Can China’s Mattress Banks Beat the Recession?

December 22, 2008 Posted by China Briefing Reading Time: 4 minutes

Central Bank of China, 1 million yuan note, China revolutionary period

Dec. 22 – With government discussions recently to increase individual income tax thresholds in China to monthly earnings of RMB3,000 before IIT has to be paid – how much room to maneuver will China now have across its tax base for the raising of revenues – and should the government give such tax freedoms, will the economy pick up?

The recent measures, announced at the last National Party Congress, were designed to assist lower paid workers in maintaining standards of living in the face of rising commodity prices. With inflation now having apparently been beaten back, lower income families have more money in their pockets. However, considering that some 130 million Chinese are estimated to earn less than US$1 per day, and that the RMB$3,000 threshold gives an annual average income of US$5,294 per annum – far above the mean average income – the numbers of Chinese actually declaring less than RM$3,000 a month are likely to be at least 50 percent of the population, possibly more.

Assuming a population of 1.3 billion, then this means 650 million people in China are not paying income tax. When one factors in the appalling record of the State Administration of Taxation in actual collections, that figure is likely to be far higher in terms of actual income tax received against the true value of collectables. One only has to take into account Tiger Woods being the highest tax payer in Shenzhen – for a one-day golf tournament in Shenzhen, three years ago – to realize that the SAT may be better off being titled the State Administration of Taxable Write Offs. For Tiger to be declared the highest tax payer for one day’s work in one of China’s wealthiest cities beggars’ belief.

To put into simple figures, and giving the SAT the benefit of the doubt, it means that at the lowest individual income tax level in China – 5 percent — the treasury is losing out on collectables of some US$170billion per annum if it was to collect a gross 5 percent on all RMB3,000 salaries paid. Add to that the poor revenue collections from Chinese businesses, and China is providing subsidies of US$500 billion a year to its nationals and businesses through poor tax collection. The truth is, no-one knows; but that figure, for us as auditors of Chinese businesses, certainly rings true. It could also be far higher.

Tax collection in China, and the stringent checks that foreign businesses have to go through to be in compliance, are at great odds with the reality for many Chinese businesses, for whom the concept of guangxi still holds true. Hence the murmurs of discontent amongst diplomats when it comes to the de facto giving of unofficial subsidies by the Chinese state; while no such policy exists, if domestic tax collection is sub-standard, it amounts to the same thing.

Accepting this, one then has to examine the pros and cons of the entire situation. The cons are that China has little room left to maneuver if it wants to increase its tax base, other than clamping down on business. 650 million peasants used to no income tax would be a hard act for Beijing to administer, let alone pacify. VAT could be manipulated, and not for nothing is it already responsible for 50 percent of all of China’s fiscal revenues. But price increases lead to inflation and stoke the black market. Beijing’s generosity over domestic tax collection may yet come back to haunt it when the national wealth gap is reduced.

On the other hand, having 650,000,000 million with more money in their pockets to spend should keep the domestic economy afloat, and especially give it a boost during Q1 in 2009 when Chinese New Year extravaganzas kick in. Again, it’s difficult to tell, and for the Chinese, difficult to administer. The harsh reality for the Chinese government is the little realized fact that most of those 650 million will not keep their savings in the bank. Much remains hidden in mattresses and secret hideaways, safe from prying eyes.

This is a legacy of China’s own recent history, and the Chinese have long memories. Although the RMB has been relatively stable since the Communist Party came to power, many recall the political upheavals of the 1960s and 1970s, comrades denounced and losing everything. The state, while seen as a protector, may not be always trusted with knowing everything. Better to keep that paper currency somewhere safe. And in a country where every banking institution is state-owned, that means looking inward. Going further back, Chiang Kai Shek’s Nationalists fought a losing battle with inflation for 30 years – even lying about the currency being backed by first gold, then silver, in an attempt to restore confidence. They failed. One Million Yuan notes were issued, and were almost worthless. When they were defeated in 1949 and forced to flee to Taiwan, what little value their notes possessed was washed away overnight. With the communist victory, only notes issued after 1948 by the Communist controlled Peoples Bank of China were legal tender – and remain so to this day in their current fifth series. .

Little wonder then that it is the hidden reserves – mattresses and old vases stuffed with notes, under the floorboards and buried in secret stashes near a tree – that may just prove to be the hidden weapon China has in its battle to increase domestic spending. Those age old, traditional saving habits need to be broken if China is to weather the recession. Has China sweetened the deal enough by giving more to the lowest earners? Will China’s rural population continue to store these savings in their mattresses or can they be persuaded now to live a little? It all remains to be seen whether China’s effort to encourage spending will ultimately pay off.