China's Major Tax Problem | Economics Explained - YouTube

china has a major tax problem or actually  china has a few major tax problems and  

most of them stem from the fact that china is  both the second largest economy in the world  

with advanced financial systems and international  trade networks while also still being a largely  

informal economy china's large economy demands  a level of government spending which requires  

a large and broad tax base to fund unfortunately  the country does not have that the united states  

china's closest peer and economic size has  federal tax revenues of around 17 percent of gdp  

or around 25 percent when you include all  local and state revenues china by comparison  

has revenues of nine percent now this video  isn't to argue for lower taxes or higher taxes  

it is instead to look at the systemic issues  that china will have to overcome to stop living  

on borrowed time and create a sustainable system  to fund its government's activities but to truly  

understand this problem we are as always going to  need to look at some specific issues why has china  

been unable to raise more taxes from its economy  is this low tax revenue actually going to hurt its  

economy and finally is there anything that they  can do to fix this issue once we have done all of  

this we can put china the second largest economy  in the world on the economics explained national  

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free so china's tax collection problem is really  three problems they can't collect taxes from most  

people the people they can collect taxes from do  a really good job of avoiding those taxes and the  

taxes they do collect don't always go where they  need to china operates off a central authority but  

no single man or even a single institution can  oversee the operations of 1.4 billion people  

in one of the lightest countries in the world by  basically every metric that's why the government  

authority is shared amongst provinces with their  own subprovincial regions and cities within those  

regions all of these local authorities are in  charge of certain government functions that are  

too small or regionally specific to be controlled  by the government organizations above them  

it doesn't make sense for the people's party  congress to be managing the trash collection  

schedule of hangzhou so they delegate that down to  the provincial government body who will probably  

delegate it down to a city council so far this  is not that unusual it's basically exactly the  

same system that i'm sure most of your own  governments use to perform their functions  

the big difference is in the way that they get  their funding in most developed economies local  

governments get their funding primarily through  a combination of property taxes and money coming  

from a more senior level of government the federal  government gives money to the states and states  

give money to their local governments they may  also have alternative revenue sources from things  

like parking tickets or business fees but those  are pretty much irrelevant compared to these two  

china's local governments are a little bit  different in that they make most of their  

money by taxing businesses and selling off 20 to  70 year leases on their land holdings in china no  

private company or citizen can own urban land so  renting it out for 70 years is the next best thing  

60 of whatever these local governments make from  businesses needs to be returned to the central  

government but the land revenues are all theirs  this is a very significant revenue source because  

the real estate market in china is absolutely  massive we made a video a few months ago about  

the real estate debt crisis the country had got  itself into to prop up this market a video that  

i'm just saying we released just a month before  the news broke about the financial troubles of the  

evergreen property development group now the thing  about land lease revenues is that they only work  

if the land is worth developing land is only worth  developing if there's some kind of infrastructure  

in place to support the people that will be living  in these new developments the solution to this is  

that provincial governments are consistently in  an arms race against one another to build out  

more infrastructure so they can make themselves  economic hubs so they can sell off land rights  

so that they can fund more infrastructure so  that they can make themselves economic hubs  

this game of chicken and egg does two things the  first is that it creates a glut of infrastructure  

ghost cities and railways that carry no  passengers are not uncommon sights in china  

again we did a video about exactly this the second  thing it does is necessitate a lot of upfront  

investment by these provincial governments the  problem is that these governments are not allowed  

to issue bonds and they don't start making land  revenues until they sell off their land holdings  

so they need to get creative they have come up  with what is called a local government financing  

platform and it's pretty much exactly as dodgy as  it sounds what these local governments do is set  

up a private company and then give that company  some of their state assets this can be cash shares  

and state enterprises or the land rights that they  are trying to sell off this supposedly private  

company can then go to the bank and use all of  these assets as collateral to get a loan the  

local government can then use this cash to fund  whatever infrastructure projects it wants and the  

banks can bundle these loans up and sell them as  bonds on the open market in 2019 local government  

