China’s lowering taxes should increase inflation

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The Financial Times is reporting that China is attempting to address its wealth gap through a number of measures, the principal one of which is raising the tax exemption on income. As welcome as such a move is for consumers facing significant food and energy inflation, in the broader context of the Chinese inflation picture it is a net negative.

China has an inflation problem now, with real interest rates being negative while food and energy costs are rising. Moreover, there is increasing evidence that China may have reached the Lewis Turning Point where the excess supply of rural workers no longer supresses compensation. This means that China could face wage-push inflation as workers are compensated to beat the rise in commodity prices. Lowering taxes is another way of accomplishing the same. However, lowering taxes is stimulative.

The FT also reports that the top 1% of households control 40-60% of household wealth. If the Chinese really wanted to close the wealth gap they should also increase taxes on this bracket by more than they lower taxes in lower income brackets in order to cool down the economy. That is not going to happen. So it is clear to me that inflation will continue to be a problem for the Chinese, requiring more aggressive moves on the monetary policy front.

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3 Comments
  1. DavidLazarusUK says

    Lowering taxes is not always stimulative. It flows straight into asset bubbles, a case in point the UK and USA. China has enough of a problem with asset bubbles. Also with the wealth gap in China being as bad as it is, I doubt that China will be able to keep the lid on problems once they erupt. China seems to be learning the wrong economic lessons. Higher taxes and a less skewed equality of wealth will keep the masses happier.

    1. Edward Harrison says

      Yes, we are going to see more money flowing into asset bubbles unless they take measures to slow the economy down – and raising reserve requirements is not going to cu it.

      1. DavidLazarusUK says

        There is an old policy weapon that seems to have been abandoned by central banks and that is the ability of central banks to demand bank reserves. By doing this they can target banks that are lending excessively and to the wrong types of loans. If banks were segmented they could easily target property loans.

        My concern is that China is following the credit route to economic growth. This is the most laisse faire method of growth, but it has serious drawbacks. This will work for a long time, but when it ends like it has in the west it will mean a very long and painful recession. For a country like China with a one party state that will mean that public anger will be aimed directly at the party. For a party that does not want to relinquish power they are going about things in a way that will surely end their influence.

        I have been thinking about the whole concept of lowering taxes being stimulative. If they are they are a very bad driver of growth. Most of the tax cuts have flowed to the very rich and have had little impact on the masses who have only really kept up through property bubbles and leverage.

  2. Anonymous says

    Lowering taxes is not always stimulative. It flows straight into asset bubbles, a case in point the UK and USA. China has enough of a problem with asset bubbles. Also with the wealth gap in China being as bad as it is, I doubt that China will be able to keep the lid on problems once they erupt. China seems to be learning the wrong economic lessons. Higher taxes and a less skewed equality of wealth will keep the masses happier.

    1. Edward Harrison says

      Yes, we are going to see more money flowing into asset bubbles unless they take measures to slow the economy down – and raising reserve requirements is not going to cu it.

      1. Anonymous says

        There is an old policy weapon that seems to have been abandoned by central banks and that is the ability of central banks to demand bank reserves. By doing this they can target banks that are lending excessively and to the wrong types of loans. If banks were segmented they could easily target property loans.

        My concern is that China is following the credit route to economic growth. This is the most laisse faire method of growth, but it has serious drawbacks. This will work for a long time, but when it ends like it has in the west it will mean a very long and painful recession. For a country like China with a one party state that will mean that public anger will be aimed directly at the party. For a party that does not want to relinquish power they are going about things in a way that will surely end their influence.

        I have been thinking about the whole concept of lowering taxes being stimulative. If they are they are a very bad driver of growth. Most of the tax cuts have flowed to the very rich and have had little impact on the masses who have only really kept up through property bubbles and leverage.

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