The Failure of China's Export Tax Rebate Policy

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China's exports have been the most seriously damaged area in its economy during the global downturn, having gone into an unprecedented decline. Monthly exports have shown only negative growth since last November, with the maximum decline of 26.4%. In August they still sat at -23.4%.

Against the current backdrop of sluggish external demand, China can do nothing to prevent export decline through the RMB depreciation and export subsidies, and can only promote exports through export tax rebates. The export tax rebate budget in 2009 amounts to 670 billion yuan, though it may reach 800 billion yuan, accounting for 14% of tax revenue for the whole year.

The overall price elasticity of Chinese exports is only 0.65. In other words, when export prices fall one percentage point, volume rises by only 0.65 percentage points, but turnover declines by 0.35 percentage points. If firms make full use of all tax rebate to reduce prices of their products, export revenue will decrease by 280 billion yuan. This means of the 800 billion yuan of tax rebate, enterprises receive only 520 billion yuan, the other 280 billion yuan going into the pockets of foreigners. Moreover, 50% of China's exports go out from foreign-funded enterprises, and that means that of the 520 billion yuan tax rebate, a large part becomes income for foreign firms. Price leakage and leakage to foreigners' income greatly reduces the effect of export tax rebates, with only about half of the tax rebate becoming national income of the Chinese people.

 

The increase of export tax rebates and decline of prices raises volume, bringing a multiplier effect to the economy through demand for labor, raw materials, spare parts and investment. But many raw materials and spare parts are imported, reducing the pulling effect. Moreover, after the substantial decline in exports and economy, export growth has been mainly for production surpluses and its pulling effect on investment is relatively weak. The multiplier effect of export volume increase in boosting GDP is about 1.2 times, that is, a unit of real export growth leads to 1.2 units of GDP growth. 520 billion yuan of the actual export increase can only generate 624 billion yuan of GDP growth. This is not a big money-making proposition.

 

The use of finance carries opportunity cost. If the 800 billion yuan of tax rebate is used for increasing direct government purchases, it will generate 960 billion yuan in GDP growth. Therefore, the cost of encouraging export through tax rebate is extremely high and plays only a limited role in promoting the economy, although it does promote a certain export volume growth. But because tax rebates rule out other government expenditure, the greater the taxes rebated the less conducive it is to restoring economic growth.

 

An important reason for encouraging exports is to maintain employment levels, to prevent the outflux of out-of-work migrant workers back to their hometowns, a recipe for social tension. China's exports focus on labor-intensive products whose output growth brings employment growth, so supporting labor-intensive industries seems an effective way to promote employment. Unfortunately, low price elasticity makes export stimulus policies ineffective in promoting export and employment growth.

 

The export tax rebate is based on volume, not the number of workers. Large and medium-sized enterprises get most of the rebate while small enterprises, most in need of the help and playing a large role in employment, have to get by with the scraps, thus greatly reducing the effect of the rebate policy in promoting employment.

 

In recent years, hiring in labor-intensive manufacturing has fallen in importance as a source of employment growth. From 2004-06, employment growth at labor-intensive manufacturers with annual revenue over five million yuan was 2.36 million people, while that of large scale capital intensive manufacturers reached 4.74 million people. At the same time, total output, exports, trade surplus and investment in capital-intensive industries far exceeded those in labor-intensive industries. China is transforming from a country dependent on abundant labor resources to one with abundant capital resources, and its comparative advantage is also changing.

 

The taxation system in many countries is based mainly on income rather than circulation, and the burden of the circulation tax in China is higher than in many other countries. If full refund is implemented, the circulation tax on products sold in domestic markets is much higher than that on exported products, and that is why exported product prices are lower than domestic prices. It seems that the export tax rebate stimulus policy achieves the so-called neutral tax rebate, but it forces Chinese consumers to pay more than their foreign counterparts, who can better afford to consume China's resources. The different tax burden increases competitiveness between Chinese enterprises in the export market, leading to export price competition to the bottom.

 

The consequence of full refund is to aggravate economic imbalances. Low export taxes attract resources to flow into the export sector, resulting in insufficient domestic supply and high domestic prices. Domestic imbalances will lead to further external imbalances.

 

Not to mention that a full tax rebate is giving rise to international trade friction. Although full refund is in line with international trade rules, it makes export prices lower than domestic prices, and "products sold abroad at below the prevailing domestic prices" equals dumping.

 

 (The author is the director of the International Investment Office of the World Economics and Politics Department at the Chinese Institute of Social Sciences.)