Through the glass, darkly

Chinas reputation for low-cost manufacturing

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

From the print edition | Finance and economics

Jan 12th 2017, 15:54

WHEN China was gripped by political turmoil in the 1960s and

1970s, Cao Dewang cut his teeth as an entrepreneur. Maos
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 Chinas 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 regulationsespecially 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
Chinas 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
Caos complaints do have some merit. In its annual
Doing Business rankings, the World Bank estimates that
Chinas 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 Chinas 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
Chinas 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 governments 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 Caos
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.