China’s reputation for low-cost manufacturing under attack

A creaky tax system can make China an expensive place to produce things

by Economist, Jan. 14, 2017

WHEN China was gripped by political turmoil in the 1960s and 1970s, Cao Dewang cut his teeth as an entrepreneur. Mao’s chaotic rule forced him out of school and he took to the street, a scrappy teenager selling fruit and cigarettes. Looking back, Mr Cao has said that it was actually a good time to do business: the government was too busy waging ideological campaigns to enforce its regulations. Mr Cao went on to become a billionaire, as China’s biggest manufacturer of automotive glass. Last month he sparked controversy by complaining that life was tough for businesses in China. There are, he said, far too many regulations—especially taxes and fees. These days the government is much more effective in enforcing them.

Mr Cao hit a nerve with his claim that it was more costly to run a business in China than in America. He should know. His company, Fuyao Glass, bought an old General Motors factory in Ohio in 2014 and announced plans to invest $200m there. Mr Cao claimed that the overall tax on manufacturers is 35% higher in China than in America. Once China’s higher land and energy costs are factored in, the advantages of its lower labour costs disappear, he said.

The State Administration of Taxation tried to refute the claims. It noted that overall tax revenues as a percentage of GDP are just 30% in China, lower than the average of 42.8% in developed countries and 33.4% in developing ones. But Mr Cao’s complaints do have some merit. In its annual “Doing Business” rankings, the World Bank estimates that China’s total tax rate as a percentage of profits is 68%, roughly two-thirds more than in high-income countries.

This points to bigger flaws in China’s taxation system: an overreliance on indirect taxes and poor design of direct taxes. According to a 2015 analysis by W. Raphael Lam and Philippe Wingender of the IMF, taxes on corporate and personal incomes account for just a small fraction of China’s tax revenues. Instead, more than half of revenues come from indirect taxes on goods and services. As for direct taxes, they are deeply regressive: social-security contributions account for 90% of tax liabilities for most households.

China is slowly tackling some of these issues. Reform of the value-added tax system (which has replaced a cruder tax on revenues) will lower the government’s take of indirect taxes. It has eased the burden of social-security payments for its poorest citizens. Richard Bao, a partner with Grant Thornton, an accounting firm, says that China is making the tax-filing process simpler for companies, at the same time as it is tightening the net around those who dodge it. And Mr Cao’s criticism suggests that China might also be making progress in another respect. Like all rich countries, it, too, now has tycoons who threaten to invest abroad if the government does not cut their tax bills.