Despite officially growing at about 5 percent, all signs point to the Chinese economy being much weaker than advertised.
This hits most directly at government finances, where spending nationally is up by about 4 percent, but revenue is down by about 3 percent through the first half of 2024. For an economy dependent on public investment and spending that is increasingly debt-constrained, this is a major problem.
China has a complex and multi-layered tax system that includes corporate, personal, VAT, and other assorted taxes and fees that provide state revenue. Because tax revenue should move closely with nominal gross domestic product (GDP) growth, Beijing should be concerned that China’s tax revenue is declining even as nominal official GDP is expected to end the year with a 6 percent to 8 percent increase from 2023.
Seeing sliding revenue into state coffers, Beijing has devised a plan to address the problem while simultaneously compounding its problems with the business sector, including state-owned enterprises.
The Chinese tax authorities and law enforcement have stepped up tax investigations of businesses and individuals nationwide. Although the investigation is too broad to be uncoordinated, there has been no official or new policy announcement about any new crackdown, leaving many wondering about what is happening or the objective.
The significant step-up in tax investigations targeting individuals, businesses, and even state-owned enterprises is causing major concern throughout Chinese society. The investigations appear to go back years and, in some cases, decades. Even more worrisome, companies and individuals report being fined enormous sums for tiny infractions dating back years, in some cases significantly in excess of the original infraction.
There are a couple of important implications of the tax crackdown. First, businesspeople and anyone with means are even more focused on shifting their capital and family out of China. Despite supposed enormous current account surpluses flowing into China, authorities are doing everything they can to keep money from fleeing the country. Document fraud in international transactions continues to facilitate the transfer of money out of China, while the emigration of wealthy Chinese and their children continues unabated. A bad business climate merely pushes even more people to leave and confirm their choice.
Second, a major crackdown seeking to recoup past taxes is not indicative of a robust economy or a public sector seeing a low single-digit yearly decline in revenue. In a robust economy, police and tax authorities have better things to do than chase decades-old tax bills that are notoriously difficult to recover.
It also raises questions about the veracity of China’s data on tax revenue. Governments everywhere are used to the ups and downs of trying to estimate tax revenue months in advance. Realistically, a 3 percent decline in revenue could be merely statistical noise. However, pushing a national tax crackdown seems to speak to concerns that government revenue is even worse than official data indicate, implying that the economy is in much worse shape than indicated in official propaganda.
It remains distinctly possible that this is an extension of the corruption crackdown that has been ongoing since Xi Jinping became chairman and merely extends it to private citizens. It is too early to tell for sure. Still, the specter of a broader societal crackdown on tax investigations dating back decades would be even more worrisome if it is primarily political.
Beijing seems intent on cracking down on its private sector and driving them away while extending control and fear to the broader population. If that is the objective, this is a great way to achieve it.
