China’s Fiscal Deficit
This paper discusses the macro economic problem of China with regards to its low revenue and looming fiscal deficit. It also presents the effects of the stated problem in the growth and sustainability of the economy. The last section of the essay proposes solutions to the problem based on fiscal policies.
Table of Contents
Title Page…………………………………………………………………………………………………1
Table of Contents………………………………………………………………………………………2
Introduction………………………………………………………………………………………………3
China’s Macro Economic Problem
Fiscal Deficit …………………………………………………………………………………..4
Implications of Spending-Driven Debt…………………………………………………5
Fiscal Reforms and Policies ……………………………………………………………..6
Increasing Revenues and Debt Management……………………………………………….8
Conclusion……………………………………………………………………………………………..10
References …………………………………………………………………………………………….11
Appendix………………………………………………………………………………………………..12
Economic Growth
I. Introduction
China’s budget deficit is expected to grow year by year from 19.24 percent to 309.8 billion yuan or r percent of the Gross Domestic product. Such condition is a cause for alarm. This fiscal deficit level has not occurred since its reform and opening in 1978. In 1996-97, the fiscal deficit has stood at 0.78 percent of the GDP. However, it has increased significantly in 1998 following the expansionary fiscal policy. It even rose up to 2.8 percent in 2000. This becomes detrimental to the development plans and economic transition of the country.
In its very essence, fiscal deficit is spending today the financial resources that are allocated for the future. The key element to this is to ensure wise spending to produce profit for the future and prevent indebtedness. The fiscal policies play a critical role in addressing this macro economic problem. Specific measures must be drawn to increase the government revenue and mitigate the economic effects of the fiscal deficit. With regards to revenue, the government must broaden its tax base activities to collect the right taxes from the right people. It must also eliminate unnecessary tax incentives and promote fair treatment on both domestic and foreign forms. Additionally, it must implement laws to prevent tax evasion since it has become so common in China. The policies must also address unnecessary expenditures such as subsidizing non performing assets.
II. China’s Macro Economic Problem
2.1 Fiscal Deficit
The decline in the Chinese government revenue has become a great concern for policy makers and economists all over the world. This condition is attributed to the deficient public service and the infrastructure gaps within the country. While China is rapidly moving towards economic development and stability, it needs to generate larger revenues to support its development plan. The inability to increase the level of revenues undermines China’s capacity to produce goods and services to its people. This condition threatens the macroeconomic stability of the country and jeopardizes its transition and integration to the world market.
The perceived reasons for the low government revenue are the lowered corporate taxes, small tax base and tax evasions. Studies also cited the decline in the profitability of state owned enterprises as the major cause of the low revenue. However, state enterprises have paid relatively higher taxes than non state enterprises. The corporate income tax has declined from almost 100% in 1978 to 33% since 1994 (, 2000, ). The presence of tax reductions and exemptions is what reduces the tax base. All of these factors caused the tax revenue to grow slowly than the GDP.
As a consequence, large budget deficits are incurred. Local governments in China are not allowed to have deficits. Thus, the deficits of the central government must be equal to or less than the national deficit. Although in reality, the national deficit is often larger than that of the central government. This is an indication that local governments are unable to make the ends meet and have to borrow from the banks. This situation is brought by the expanded activities of the state both quantitatively and qualitatively (for instance, the improvement of infrastructures and support of industrialization). Consequently, the tax income cannot keep up with the expenditures and the public deficit and debt are likely to grow (, 2004, ).
2.2 Fiscal Reforms and Policies
There is a close relationship between the increase in government debt and the budget deficit since the economic reform of China. For one, the yearly budget deficit and its growth determines the increase in debt. On the other hand, successive deficits forced the government to pay the due debt with new issuance resulting to increase in the debt for the following year. Between 1978 and 1993, with 1985 and 1986 as exceptions, the budgetary expenditure of the government has exceeded its budgeted revenues. Amidst the multitude of fiscal adjustment policies since 1978, the one that impacted the state revenues most favorably is the tax assignment reform in 1994. The main reason behind the tax assignment was the decline in shares of the state revenues against the GDP and total revenue and its desire to increase control in the local government’s expenditure. The reason for curbing the local government is that despite the rising revenues the local authorities continue to make rapid capital expenditures (, 2000, ).
There are three major adjustment measures that contributed significantly in increasing the share of revenues. First, the government implemented a uniform rate for the shared portion of the tax revenue instead of the negotiated share. Prior to the adjustment measure, local governments share rates based on the negotiated conditions. The central government controls 75 percent of the shared taxes while the remaining 25 percent is distributed across the nation. Second, the central government initiated its tax office that collects its shred taxes. Thirdly, the central government widened the base of taxable activities and raised the taxes of the productive activities (, 2000, ).