financing bonds constituted 39 of all outstanding  bonds in china's domestic market the other 60 was  

up until recently mostly made up of real estate  bonds sold by the development companies that  

needed funding to build on the land that was being  leased out to them by these local governments  

these local government financing platform  bonds are deemed to be quite safe because they  

indirectly have the backing of the communist party  and it's unthinkable for many chinese investors  

that the government would default on their debts  this also has the benefit of pushing government  

debt into the private sector so national debt to  gdp figures look better than they really should  

of course the problem is that these are local  governments not the national government and  

they have every chance of going bankrupt because  they are limited in how they can raise revenue so  

far this whole system hasn't been an issue because  the real estate market has appreciated in value so  

relentlessly that even the most reckless borrowing  practices can be wiped away with the money that is  

made by leasing out this land but this precarious  status quo is starting to come undone for starters  

china is still practicing strict lockdowns to stop  the spread of covert the government has adopted a  

zero case policy which means even entire cities as  large as shanghai will go into complete lockdown  

should any cases be detected these lockdowns have  banned people from leaving their house for any  

reason outside of getting groceries so businesses  are obviously suffering a lack of business  

activity has cut off a major source of revenue  for local chinese governments and that's before  

we get into the problems in the real estate sector  the unwavering confidence the chinese people once  

had in real estate is will wavering off the back  of high profile property development bankruptcies  

this has meant that less people want to invest in  properties which means less are getting built less  

getting built means that local governments gain  less revenue from renting out their land holdings  

it also means that banks are no longer interested  in accepting these land holdings as collateral to  

underwrite the bonds for these local government  financing platforms to make this all worse the  

chinese central government has started issuing tax  returns to compensate citizens from being locked  

into their homes while simultaneously pushing  for more infrastructure projects to offset the  

economic impacts that the lockdowns caused in  the first place this means less money coming  

in more money going out and less options to raise  money to bridge the financing gap in the meantime  

now if highly speculative financial assets that  are deemed too safe to fail because they are  

backed by real estate in the market that has been  booming sounds familiar to you then this should  

probably make you a little bit worried to top this  all off almost all bonds issued in china are rated  

at least double a and local government financing  bonds are almost exclusively rated at aaa  

which suggests to investors that these are the  safest possible investment when the reality is  

anything but this is a 19 trillion dollar bond  market that is based on a system that requires  

perpetual growth you might have been thinking  this entire time that should this market implode  

spectacularly well that would be bad but the  central national government would step in to bail  

these local governments out if for no other reason  than to save the reputation of their own party  

but they might not be able to the chinese  bond market is massive the total value of the  

global mortgage-backed securities market is 11  trillion dollars and in many ways that market  

was probably better regulated this is a market  significantly larger than china's entire gdp  

and this is all to say nothing of the other big  problem with how the chinese government handles  

land 20 to 70 year leases eventually come to  an end and some of those shorter leases have  

now started to expire which is presenting the  government with a problem what do they do with  

that land now the traditional agreement was that  this land would go back to the government but  

obviously that idea is very unpopular amongst the  people that will be kicked out of their homes and  

stripped of their largest investment a widespread  belief has grown amongst chinese citizens that  

the land will never be taken back off them once  these leases expire because it would simply be too  

politically unpopular the real estate market also  supports this way of thinking homes with 20 years  

left on their land lease cost the same as homes  with 70 years left on them all other things been  

equal why would anyone pay the same price for  a home that they can only live in for 20 years  

when there is a similar property available that  they can live in for 70 years well because they  

don't expect that these leases will ever come to  an end that and building standards in open china  

mean that these buildings probably won't last that  long anyway this stasis has been further confused  

by new laws that proclaim that residential land  rentals would be automatically renewed but failed  

to mention if they would be renewed for free or  if land holders would need to pay for a new lease  

a member of the drafting team that wrote this  law actually later admitted that they kept it  

intentionally vague because they did not want  to be responsible for choosing how this issue  

would be resolved if the government does cave and  chooses to extend land rentals forever with no  

