market also supports this way of thinking homes with 20 years
left on their land lease cost the same as homes with 70 years left on them all other things been
equal why would anyone pay the same price for a home that they can only live in for 20 years
when there is a similar property available that they can live in for 70 years well because they
don't expect that these leases will ever come to an end that and building standards in open china
mean that these buildings probably won't last that long anyway this stasis has been further confused
by new laws that proclaim that residential land rentals would be automatically renewed but failed
to mention if they would be renewed for free or if land holders would need to pay for a new lease
a member of the drafting team that wrote this law actually later admitted that they kept it
intentionally vague because they did not want to be responsible for choosing how this issue
would be resolved if the government does cave and chooses to extend land rentals forever with no
further fees then they would have cut themselves off from one of their primary revenue sources
so this leads us on to the other problem china has with taxes people don't pay them china does have
traditional progressive income taxes ranging from 3 up to 45 depending on how much citizens earn
the problem is that most people don't pay this most people in china are still employed in the
informal economy they run small stores or work on farms or do a number of other jobs that are paid
with cash in hand or transfers over wechat people on the other end of the financial spectrum rarely
get their income from a paycheck and instead are able to funnel it through businesses and
other assets which can massively reduce their tax burden it is a narrow minority who are wealthy
enough to have a formal job while not being wealthy enough to have the means to avoid tax that
end up paying it there have been a number of scandals surrounding high-profile chinese
business leaders and celebrities engaging in tax avoidance and the truth is that the government
could probably stop most of this tomorrow if it really wanted to but it doesn't for two reasons
the first is that loose regulations around business taxes encourage business activity
and encouraging business growth has been a core driver of the country's massive economic growth
over the past three decades the second is that if they let people get away with dodging taxes
then at any time they can just choose to investigate those people and they will always know
that they will find something to arrest them for very handy for silencing an outspoken celebrity
or business leader of course the problem this creates is that you can't effectively tax just
two percent of the population not only does that leave an unfair burden on the workers
who are genuinely paying their fair share and not only does it hamper the government's ability to
raise regular tax revenue it also fundamentally limits the government's control over the economy
a lot of focus has been placed on monetary policy recently in light of record high inflation
but fiscal policy as in the raising and lowering of taxes and government spending is just as
if not more important to running an effective economy increasing taxes can be a very effective
tool for curbing inflation and lowering taxes can accelerate economic growth during difficult times
but a tax break is only effective if people were paying taxes to begin with
if the government fails to levy taxes on the majority of the population this control mechanism
is all but ineffective levying income taxes on just a small portion of the population means that
the chinese government really does not have that much control over the economy if it's going in any
direction other than up managing an economy as big as china's during a downturn without broad control
over the tax base would be like trying to land a jumbo jet by flapping a hand fan sure everything
might fall into place but they really don't have that much control over it
okay now it's time to put china the world's second largest economy on the economics explained
national leaderboard starting as always with size and obviously there is not much to say about this
with a gdp of 14.7 trillion dollars it gets a 10 out of 10. that gdp is spread relatively thin out
over the world's largest population though so it has a gdp per capita of 10 400 this now makes it
a middle-income country by global standards and despite the criticisms i give it no one can take
away from the fact that it has been home to the single most intense period of economic development
ever in history this figure is almost exactly in line with the world's gdp per capita of 10
900 so it gets a 5 out of 10. stability and confidence is a difficult one to place
the economy itself is so large and influential these days that it's certainly not going anywhere
anytime soon but we have also repeatedly seen things like businesses not to mention people
been erased on the whim of the government this sovereign risk combined with increasingly worrying
news surrounding lockdowns and military ambitions means that the country can't get more than a six
out of ten growth in china has been unbelievable it's almost hard to imagine a time now when
china wasn't a major economic superpower but its economy has more than doubled in size since 2010
and it's more than 10 times larger than it was in the year 2000 it gets a 10 out of 10. no
other economy has really ever come close finally industry and again what is there to say china has
got to where it is today by being the workshop of the world they have developed from being a center
of low cost manufacturing where foreign companies could take advantage of a cheap pool of labor
to the unrivaled industrial hub they are today the country now has an advanced financial system
a healthy domestic market and globally recognized local companies sure they aren't producing the
real high-end stuff like airliners and competitive microprocessors but they still can't get anything
other than a 10 out of 10. altogether this gives china an average score of 8.2 out of 10
which puts it into second place on the economics explained national leaderboard this video is made
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