Written By: Jeff Hicks and Max Norton

Assisted By: Joanne Xu and Yi Zhao

Posted: February 23, 2021

By mid-March, 2020, many Canadians had come to recognize the COVID-19 pandemic as a once-in-a-lifetime crisis that could cause permanent changes to their lives. Just as online classes immediately began to transform the experience of legal education, academics also shifted their attention to the enormity of the challenges brought by COVID. The Centre for Asian Legal Studies organized a COVID-19 Roundtable on March 5. In the ensuing months, faculty members and students together pursued multiple strands of research on COVID’s impact on law and governance in Asia.

You can find some examples of student research in this area at the CALS blog: topics ranged from changes in Canadian immigration policy, international competition and coordination in vaccine research, to novel uses of parliamentary power in China during pandemic times. Many of these research projects are still ongoing, and we would be very interested in feedbacks from readers of this newsletter.

One example that illustrates our research on governmental responses to COVID is a working paper jointly authored by Jeff Hicks, Max Norton (both  Ph.D. students at UBC’s Vancouver School of Economics (VSE), and Wei Cui (Allard law and CALS member). The paper, titled “How Well-Targeted Are Payroll Tax Cuts as a Response to COVID-19? Evidence from China,” studies the most substantial piece of economic policy that the Chinese government adopted in response to the COVID shock—a payroll tax holiday made available to almost all firms in the country. Not only is the policy important, a large and unique dataset we used to carry out the study also enabled us to make findings otherwise infeasible.

On February 20, 2020, China’s Ministry of Human Resources and Social Security (MOHRSS) announced that for the period between February and June, all businesses other than the largest (less than 1%) of firms were completely exempted from the obligation to make employer contributions to three components of China’s social insurance (SI) regime: pension, unemployment and injury. The remaining large businesses as well as private, non-business employers received a 50% reduction in contribution obligations for 3 months (February-April). In June, MOHRSS extended the exemption for the first group of firms to the end of 2020, and the 50% reduction for the second group firms to June.  Separately, on February 21, 2020, China’s Nation Healthcare Security Administration announced guidelines for mitigating employer contributions for medical insurance (MI)—the second largest component in China’s SI system after pension insurance. Under these guidelines, local jurisdictions may reduce employer MI contributions by up to 50%, for 5 months (February to June).

These tax holidays represent a response to COVID that is large both in aggregate terms and for each firm beneficiary. The government estimated that the foregone revenue to the nation’s pension systems alone exceeded CNY 576 billion by the end of June. The entire fiscal cost for 2020 could easily surpass CNY 1 trillion (CAD 200 billion)—which would be larger than the projected combined costs of the Canada Emergency Response Benefit and Canada Emergency Wage Subsidy programs. For many employers, the policies brought a tax cut that was more than 20% of the wages paid. At least at first glance, these policies should improve the cash flow and the probability of survival for businesses, support job retention, and even facilitate the hiring of new workers.

A distinctive feature of our study is the use of confidential taxpayer data from one large Chinese province. We use this data to simulate the impact of China’s 2020 payroll tax cuts, and this approach carries a critical advantage. Not only does China have no national SI regime, even China’s provinces do not have their own unified SI systems. Pension insurance is often pooled at the prefectural level, and MI may be pooled at even lower, county levels. This means that when provinces report their SI budgets to the national government, they are aggregating budget reports generated by cities, which in turn are aggregating budgetary reports by counties and other lower units. The more layers there are in this aggregation process, the more information is lost. In contrast, comprehensive firm-level data gives both researchers and policymakers a more detailed, ground-up view of the impact of changes in SI policies.

Our first finding is directly attributable to this data advantage. Our firm-level data covers both firms that participate in SI and those that do not.  We observe that as many as 54% of active firms—representing 24% of aggregate economic activity—do not participate in SI at all. Therefore, they stand to receive no government support from the 2020 tax cuts. Moreover, non-participation is far higher among small firms: only 22% of the smallest decile of firms make SI contributions compared to 78% of the top decile (see Figure 1). This means that the payroll tax cut would be unable to deliver benefits to a vast population of small firms that engage in informal labor practice (in the sense that they do not offer their employees SI benefits.)

