China’s Case for Trump’s Tax Cuts
Here’s an argument for the Trump Administration’s tax reform from a surprising source: China’s leaders fear the plan will lure manufacturing to the U.S. Forget a trade war, Beijing says a cut in the U.S. corporate rate to 15% from 35% would mean “tax war.”
The People’s Daily warned Friday in a commentary that if Mr. Trump succeeds, “some powerful countries may join the game to launch competitive tax cuts,” citing similar proposals in the U.K. and France. Worst affected, the Communist Party’s premier mouthpiece opined, would be “export-oriented countries that are powerless to compete in tax reductions”—i.e., China.
Beijing knows from experience how important tax rates are to economic competitiveness. Conventional wisdom holds that low labor costs turned China into “the world’s factory.” Less widely known is the role taxes played in its growth miracle.
China’s double-digit growth streak began in the mid-1990s after government revenue as a share of GDP declined to 11% in 1995 from 31% in 1978—effectively a supply-side tax cut. But then taxes began to rise again as the Communist Party reasserted control over the heights of the economy. In 1999 the government set a revenue goal of 20% of GDP, and the tax man’s take now stands at 22%.
China’s big government doesn’t stop there. The central government runs a fiscal deficit of 3%, and local governments fund their operations through borrowing from state banks. It’s no coincidence that as government has grown, growth has slowed to below 7%.
Chinese companies have started to complain that the high burden is killing profits. Zong Qinghou, founder of the country’s largest beverage company Wahaha, revealed that his company pays more than 500 different fees to government entities, in addition to taxes. The proliferation of such levies contributed to low private-investment growth last year.
Chinese windshield maker Fuyao Glass opened a $600 million factory last October near Dayton, Ohio, and plans other facilities in Illinois and Michigan, creating 4,500 jobs. CEO Cao Dewang caused a stir in December when he told a reporter the decision was driven by tax differences: “Overall taxation for manufacturers in China is 35% higher than that in the U.S.”
Mr. Cao said out loud what many entrepreneurs mutter under their breath. China’s 25% profits tax may be lower than the U.S. 35% rate, but the country also imposes a 17% value-added tax as well as 16 other taxes. Inputs such as land, electricity and transportation are all much cheaper in the U.S., Mr. Cao said. Left unsaid is another big cost: Chinese officials demanding bribes. Together, these can cancel out China’s lower labor costs.
When electronics giant Foxconn announced in January that it is considering a plant in the U.S., American commentators wondered whether pressure from the Trump Administration was a factor. But in China it was read as further proof that high taxes have started the process of “hollowing out.”
President Xi Jinping began to address the problem about 18 months ago when he launched “supply-side reforms” to cut corporate taxes and regulation. The results have been modest because the government reverted to Keynesian spending stimulus. But the program’s stated goal of restoring lost competitiveness shows that Beijing understands the importance of corporate tax rates to growth and prefers not to have to compete in a “tax war.”
The U.S. inflicts one of the highest corporate-tax rates in the world, and reform is urgently needed to compete against other developed economies. If that’s the stick, the People’s Daily warning offers a carrot: A supply-side cut can make the U.S. attractive to Chinese companies suffering from big government at home.
Appeared in the May. 02, 2017, print edition.