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A Break From the Norm?
How will the U.S. tax cut affect China?
 NO. 20 MAY 18, 2017
A tax officer helps a local resident file her tax returns electronically at a tax office in Luoyang, Henan Province, on September 27,2016 (XINHUA)

The Donald Trump administration unveiled a tax cut plan on April 26 that would reduce the top U.S. corporate tax rate from 35 percent to 15 percent and the top individual income tax rate from 39.6 percent to 35 percent. It would also reduce the number of personal income tax brackets to three from seven, with new tax rates of 10 percent, 25 percent and 35 percent. The plan would nearly double the standard allowance for married couples to $24,000 from $12,700.

Such a significant tax cut has aroused responses worldwide. The leading Chinese newspaper People's Daily said the U.S. tax cut is provoking a "tax war." But I think there is room for discussion on this point.

China launched a tax reform on May 1, 2016—replacing business tax with value-added tax—which is equivalent to a tax cut. Premier Li Keqiang has also announced that China would cut taxes by 380 billion yuan ($55.15 billion) in 2017. Therefore, the tax policies of nations must be decided by their own economic conditions.

During the terms of presidents Ronald Reagan and Bill Clinton, tax reductions prompted the recovery of the U.S. economy. Trump's tax plan fulfills a campaign pledge. It is very likely more governments will take similar actions in the future.

Then how will the U.S. tax cut affect China?

First, it will change China's use of currency approaches to boost economic development, a strategy which it has employed for many years with the result that, as the scale of the currency in circulation has expanded, China has experienced inflation of asset bubbles. For instance, real estate prices have soared in recent years partly based on currency depreciation. In addition, commercial banks have also fueled the bubbles by introducing various new financial products that have increased by a large amount the money in circulation.

At a group study session on April 25, the Political Bureau of the Communist Party of China Central Committee focused on national financial security and the risk spillover effects of the adjustments of monetary and financial policies in foreign countries. This move, as well as the drastic changes in financial regulatory methods, indicated that some changes would take place in China's economic reforms.

Second, the U.S. tax cut will affect China's tax structure. Currently China's main sources of tax revenue are indirect taxes levied on commodities or services. Indirect taxes increase prices paid by consumers, and increasing the rates of such taxes results in price hikes. But, under the taxation systems of many other countries, direct taxes such as income tax and property tax are the major tax revenue sources. Such a tax structure makes it difficult for taxpayers to shift the tax burden to others, so it is better able to adjust reallocation of social wealth and thereby guarantee social security.

In China, since the proportion of direct taxes is low, wage earners form a majority of tax payers, contributing 40 percent of the nation's total income tax. However, high-income groups have a lighter tax burden, since they enjoy more sources of tax deduction. Taxation fails to narrow the disparity between the rich and the poor in the country. The U.S. tax cut can serve as a model for China's future tax reform that the proportion of direct taxes should be raised.

The U.S. tax cut will certainly intensify difficulties for non-market economies and less competitive corporations, which conforms to Trump's protectionist stand on trade. China will face a competition of tax rates with the United States, but there is also a competition of productivity between the two countries. So, for China it is more urgent to improve its market economy system and realize reasonable allocation of resources.

The U.S. tax cut will affect China's economy to some extent, but there will be both risks and opportunities. If we can address the challenges well, China's economic structure will be improved. So, we should see the U.S. tax cut in the light of development and try to gain opportunities for domestic economic growth.

This is an edited excerpt of an article written by financial commentator Xu Quansheng and published in Securities Times

Copyedited by Chris Surtees

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