Figure 1 SI Participation Is Very Low among Small Firms in China

Despite this fundamental limitation of the policy, we find several forces that push in the other direction and give rise to desirable targeting properties. The first has to do with the fact that small firms tend to be more labor-intensive than large firms: their wage bills represent a larger portion of their total costs. Consequently, a payroll tax cut delivers greater benefits to smaller firms relative to total costs. On average, firms that participate in SI receive benefits equal to 1.3% of annual business expenses. But among the lowest decile of firms that participate in SI, the subsidy rises to 14% of annual expenses. This is approximately 20% of cash holdings the median small firm has on hand.

A second force that improves targeting is the regressive tax structure of China’s SI scheme. When an employer pays SI premia with respect to an employee, the employee’s wage is assumed to be no lower than 60% of the local average wage. This floor on employer premia means that the effective tax rate of the premia is very high for low wage workers. Meanwhile, employers are assumed to pay wages no more than 300% of the local average wage, which means that hiring workers for higher wages generate no additional SI premium expense. By suspending this system, the payroll tax holiday delivers more benefits to firms that hire low-wage workers—which tend to be more affected by the COVID crisis.

These first two forces combine to allow China’s payroll tax cuts to deliver greater benefit (relative to business expenses), as can be seen in Figure 2. In fact, even when non-participating firms that receive no benefits at all are included (as represented by the grey line in Figure 2), the smallest firms receive on average greater benefits as a fraction of their total costs.

Finally, we find that many industries that are most negatively affected by COVID-19 also tend to be more labor-intensive. This pattern is illustrated by the hospitality, education, and culture and entertainment industries, and we verify it partly by drawing on results from a recent study conducted by researchers at Tsinghua University. For this reason, the SI tax cut also delivered a greater benefit (as a proportion of businesses’ operating costs) to industries that are more exposed to the economic downturn (see Figure 3).

Figure 2 Payroll Tax Cuts Deliver Greater Benefits to Small Firms on Average

Figure 3 The Payroll Tax Cut Delivered Greater Benefits to Vulnerable Industries

Students who participated in this research project included not only the two co-authors named above but also research assistants Joanne Xu and Yi Zhao who gathered important data and legal information. Indeed, without the effort of our talented students, many of the research projects would not be feasible. Your feedback on our research will thus not only constitute welcome advice to our faculty members but also especially contribute to our student training.

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Written By: Wei Cui

Posted on: February 22, 2021

On December 30, 2020, Chinese President Xi Jinping convened a meeting of one of the most important decision-making bodies currently in the Chinese Communist Party: the Central Committee for Comprehensively Deepening Reforms. Xi gave a strongly ideological speech: in summarizing a report that offered a comprehensive evaluation of the Party’s measures for “deepening comprehensive reforms” since 2013, he claimed “historical” and “revolutionary” accomplishments for his leadership. The meeting also approved a slate of new policy directives, covering many high-salience topics ranging from strengthening Party leadership in state-owned enterprises to building a green, low-carbon economy. Among the new directives approved was a document named “Opinions regarding Further Optimizing Tax Enforcement Methods.” This new edict about tax administration—a topic that normally does not grab media attention—was immediately lauded as the most newsworthy item in Chinese taxation in 2020.

With the world in turmoil, why is President Xi Jinping thinking about tax administration now? One might have tried to look for an answer in the Party edict itself. But like many other recently issued, top Party leadership decisions that are supposed to represent important policy recommendations—and be the subjects of diligent study by Party members—the December “Opinions” on optimizing tax administration are nowhere to be found. It is unclear that the document will ever come to the public light. Thus, even when senior government officials stress the importance of Xi’s new take on tax administration and elaborate its implications, they cannot reveal what exactly it says. Instead, they merely repeat the official media’s summary of the “Opinions.” According to this summary, Mr. Xi would like tax enforcement to be more “precise,” taxpayer services to be more “attentive,” and tax administration to be more “sincere and collaborative.” Compliance and taxpayer satisfaction should both substantially increase, while compliance and administrative costs “notably reduced.” Tax administration, according to Mr. Xi’s vision, should play a fundamental role in the country’s governance.

What does this all mean? We know that tax administration had in fact been on Xi’s mind for several years already: in March 2019, China’s State Tax Administration (STA) cited “important instructions and comments” from Xi on “optimizing tax enforcement,” in an internal document circulated to tax administrators around the country. Judging from the trajectory of Chinese tax policy in the last few years, two explanations about what motivates Mr. Xi are likely relevant.