The changes that contributes greatly to the increase in taxable revenues is the inclusion of more productive activities subject to VAT and the increase in VAT rates for various products. Also, contributing in the state revenues is the introduction of capital gains tax applied to property and stock transactions. The results of these measured led to the increase in the state’s total shred revenues and surpluses. However, the total revenue and the state’s share in it constitute domestic and foreign borrowings (, 2000, ). Though the tax reform helped increase revenues, it did not eliminate all the major problems plaguing China’s fiscal system.
2.3 Implications of Spending-Driven Debt
China adopted an expansionary fiscal policy by greatly increasing government expenditures since the Asian financial crisis. This policy was implemented throughout the administration of Zhu Rongji. When the new administration took place in 2003, the expansionary model was pursued as a fiscal policy. Even though the policy is phased out in 2004, the fiscal deficit is still huge. If the government will continue to run budget deficits, then it is likely that the government debt will continue to rise as well. In case of negative shocks, the government debt will be hard to sustain.
Consider a scenario where the government continues to spend and run budget deficit until 2008. After which it stops the policy with the reduction of expenditures to the baseline level. The government deficit will not become sustainable then since it has already reached a higher level. After the eight years of budget deficits, the ratio of debt to GDP would have grown from 22% in 2000 to 38.1% in 2009. Assuming that the government maintains this ratio by increasing taxes or reducing expenditures after 2009, it is likely to consider four different methods of financing the debt: (1) increasing the capital tax income (2) increasing the labor income tax (3) increasing the general income tax (4) decreasing government spending below the baseline level ( ,2005,).
Although China became more open since the economic reform, its still maintain its control over the capital measures. With this, some consider China as a closed economy in regards to capital flows. Others consider it a small open economy. With the spending driven policy, private investments are lower than the baseline without any fiscal expansion both in the short and long term. The reason behind this is that interest rates will increase and become costly due to rising government expenditure and debt. Also, government spending curbs out potential investments by reducing the incentives.
If the taxes are raised and the spending is reduced to finance the debt, the interest rate will stop from increasing but will remain in a relatively higher level than the baseline. Hence, the investment will remain below the baseline after the fiscal expansion. The different methods for debt financing have different implications on private investment, capital stock and output. The decrease in future government spending is likely to cause smaller decrease in investment, capital stock and output as compared to the increase in labor income tax or general income tax. Increasing the capital income tax with huge decreases in investment, capital and output is not an efficient method at all. When the general income tax is utilized to finance the debt, the decrease in investment, capital and output is greater than the increase in labor income tax (, 2005, 2006, ).
III. Increasing Revenues and Debt Management
Low governmental revenues are detrimental to the economic reforms and development of China. Hence, it is important that the Chinese government raise its budgetary revenues to sustain its growth.
First, the government must merge the extra budgetary revenues into the budgetary revenues and eliminate off budgetary measures. Extra budgetary and off budgetary revenues account for 50% and 30% of the revenues respectively. Such revenues are often misused and abused, thus cutting off such revenues will also decrease corruption and make better use of the scarce revenues. Extra budgetary and off budgetary revenues are generated form free collections. There are about 1,000 types of fess authorized by the Chinese government as compared to the 23 taxes (, 2000, ). Converting such fees to taxes will increase the government’s budgetary revenues.
Second, the government must broaden its tax base activities. This would mean the elimination of tax reductions and exemptions and the creation of new taxes. For instance, the personal income tax is low in china. The portion of employees’ compensation is given either in cash or in kind. Thus, the government must strengthen its accounting systems and collect taxes in all taxable income. In addition, the agricultural tax base set 40 years ago must be reviewed according to its current productivity. It must also treat foreign and domestic investments equally and eliminate unnecessary tax incentives to other firms. This will not only increase the revenue but also prevent capital flights. In addition to this, the government must reinforce tax laws to reduce tax evasions. Tax evasion has become common in China. The government need to set stiff penalties for tax evasions and rewards fro those following the tax laws. Additionally, non state enterprises must be treated equally in loan markets as do the state enterprises. Excessive fees on these non state enterprises must be reduced while increasing the tax collection by reinforcing the tax laws.
Chinese officials complain that the revenues generated from assigned local taxes fell short of their expenditure needs. It also makes sense for the central government to confer a degree of autonomous power to the local governments in setting the rates and base of local taxes. However, the power given to them must not distort the allocation of resources in the economy. This would enhance the efficiency of the fiscal system because the decentralized decision making is much more suitable in addressing the needs of the local residents. Some forms of transfer from the central to the local government are needed to fill both the vertical and horizontal fiscal gaps (, 2004, ).
