044：Government Spending：Patterns Around the World

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Today we're going to discuss government taxation patterns around the world. Let me tell you a few things that Americans often say about taxes. If someday you visit Washington, DC, you might walk past the office of the Internal Revenue Service, which is the main agency of the US government for collecting taxes. There's a sentence engraved in the stone at the front of the building. It says“taxes are the price we pay for a civilized society”. That's what you might expect the tax collectors to think I guess. 

Of course, there are other views on taxes too. Americans sometimes quote a line from a decision of the US supreme court about two hundred years ago. They wrote “the power to tax is the power to destroy”. There's also a famous comment from Benjamin Franklin, who was an inventor,a writer and a politician around the time of the US revolutionary war back in the 1770s, Franklin once wrote “nothing is inevitable except for death and taxes”. 

All of these statements seemed to me to have some truth. Taxes provide finance for government, for law and order, for infrastructure, for education and health care, for civilization in some ways. But there certainly are times when you're paying taxes, it can feel like someone is stealing your money. And it feels like taxation is the power to destroy. And it also feels that whether taxes are good or bad, they just are not avoidable. They're going to happen no matter what. 

In this lecture, we're going to talk about some patterns of government taxation in China and around the world. Let's first talk about the usual shifts in patterns of taxation as an economy grows. And second, we'll talk about how does China's government raise tax revenues? And third, how is China's tax system likely to evolve moving forward? 

Our first topic is the usual shifts in patterns of taxation as an economy grows. We talked in the previous lecture about how government spending as a share of gross domestic product tends to rise as an economy moves from low income to middle income to high income. To understand how this happens on the tax side, think about the challenge of collecting taxes in a very low income country. 

Often in that kind of country, a majority of the workers don't have formal jobs where they get regular pay for regular hours at regular periods. They work in what economists call the informal sector. They're paid in cash or workers in the agricultural sector might actually produce a certain amount of what they eat or just barter with other local farmers. Most countries have a few big companies, but in poor countries, sometimes there seems to be a lack of middle sized and smaller companies. And those very small companies often don't have very clear financial records that anyone can check or look at. 

In these same low income countries，government itself often doesn't have very strong capabilities either for gathering financial information or for enforcing taxes. So in this situation, what kind of taxes would you expect to see？ One common kind of tax are trade taxes that can be collected at the border as goods enter or leave the country. Another common kind of taxes, that if there are some large companies, then you can tax those firms and use them as a method of generating revenue for the government. As an economy grows and develops, this starts to change. 

There are often still some border taxes and company taxes, but relatively speaking, they play a smaller role. You start shifting to value added taxes, taxes on a firm's payroll, or taxes on personal income. China has overall followed this broad pattern. Back in the 1980s and early 90s, China's economy was still dominated by large state-owned firms. And when the government owns a company in a way, it doesn't even make sense to talk about paying taxes，and how can you tax what you already own? Instead, it was often true that the government could just require that the company provide health care or housing or build a road or pay a fee or transfer money for some other purpose. But in the 1990s, as China's major transition away from state owned enterprises and toward private companies got started, you obviously needed a different system of taxation. And that's when China started in 1994 its state administration of taxation to collect taxes. 1994 is also when China first really spread into wide use its value added tax. That's a very popular method of taxation around the world. Out of the roughly a hundred ninety three countries in the world, hundred and sixty six of them have a value added tax. 

Back in 1994, tax revenues in China were about twelve percent of gross domestic product. But since then, as China's economy has grown and the per capita incomes have risen, that is doubled or perhaps a little more. And so China's taxes are now something like twenty five percent of gross domestic product. And again this is a fairly usual pattern as a country goes from low income to middle income we talked about in the previous lecture. If you look around the world, it's common to see low income countries with total government spending and taxes in the range of maybe ten to twenty percent of GDP，with some exceptions of course. Middle income countries are more like twenty to thirty per cent of GDP. And high income countries are above that from areas like thirty five percent of GDP for the US, Japan,the United Kingdom up to some European countries where taxes are more like forty five or fifty percent of GDP. So it's clear that China's total tax revenue has been rising and shifting over time. 

Let's move to our second topic then how does China's government raise tax revenues? Well, taxes in China can be classified into three different types based on how much they are shared between central and local government. For example, there are some taxes that really just go to the central government. There is, for example, a consumption tax, or it's a tax that applies to astute a few specific goods, like alcohol, tobacco, cars, certain products made from oil, as well as various trade related taxes. You take all of these together, and that adds up to about ten percent of the total taxes that China's government receives. 