First, a signature policy Mr. Xi has pursued is the delivery of big tax cuts to the Chinese economy. The tax cuts announced in the last few years are very wide-reaching—in Xi’s own terms, they are “inclusive”—and are available to both individuals and business taxpayers. Having decided on such an approach of reducing the private sector’s tax burden, it is understandable that China’s political leaders want to see results—in the forms of both economic growth and political popularity. And it is typical for leaders in China’s central government to see local governments and grassroots tax administrators as not completely reliable in implementing such policies. Unlike the central government, China’s local governments directly face budgetary pressures. They are thus perceived as potentially too interested in maximizing revenue to permit taxpayers to access the tax preferences announced by the central government. Tax administrators, in the meantime, naturally take greater pride in raising than in giving up revenue. In other words, Mr. Xi may fear a major principal-agent obstacle in the delivery of tax cuts. Bringing China’s tax administration under his firm discipline may seem to be a critical solution.

But a second explanation points to a different source of anxiety. During his reign so far, Mr. Xi has also championed major social spending programs. A widely-discussed project is the eradication of poverty by 2020. Pension and health insurance regimes that are funded by tax revenues instead of employer and employee contributions have also expanded. These large spending programs are crucial to Mr. Xi’s claim to legitimacy and his vision of a “well-off” society, but they are very costly. Sustaining these spending programs seems to be on a collision course with the goal of keeping tax cuts. The fiscal challenges that many local governments face seem so severe that there is evidence that the government has already begun to censor discussions of the topic. A few years ago, Mr. Xi’s main proposed solution appeared to be cutting waste within the government (most famously through anti-corruption campaigns). A newer solution now seems to be “precision” in tax administration: tax administrators should be able to offer tax cuts where they are required to, but also raise revenue when there is tax to be collected.

Is there room for such optimization in Chinese tax administration to achieve Mr. Xi’s wishes? My research in the last few years on Chinese tax administration—summarized in a book I am completing that will be published by Cambridge University Press—suggests that the prospect is not sanguine. There are several basic reasons for this conclusion. First, taxpayer services in China are already quite strong by international standards, and taxpayer satisfaction (based on official surveys) has been very high for many years. This is substantially the result of the fact that Chinese tax administration resources are distributed in a dense network of grassroots offices located in amazing proximity to taxpayers: one runs into tax offices in China more easily than one can find Canada Post offices in Canada. Consequently, Chinese taxpayers routinely rely on tax administrators to help them with tax compliance, leaving little to be done by accountants and tax return preparers. Chinese tax administrators have also rapidly adopted new technologies, such as smart phone apps, to facilitate taxpayer compliance in recent years.

Low compliance cost is not the only thing that reduces Chinese taxpayer complaints. Tax administrators also rarely impose penalties, removing a major source of antagonism in tax collection. Even when taxpayers are selected for audits, they are often given the chance to “self-inspect” first, and declare previously under-reported tax liabilities with no fines. Thus, at least by international standards, Chinese tax administrators already adopt a very “collaborative” approach to tax collection.

This is especially remarkable given that Chinese taxpayers are generally not perceived, even among themselves, as that compliant. Tax cheats are known to easily get away. Indeed, some scholars have produced evidence that tax incentives announced by the central government often do not perform well, because taxpayers are already successful at reducing taxes through evasion. That is to say, it may not be zealousness in tax collection, but the very tolerant approach taken towards non-compliance, that prevents the recent tax cuts from being more effective. There are thus reasons to think that if Chinese taxpayers complain—if the government believes that greater political popularity can be gained through tax cuts—it is not because taxpayers have been treated badly, but precisely because taxation is one thing that citizens are allowed to complain about.

Finally, precision in tax administration cannot simply be willed into being. A major cost of China’s decentralized tax administration is that it hinders specialization among frontline tax offices. Local tax administrators are asked to serve and monitor assigned taxpayers in comprehensive fashions, which makes it impossible for them to gain expertise on a subset of tasks. The STA has paid lip service to specialization for decades, with little to show for accomplishments. When tax administrators lack expertise, and when taxpayers invest little in compliance and rely instead on local tax administrators, it is unclear how compliance can avoid being a matter of just muddling through. Perhaps the government thinks that a path to precision lies in advances in information technology and more comprehensive databases, but this remains largely speculative.

China’s grassroots tax administrators will likely share these doubts about Xi’s new ideological explorations on tax administration as the foundation of governance. But they of course cannot express them. For the time being, the proposal to optimize tax administration will simply have to be repeated. Just as one can only pretend, without ever being sure, that some of the government officials eulogizing the proposal actually are lucky enough to have read the secret Party document, one is left to pretending that the proposal means something.

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