Even before the massive lockdowns in Shanghai and other Chinese cities in April 2022, China’s economy faced strong headwinds, causing the government to lower interest rates in January and announce tax cuts in early March. As the economic disruptions associated with China’s “zero-Covid” policy continue to unfold, the issue of what the government should do to restore quickly-eroding consumer and producer confidence has, for many, taken on even greater urgency. For one thing, how much can tax policy ease the coming economic pains?
To answer that question, it would be useful first to look at the size of the recently announced tax policy stimuli. Yet assessing the size of tax cuts is an exercise fraught with ambiguities. The State Council estimated that the new tax policies introduced in March would result in “tax reductions and refunds” totaling CNY2.5 trillion in 2022. Now, China’s total tax revenue in 2021 was CNY17.27 trillion. A 2.5-trillion-yuan tax cut might seem to suggest that the government is foregoing a remarkable 14.5 percent of its total potential revenue.
Has the government really proposed to shrink itself in such an extraordinary way? Some official media outlets did assert that the government’s goal was precisely to “exceed society’s expectations” in its policy largesse. But how can this be reconciled with the fact that, in the budget tabled at the meeting of the National People’s Congress (NPC) in March, government general revenue is projected to sustain a 3.8 percent increase in 2022?
To address this apparent discrepancy, one could start by noting that 60 percent, or CNY1.5 trillion, of the proposed “tax reductions and refunds” come from one source: refunds of the value added tax (VAT) charged on firms’ input purchases. A key point is that one dollar of input VAT refund does not mean one dollar of foregone revenue. In fact, the benefit to taxpayers is at least one order of magnitude smaller: CNY1.5 trillion of VAT refunds may mean just CNY100 billion in tax savings to taxpayers. That is still a notable amount but not nearly as eye-popping.
The reason for this discrepancy is simple. Buyers pay VAT on purchases and receive VAT invoices from their vendors (who collect and remit the tax collected to the government). For example, a manufacturer purchasing equipment worth CNY1 million is charged 13 percent VAT, pays CNY1.13 million to the equipment vendor, and obtains a VAT invoice for CNY130,000. When the manufacturer makes its own sales, it in turn collects the VAT from customers, but remits only a portion of the VAT collected to the government. If the manufacturer makes sales of CNY1.1 million and collects CNY143,000 of VAT from customers, it will use its CNY130,000 invoice (from the prior equipment purchase) to claim an “input VAT credit”, and remit to the government only CNY13,000. The manufacturer effectively recovers, from its customers, the CNY130,000 of VAT it paid earlier on input purchases.