further fees then they would have cut themselves  off from one of their primary revenue sources  

so this leads us on to the other problem china has  with taxes people don't pay them china does have  

traditional progressive income taxes ranging from  3 up to 45 depending on how much citizens earn  

the problem is that most people don't pay this  most people in china are still employed in the  

informal economy they run small stores or work on  farms or do a number of other jobs that are paid  

with cash in hand or transfers over wechat people  on the other end of the financial spectrum rarely  

get their income from a paycheck and instead  are able to funnel it through businesses and  

other assets which can massively reduce their tax  burden it is a narrow minority who are wealthy  

enough to have a formal job while not being  wealthy enough to have the means to avoid tax that  

end up paying it there have been a number  of scandals surrounding high-profile chinese  

business leaders and celebrities engaging in tax  avoidance and the truth is that the government  

could probably stop most of this tomorrow if it  really wanted to but it doesn't for two reasons  

the first is that loose regulations around  business taxes encourage business activity  

and encouraging business growth has been a core  driver of the country's massive economic growth  

over the past three decades the second is that  if they let people get away with dodging taxes  

then at any time they can just choose to  investigate those people and they will always know  

that they will find something to arrest them for  very handy for silencing an outspoken celebrity  

or business leader of course the problem this  creates is that you can't effectively tax just  

two percent of the population not only does  that leave an unfair burden on the workers  

who are genuinely paying their fair share and not  only does it hamper the government's ability to  

raise regular tax revenue it also fundamentally  limits the government's control over the economy  

a lot of focus has been placed on monetary  policy recently in light of record high inflation  

but fiscal policy as in the raising and lowering  of taxes and government spending is just as  

if not more important to running an effective  economy increasing taxes can be a very effective  

tool for curbing inflation and lowering taxes can  accelerate economic growth during difficult times  

but a tax break is only effective if  people were paying taxes to begin with  

if the government fails to levy taxes on the  majority of the population this control mechanism  

is all but ineffective levying income taxes on  just a small portion of the population means that  

the chinese government really does not have that  much control over the economy if it's going in any  

direction other than up managing an economy as big  as china's during a downturn without broad control  

over the tax base would be like trying to land a  jumbo jet by flapping a hand fan sure everything  

might fall into place but they really  don't have that much control over it  

okay now it's time to put china the world's  second largest economy on the economics explained  

national leaderboard starting as always with size  and obviously there is not much to say about this  

with a gdp of 14.7 trillion dollars it gets a 10  out of 10. that gdp is spread relatively thin out  

over the world's largest population though so it  has a gdp per capita of 10 400 this now makes it  

a middle-income country by global standards and  despite the criticisms i give it no one can take  

away from the fact that it has been home to the  single most intense period of economic development  

ever in history this figure is almost exactly  in line with the world's gdp per capita of 10  

900 so it gets a 5 out of 10. stability  and confidence is a difficult one to place  

the economy itself is so large and influential  these days that it's certainly not going anywhere  

anytime soon but we have also repeatedly seen  things like businesses not to mention people  

been erased on the whim of the government this  sovereign risk combined with increasingly worrying  

news surrounding lockdowns and military ambitions  means that the country can't get more than a six  

out of ten growth in china has been unbelievable  it's almost hard to imagine a time now when  

china wasn't a major economic superpower but its  economy has more than doubled in size since 2010  

and it's more than 10 times larger than it was  in the year 2000 it gets a 10 out of 10. no  

other economy has really ever come close finally  industry and again what is there to say china has  

got to where it is today by being the workshop of  the world they have developed from being a center  

of low cost manufacturing where foreign companies  could take advantage of a cheap pool of labor  

to the unrivaled industrial hub they are today  the country now has an advanced financial system  

a healthy domestic market and globally recognized  local companies sure they aren't producing the  

real high-end stuff like airliners and competitive  microprocessors but they still can't get anything  

other than a 10 out of 10. altogether this  gives china an average score of 8.2 out of 10  

which puts it into second place on the economics  explained national leaderboard this video is made  

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