MNI: China’s Tax Revenue Fall Expected To Continue In H2

China’s 1.6% drop in tax revenue since January is expected to persist through the year, as economic growth shifts from tax-heavy real estate toward lower-yielding new energy industries, with authorities likely to use off-budget measures to support the economy and fill public financing gaps to maintain the budget deficit near the 4% target, local economists told MNI.

Persistently negative producer price index (PPI) growth and ongoing corporate profit weakness will continue to weigh on income and value-added tax (VAT) receipts, said Wang Zhe, senior economist at Caixin Insight Group in Beijing. “Real estate is no longer a major taxpayer given its decline, while revenue from fast-growing new industries like electric vehicles remains limited due to their preferential treatment and low profitability,” Wang Zhe added.

Robust Q1 GDP of 5.4% coupled with low tax revenue was not indicative of a tax-cut led growth model, but rather government’s reliance on infrastructure investment financed through sovereign bond issuance and manufacturing growth supported by subsidised bank credit, said Wang Dan, director at Eurasia Group. “With industrial profits down, business earnings and tax cuts are insufficient to drive new investment – they merely help keep operations running," Wang Dan added. 

Official data released last week showed national general public budget revenue, of which tax accounts for the bulk, declined 0.3% y/y from January to May. This fell short of the 0.1% full-year increase targeted at the National People’s Congress in March. Authorities in 2023 extended preferential tax policies for new energy vehicle purchases to the end of 2027.

POLICY RESPONSE

With tax revenue falling short of expectations, the government is likely to cover general expenditure gaps – including salaries and benefits – through off-balance sheet measures such as increased state-owned enterprise profit transfers or spending cuts, said a chief economist at an advisory firm. “This method preserves the roughly 4% budget-deficit target, rather than raising additional on-balance sheet general-purpose bonds, which are usually capped,” the economist said.

However, Wang Dan noted the deficit could reach its upper limit if authorities roll out an additional CNY2 trillion in fiscal stimulus – likely needed to meet this year’s GDP growth target – after a disruptive trade war pressured small and medium-sized enterprises, prompted firms to relocate overseas, and worsened labour market conditions in the first half.

Still, most of the stimulus would be channelled toward infrastructure, limiting its direct impact on the official budget deficit, she added.

But as the economy slows, the government needs to both cut taxes and increase spending and deficits, concluded Wang Zhe, adding that policy must remain accommodative in H2 amid persistent uncertainty in U.S.-China trade relations.