China must prepare response to Trump tax plan

By Miao Shan and Ma Caichen Source:Global Times Published: 2017/5/10 22:18:39

Illustration: Peter C. Espina/GT

US President Donald Trump's economic team unveiled a one-page plan on April 26, proposing what they called the largest tax cuts since Ronald Reagan's presidency. For individual taxes, the proposal would simplify the current seven tax brackets to three with rates of 10 percent, 25 percent and 35 percent and double the standard deductions. For corporate taxes, the proposal would reduce the rate from 35 percent to 15 percent and introduce a one-time 10 percent tax on companies' overseas profits.

Yet, without a detailed plan and given quite a lot uncertainties, there is a long way to go for Trump's ambitious tax reform plan to get passed. But if the US legislature passes the bill, it will likely have a profound impact on the US economy and the world economy as a whole.

First of all, the plan would exacerbate the US federal government's fiscal deficit and the wealth inequality problem. According to a cost estimate by the Committee for a Responsible Federal Budget (CRFB), the tax cut plan could cost $5.5 trillion in lost fiscal revenue in the coming decade. The Tax Policy Center, a nonpartisan think tank, estimated that Trump's tax proposal could reduce the government's revenue by at least $240 billion a year, which would surely be unbearable for the government. As such, many researchers and the media have questioned the financial pressure brought by tax cuts, arguing that the federal government has failed to offer any plan to offset the lost revenue. Moreover, many are also concerned that the tax reform will mainly benefit the richest. According to William G. Gale, an economist at the Brookings Institution, 50 percent of the benefits of Trump's tax proposal would go to the richest 1 percent of the country.

Second, the tax cut proposal would increase jobs by accelerating capital inflows and would exert an impact on global capital flows. Trump once said he wanted the US to be the world's greatest "magnet for innovation and job creation." A Tax Foundation report estimated that Trump's tax plan would add about 2 million new jobs. Meanwhile, Apple, Ford and other US multinationals have expressed their willingness to move profits back to the US or to scrap plans for overseas factories. Moreover, the 15 percent corporate tax rate is not only lower than the 25 percent average among OECD countries, but also close to the levels in some tax haven nations. This could make the US an attractive investment destination for global investors, pointing to changes in the world capital market.

Third, considering the spillover effect of the US economy, the tax cut plan would also lead to a global race to cut taxes. The world is now undergoing an intensified wave of competitive tax reduction, with the UK, France, the Netherlands, India and other countries already releasing their own tax cut plans.

For instance, the UK government pledged to cut corporate tax from the current 20 percent to 17 percent by 2020, and media reports said that the government may cut this even further to 10 percent if the EU refuses to agree a post-Brexit free trade deal with the UK. In India, the government plans to implement an overall taxation overhaul as well as tax cuts for individuals and for small and medium-sized companies.

So what should China do amid the rising taxation competition? First of all, China should continue to promote its tax system reform to effectively reduce the overall cost burden on enterprises.

Starting from May 1, 2016, China extended a pilot program of replacing business tax with value-added tax (VAT) to all industries. Statistics from the State Administration of Taxation showed that since the implementation of the VAT reform, about 98 percent of the taxpayers under the pilot program saw their taxation burden relieved or unchanged, and an increasing number of taxpayers have enjoyed the benefits from the expansion of the tax reform. China's VAT reform has cut the tax burden on companies by some 680 billion yuan ($99 billion) in the year since it was launched, according to a South China Morning Post report.

However, China's fiscal revenue grew 14.7 percent year-on-year during the first quarter of 2017, according to data from the Ministry of Finance, offering room for more tax cut measures. Tax reductions could not only stimulate economic vitality but also force the authorities to cut out inefficient and ineffective expenditure.

Second, China could consider relevant tax measures to prevent capital outflows. Given the potential impact of the US tax plan, Chinese monetary regulators may face challenges in preventing capital outflows. Against such a backdrop, China needs to maintain an internationally competitive taxation environment by adopting appropriate tax cuts in the domestic market while levying taxes on capital outflows at the same time.

Miao Shan is a special research fellow with the China Fiscal and Taxation Development Center of Nankai University. Ma Caichen is a professor with the School of Economics of Nankai University.

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