Remember the Beatles? They had many great songs; one my favorites was Tax Man. A few key lyrics below allude to what is happening in China these days,
"...(if you drive a car, car;) - I’ll tax the street;
(if you try to sit, sit;) - I’ll tax your seat;
(if you get too cold, cold;) - I’ll tax the heat;
(if you take a walk, walk;) - I'll tax your feet…..”
And thus the Chinese have figured out if the provincial and local governments cannot forever sell land, they must come up with other sources of operating income, ideally recurring in nature. Further, as development in the country continues, people are asking the question “why wreck our province when the other provinces enjoy the benefits of our resources?” The solution? Taxes.
In the past few weeks there have been two major pieces of news on this front. First, announced are plans to expand a pilot program implementing resource taxes across the entire country and second, real estate property taxes are to be implemented in Shanghai and Chongqing. Those 大亨 (“da heng” big shots) with multiple homes or especially high-valued homes seem to be the targets of the tax.
China is distinguished by natural resources being found in locations rather remote from where they are used. Basically, China’s natural resources are in the west and the production, post Cultural Revolution and Great Opening, is along the Pacific coast. Extractive industries extracted and polluted, the manufacturers had “inputs” and they could manufacture things for the domestic and export markets.
The provinces have never been able to “cash in” on their natural wealth and have been equally unable to fund environmental cleanup of the messes made. A year ago in the extreme western area known as the Xinjiang Uygur autonomous region (about as far west as you can go in China before you find yourself in Borat’s glorious Kazakhstan), a pilot program was rolled out, taxing oil and natural gas. The national government decided this pilot was successful and will begin implementing this natural resource tax nationwide over the next five years. The first beneficiaries of this expansion will be the other twelve western provinces and autonomous regions.
The NDRC has released a few salient details including a targeted 5% tax rate that will also shift depending on the commodity. Not wanting to ignore the appeal of economics, the tax rate will also be applied to the market price of the commodity rather than the tonnage as was the case with the initial pilot program. It is worth noting that the taxes will be applied to not just oil and gas, but also to rare earths, water and coal. Expect to see these taxes passed on along the supply chain. I find the inclusion of coal, used so much for power and heating, and water to be noteworthy. The eastern cities, big consumers of both, will likely feel those higher costs. Certainly economists won’t call it inflation, but the public whose purses will be squeezed certainly will feel that way.
Property prices here in China remain a hot topic as the numbers climb ever higher despite a barrage of actions and restrictions by the national government to quell the price escalation. On the demand side, second homes now require a 60% down payment as a means to prevent speculation (and presumably protect the banks from mortgage exposure) and a 10% premium on mortgage lending rates for certain price categories was also tried.
The next step is to roll out property taxes. To those westerners, it may come as a surprise that property taxes on homes or apartments did not exist in China. In the west, property taxes make up a significant portion of the local government operating budget. Here in China, the local government has a hand in the property game because they sell land, owned by the government, to developers. The proceeds from the land sales have then been used to fund the governmental annual operating budget. Clearly, not a sustainable model!
To create a recurring revenue stream for the provincial and local governments, the idea of taxes is appealing. Taxes targeted at the escalating real estate sector make them even more appealing. This initial foray into taxation will be modest targeting just Shanghai and Chongqing.
In Shanghai if one buys a second home with a price of more than 2x the average (watch that word as it is a gameable one indeed!), then an annual tax of 0.60% (60 basis points) will be collected. If the home has a price of less than 2x the average, the tax rate is 0.40%.
In Chongqing, the top rate will be 1.2%. Homes priced at 3x-4x the market average will be taxed at 1% and homes prices at 2x-3x the average will be taxed at 0.50%. The government acknowledges these are low initial rates as they wish to assess the impact on the market. I suspect over time the rates will creep higher and as local finances require more money, the bracket ranges will creep lower as well. Of course, the program will likely be extended to other major cities including, ahem, the capital at some future point. To create a blatantly unequal tax situation over the long-term only adds further pressure to the hukou structure I have discussed in early comments.
In any case, the tax man has arrived and the fine Chinese citizens may feel his chopsticks in their purse soon. Oh, and what might he come after next? I hear a lot about congestion pricing for automobiles.