Lastly, the expenditure side concerns the subsidies to loss incurring state enterprises. For instance, in 1985 the combined revenues of the central and local government amounted to 200.5 billion yuan. The subsidies to loss incurring state enterprises amounted to 50.7 billion which is about one fourth of the total revenues. The subsidy-revenue-ratios have been decreasing but more of the state’s revenues subsidized these enterprises. The same enterprises are also the beneficiaries of policy directed credits from state banks (, 2000, ). These credits become noncoverable losses to the state bank which compromises the bank’s position. Thus, the issue of privatizing state enterprises must be given consideration.
IV. Conclusion
The effectiveness of fiscal policies depends on the availability of well developed instrument that will assist in achieving the desired effects through specific measures. Blunt fiscal measures can result to the impairment of other areas. Thus, an effective fiscal policy requires the government to collect the right revenues from the right people. On the revenue side, there is the compelling need to improve the competency in the collection of taxes. Instead of the abridged tax revenues, it must gather taxes from a broader base of revenue sources. An effective tax collection system will enhance the revenue intakes and instill a sense of social responsibility. Ultimately, the government must continuously reform its fiscal policies towards greater revenues and lower indebtedness. The problem with debt is not the figure itself but its growth rate. The burden of excessive spending today falls upon the future generations. If the present government is convinced that borrowing is necessary, then it should arrange the repayment of the accumulated debt.
References
Books
Journal
Internet Sources
Appendix
China Advised to Keep an Eye on Fiscal Deficit
China has to turn to a continuous expansionary fiscal policy to rev up and maintain its economic growth. But the question is how long the fiscal syringe can last.
With the 150 billion yuan (US.14 billion) treasury bonds in the 2002 fiscal year coming into place, China’s budget deficit will shoot up year on year by 19.24 percent to 309.8 billion yuan (US.46 billion), or 3 percent of the gross domestic product (GDP), an internationally recognized alarm level.
For the first time, China’s fiscal deficit has touched such a level since the country started its reform and opening-up in 1978.
“The Chinese government is now standing in hot water, fighting a tough battle with the looming deflation,” , a researcher with the State Economic and Trade Commission, said in his signed article published in the Beijing-based China Business Times.
The rising fiscal deficit results mainly from the big sum of spending used for countering the sluggish domestic consumption, according to .
China seems to have fallen prey of an irksome deflation beginning in 1996 after it accomplished a praiseworthy “soft-landing” out of the sizzling macro-economy during 1993-94.
Characterized by the declining prices and consumers’ cautious buying sentiment, a mild deflation has risen as the policy-makers’ arch-foe since then, pressing the central government to take a proactive fiscal orientation.
In 1996-97, the fiscal deficit of China stood at 0.78 percent of the GDP.
But after it embarked on an expansionary fiscal road in 1998, the deficit level rocketed all the way to 2.8 percent in the year 2000, and will finally exceed 3 percent by the end of this year, said.
Compared with the deficit level in 1997, the total deficit size will more than double in 2002, up 27 percent per year on average, he said.
“This is surely not a sustainable economic growth,” he said. “China is running toward a ‘fiscal deficit trap’.”
Worse than that, if taken into account the non-performing assets in the State-owned commercial banks and the central and local governments’ hidden debts to the weak national social security network, the comprehensive deficit of China should be at least over 70 percent of its GDP, far exceeding that of even most developed countries, which is usually around 60 percent.
But the Chinese Central Government does not seem to concern too much about the rocketing fiscal deficit.
At the Central Economic Work Conference held early this month, the Central Committee of the Communist Party of China still chose a proactive fiscal policy, together with a stable monetary policy, as the keynote of China economic arrangements in 2003.
The Central Government has so far issued a total of 660 billion yuan (US.8 billion) worth of long-term treasury bonds and plans to release another 140 billion yuan (US.9 billion) in bonds next year.
A government’s fiscal deficit is in nature to spend today the money allocated to tomorrow.
As long as the government can be sure that tomorrow will be better than today, nothing is too serious. The key is to ensure that today’s spending is wise and efficient enough to produce profit for tomorrow.
Of this, the Chinese Government appears to have reason to feel confident.
The National Bureau of Statistics said that China’s GDP will grow by 8 percent this year, hitting the threshold size of 10 trillion yuan (US.2 trillion).
The Chinese Academy of Social Sciences and the Development & Research Center under the State Council, both governmental think tanks, all predict another around 8 percent GDP growth next year.
But the Central Government would rather take a wary footing.
Financial Minister Xiang Huaicheng declared Wednesday that the central finances will not support a penny more for any “image-polishing project”, the program to publicize the administrative performance, launched by governments at all levels.
“To practice strict frugality and stop waste is the key content for next year’s financial work,” he said.
By PD Online Staff
Credit:ivythesis.typepad.com
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