There are then taxes shared between the center and local jurisdictions. Um. These include the value added tax and the personal and corporate income taxes. You take all these together, the shared taxes collect, more than half of all the taxes of China's government, something like fifty five percent of all the tax revenue of China's government. Now, It's worth saying what a few of these are I guess. The value added tax is the big one. It collects more than thirty percent of all China's tax revenues all by itself. 

Well, what is the value added tax? Think about a process of economic production that has several different stages. For example, you can think of iron comes from the mine, It's processed into steel. The steel is cut into various pieces and shapes. The shapes are used in a refrigerator, are in a refrigerator, a car, some product like that. You can think about different companies being involved in each step of that process. And each step of the process adds some value. So value added just refers to what was the value that was added at each stage of production. 

It's not that hard to think about. You take the selling price, and you subtract out the price of anything the company bought from an outside supplier. The extra amount will be what value your company added. Now, in economic terms of value, added tax is actually a close cousin of a sales tax on the price of the final product. To understand why that's true, think about the collecting value added at each stage of production. By the time you're done, you will have collected value added on all one hundred percent of the value from beginning to end. 

So that's similar to having a sales tax, which is imposed at the time the very final product is sold. The corporate income tax in China collects about seventeen percent of all tax revenues, while the personal income tax is only about five percent of all tax revenues. Now, this is a little unusual. In comparison to high income countries, China is a little bit unique in how much it relies on the value added tax and the corporate income tax, which together are about half of all of China's tax revenues. On the other hand, the personal income tax collects much less revenue than in high income countries.

In China. Again, the personal income tax is about five percent of all revenue. For most high income countries, it's closer to twenty five percent or more. We need to come back to that idea, but let's finish by talking about the taxes collected by lower levels of government and spent there which were about one third of all taxes for Chinese government. The biggest of these are the social security payments that cover social insurance, like pensions for the elderly, health care, and officially these are divided up where the firm or the employer pays some and also the employee contributes some. 

These are social security payments for about one fifth of all taxes collected by China's government. And a final big source of revenue for local governments are taxes related to real estate and real estate transactions, which were about ten percent of all tax revenue. That's quite high compared to real estate taxes in most other middle income countries，but as noted earlier, China has a booming real estate market, so it makes sense that it gets more taxes from that area. China's real estate taxes as a share of gross domestic product, are actually pretty similar to the common levels in high income countries. 

Let's move to our third topic. How is China's tax system likely to evolve? China will of course, make its own specific choices about its future tax system. It won't necessarily follow patterns from the rest of the world, but these patterns do come into being all over the world for good underlying reasons. So maybe it's worth looking at what they would imply for how China's taxes might evolve in the future. 

Tax revenues are likely to continue to rise as China's spending on pensions and health supporting the poor and so on continue to rise. China's single biggest source of revenue is the value added tax again, that's more than thirty percent of total revenue, and it will probably stay quite large. There's a reason so many countries like using a value added tax. So I don't expect a huge change there. 

Corporate income tax is a different issue. It now collects about seventeen percent of China's total revenue，total tax revenue. But the general pattern across European countries for a few years has been lower corporate income taxes. Late in 2017, the US also passed a law that cut corporate taxes as well. The main reason here seems to be that in a globalized economy, you want to give companies an incentive to earn profits and do their operation in your country not somewhere else. And that happens everywhere.In May, 2018, China's government announced a cut in corporate taxes. So, well, I wouldn't necessarily expect corporate taxes to drop a lot. I would not expect them to rise much either. 

The personal income taxes, something else,that's not only about five percent of China's tax revenue,and this is the one area that so much lower than in other high income countries. But it is, by all accounts, very complex, many different categories of income, many different rules. 

I know this topic is a controversial one, but I suspect that in the future China will move toward an income tax that is simpler and also covers more people. Also an income tax can be set up, so those with higher incomes will pay a larger share of income. And in many countries, this is one of the main ways that those who have benefited from the economy pay a greater share in taxes. In fact, it might be that the corporate income tax goes down, but high income people who have positions at big corporations might find that their personal taxes go up. 

With social security taxes,that's about twenty percent of total revenues for China, those are likely to rise over time as costs of pensions and health care keep rising. My expectation there is that in the future, social security pensions in many countries have a rough connection, where if you pay in more over your lifetime, you get substantially higher payments in retirement. In China, this connection hasn't historically been very strong, but I suspect it'll get stronger in the future. 

In the next lecture，we’ll focus on how the government can use tax and spending policy to influence the entire macro economy.

I'm Timothy Taylor. Thank you for listening to Himalaya.