The Ministry of Finance (MOF) announced that China is in the process of rolling out “sizable reduction of tax and fees” to reduce the operational cost for the corporate sector. According to the MOF, China has taken more efforts to reduce taxes & fees in 2018, with the annual tax cut amounting to Rmb1.3trn. However, growth of tax revenue in 1-3Q18 still reached 12.7% YoY, exceeding that of the nominal GDP. Recent economic data points to slowing growth momentum – property sales started to slow, corporate profit growth declined, while export growth also looks increasingly unsustainable. Against this macro backdrop, China’s fiscal policy will likely become more accommodative.

China’s overall “fiscal burden” has risen significantly since 1995, before consolidating in recent year. China’s general government revenue to GDP ratio (excl. land transfer proceeds) reached 29.1% in 2015, before edging down to 27.5% in 2017.

China’s corporate sector bears the brunt of the fiscal burden—the ratios of VAT & corporate income tax to GDP are notable higher than the peers. VAT, social insurance contributions, & corporate income tax combined took up 55% of China’s overall government revenue in 2017.

China may further lower VAT rates in 2019, while there is also room to cut corporate income tax rate. China reduced the VAT rates for the top two tax brackets from 17% and 11% to 16% and 10% on May 1 2017. Since around half of China’s VAT revenue are contributed by corporates in the “top bracket” (with the rate of 16%), we estimate that a 2ppt cut of VAT rate in the “top bracket” corresponds to a 0.4ppt reduction in weighted-average effective VAT rate and a total of Rmb400bn in tax cut. Meanwhile, the budget deficit ratio may rise to 3% in 2019 from 2.6% in 2018, assuming constant revenue and expenditure ratio of the government outside of VAT.

Furthermore, it is necessary to cut Social Security (SS) contribution rate substantially, in order to offset the rise in effective SS contribution rate after the centralization of SS collection in China next year. The “handover” of SS collection to the tax bureau may push up the effective SS-related cost for the corporate sector by more “inclusive” SS collection. According to our estimate, a 6-8ppt cut to the overall contribution rate may help offset the increase in effective contribution ratio for the corporate sector.

Over the medium-long term, China will likely further reduce the tax burden of the corporate sector. China plans to reduce the number of “VAT brackets” to 2 from 3 over the medium term and further reduce the VAT ratio. Meanwhile, we believe China will also stick to the 3% maximum deficit threshold as part of their fiscal discipline. Therefore, in order to reduce the macro tax burden in a more sustainable manner, the government will likely take more effort in improving the efficiency of fiscal expenditure and fiscal resource allocation. Meanwhile, falling corporate tax burden may be accompanied by rising household tax contribution over the long run.