China’s fiscal policy and the new rhetoric of inequality

The Chinese Communist Party is now ideologically committed to reducing income inequality. That the previous sentence is not in fact a meaningless circular statement says a lot about the peculiar evolution of socialism in China since 1978. But after dodging around that part of its socialist ideological heritage for the last few decades, China’s leadership is now grappling with the issue of inequality more directly, at least in its rhetoric. The 14th Five-Year Plan adopted in March includes a section that calls for “proactively narrowing regional, urban-rural and income gaps.” And Xi Jinping himself has recently been highlighting the goal of “common prosperity,” a term that has deep political resonance in China because of its use by Deng Xiaoping.

This has not been a sudden shift of direction. Various elements of the bureaucracy have been working over the last couple of years to lay the ground for this new policy focus, a process that I described in a previous post. Attention to inequality is a natural sequel to, and development of, Xi’s now-concluded campaign to eliminate absolute poverty. But how this new rhetoric will translate into reality is far from clear. Officials have not yet put forward big ideas on how to actually narrow inequality, and it seems they could not reach agreement on the details in time for them to be included in the plan. The Five-Year Plan document itself includes only a general discussion of goals, and a pledge to draft a separate “action plan” on common prosperity.

In the US, those who want the government to do more to reduce inequality usually focus on major shifts in fiscal policy, like raising taxes on higher-income households and expanding benefits for lower-income ones. But China’s fiscal policy is peculiarly conservative in its spending priorities and its tax structure is actually regressive. It’s notable that, for instance, the government declined to offer any direct income support to households during the Covid-19 pandemic, which it could have done for a very modest fiscal cost. Rightly or wrongly, a bias toward supply-side policy is strongly entrenched among Chinese officials. Xi’s new political rhetoric about reducing inequality and achieving common prosperity thus sits rather awkwardly on top of a set of entrenched government policies that have long tolerated, or even encouraged, greater income inequality.

The signals so far do not suggest that a radical reordering of the government’s taxing and spending priorities is on the way. At a press conference last week, assistant minister of finance Ou Wenhan was asked about how fiscal policy would help advance “common prosperity,” and his response offered a few clues to official thinking. Importantly, he said that “it is necessary to maintain the overall stability of the macro tax burden” over the coming five years. That means there will not be a major increase, or decrease, in tax revenue’s ratio to GDP. In other words, the government is not preparing to raise revenue to finance a major expansion of the welfare state. Indeed, Ou indicated that it still wants to cut taxes at the margin for manufacturers and small businesses.

Any additional spending on redistributive programs will therefore have to come from moving around existing funding sources. While Ou did pledge to improve the social safety net, there were no promises of a generous New Deal for China’s citizens. Indeed he warned that protections must not go too far, or be too expensive. “We must strengthen our ability to evaluate the fiscal affordability of livelihood policies, and avoid the risk of over-promising and over-protecting,” he said.

Another indication of the government’s interest in keeping down the fiscal cost of addressing income inequality is its focus on the so-called “tertiary distribution.” In the jargon, the primary distribution of income is income directly received from labor and capital, while the secondary distribution of income results from the government redistributing that income through taxes and spending. The tertiary distribution of income refers to the additional redistribution achieved through private charities. Ou said the government will “support the role of charity and other forms of tertiary distribution, and give full play the role of charitable organizations” in supporting the poor, elderly and sick. That suggests a desire to keep some of the costs of political promises off the government’s books.

The finance ministry does sound as if it is getting ready to toughen enforcement of China’s rather lax personal income tax system, and bring many of the high-income individuals that now successfully evade taxes into the tax collection net. Ou spoke of establishing “personal income and property information systems,” and of the need to “appropriately regulate excessively high incomes, outlaw illegal income, and curb income obtained through monopoly and unfair competition.” It does sound like the new era of common prosperity will be one of tougher legal and political scrutiny of high-income and high-net-worth individuals.

The most substantive commitments to inequality-reducing policies were in Ou’s pledges to “Increase financial support to less developed regions and gradually achieve equalization of basic public services” and to “further tilt transfer payments to central and western regions and depressed regions.” China’s government has long preferred to treat poverty and inequality as problems of geography: if poor people tend to be in certain places, just give those places more money. Raising fiscal transfers to lower-income provinces could certainly help those areas, and given that it uses existing institutions, would also be a relatively easy policy to execute. But there has already been a lot of regional aid in China in recent decades, and using government-sponsored investment projects as a tool of regional development has at best a mixed track record.

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