Categorized | China, Tax, Trade

CPA White Paper: How China’s VAT Massively Subsidizes Exports

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Edwin Way, a graduate student at Indiana University, is a CPA research intern.  He recently studied China’s strategic use of value added tax rebates (export tax rebates) to gain a competitive, and in our view unfair, advantage in global trade.

China spends almost $100 billion per year now subsidizing exports in this facially WTO-legal way.  Free trade utopians in DC will have their worldview shattered by examining the tactics of state-managed capitalism by China and others.

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Chinese export tax rebates: A $100 billion a year tool that’s helping China “win the future”

By Edwin Way, CPA Research Intern

$455 billion — almost half a trillion US dollars.

This is the amount the Chinese government spent to subsidize their domestic companies’ exports between 2002 and 2009.  It is the cumulative amount China paid in export tax rebates during that time to increase its exports to America and other countries.  Indeed, as the global recession of 2008 took hold, the export tax rebate payments in China increased.

Currency issues have grabbed the world’s attention, but China’s system of export tax rebates has also played a major (and underappreciated) role in the rise of China’s exporting juggernaut.

While currency manipulation violates both the spirit and letter of American and international trade laws, China’s export tax rebates are, on their face, consistent with WTO rules.  But the strategic use of these rebates appear designed to gain an export advantage, and thus violate the WTO.

According to the GATT/WTO trade agreements, a country with a value added tax (VAT) such as China can legally rebate to its exporters the VAT taxes they pay on exports. The assumption here is that China’s tax rebates will be offset by import VAT taxes in other countries. Unfortunately for US manufacturers, the US does not have an import VAT tax and has near 0% tariffs. As a result, Chinese exporters can more easily undersell their American competitors in the US market. They need not pay the payroll, business and other US taxes paid by US producers, while the taxes Chinese companies paid the Chinese government are refunded to them when they export to the US.

US manufacturers face this problem when competing with the Chinese, but also with the Europeans, Japanese, South Koreans and many other nations. The Chinese export tax rebates system is, however, distinctive not just because of its scale – now roughly $100 billion a year — but also two other features: 1) the way China uses VAT export rebates to promote strategic industries; and 2) the use of these rebates to subsidize Chinese exports, particularly when China’s trading partners are in economic trouble.

The Chinese government has used export VAT rebates to promote strategic industries and industries with high-value added and high labor content to help maintain employment. Since 1994, China’s national value added tax has been set at 17%, with exporters able to recoup up to the full 17% depending on the industry. In general export tax rebates have been higher for more sophisticated industries and lower for less desirable industries, and these rates are frequently adjusted. For example, in 2005, the Chinese raised export tax rebates for information technology and biomedical products, while reducing rates for lower value-added textiles and apparel, and eliminating export tax rebates on energy intensive and industries, such as some kinds of basic steel (under the lianggao yizi policy).

Export tax rebates are also a key component in government initiatives to expand and upgrade industries that Beijing believes China does not yet dominate but should. For example, in September 2009, the central government announced seven new policies to promote Chinese auto parts exports. Significantly, the official announcement of these new policies listed maintaining the full 17% tax rebate before the other six policies, which included among other things increasing access to loans and export credits.1

China’s system of export tax rebates is extraordinarily detailed, with slightly different rebates targeted for thousands of different kinds of products. An association of trade lawyers from the southern province of Guangdong put together a helpful online database that provides information on each of these rebates for more than ten thousand product categories.2 [This same website provides a handy database for Chinese tariff rates for a similarly vast number of products]. To illustrate the detailed nature of this system, a table is provided below that highlights a sample of rebates for a selection of products.

China’s system of export tax rebates is a powerful illustration of the truth that China is unapologetically pursuing industrial policy: “picking winners and losers” down to a very fine grain and on an enormous scale.

Along with China’s other tools of industrial policy, export tax rebates have been remarkably successful at changing the nature of China’s trading relationship with the rest of the world. Economists have long observed that poorer developing countries tend to export raw commodities while wealthy developed countries mostly export more advanced manufactured goods. By this metric, China has moved decisively towards developed country status even as the US is moving in the opposite direction.

Between 2002 and 2009 the proportion of primary products (tin, bauxite, wool, etc) in China’s exports fell from 8.7% to 5.2% while the share of these goods in Chinese imports leapt from 16.6% to 28.8%.3

In contrast, in just seven years the proportion of raw commodities in US exports to China doubled from 15% to 30%.4

By 2009, just four commodities: soybeans, cotton, lumber, and copper accounted for almost 20% of US exports to China.5

Chart: Primary Commodities as percentage of total exports (detailed)

Source: US Census Bureau

In addition to guiding Chinese industrial development, export tax rebates have also helped Beijing surreptitiously subsidize export industries without seeming to violate WTO statutes. As professor Cui Zhiyuan of Beijing’s Tsinghua University has pointed out, Chinese companies since the 1990′s have consistently over-invoiced their value added taxes as a way of increasing the amount they receive in rebates for exporting.6 Total requests for VAT taxes usually vastly exceed Beijing’s budget estimates, and this is a practice that gives the Chinese central government considerable flexibility in subsidizing favored industries. Preferred industries can receive their requested export tax rebates in full, which amounts to a de facto hidden government subsidy.

The system of export tax rebates also allows the Chinese government to help exporters thrive even when global exporting conditions deteriorate. When China’s trading partners suffer periods of recession or slow growth, Beijing can use export tax rebates to help its companies maintain or expand their market share in these depressed economies. Beijing more generously fulfills Chinese companies’ export tax rebate requests and also typically increases the amounts rebated. In these periods, Chinese companies generally also get “back taxes” receiving not only their current exaggerated export rebate requests but also previous years’ exaggerated export tax rebate requests.7

For example, after the Asian financial crisis badly damaged the economies of Thailand, South Korea, and Indonesia, the Chinese government increased the value of export tax rebates and expanded the number of products covered nine times from early 1998 through 1999.8 After the 2008 financial crisis devastated the economies of Europe and North America, the Chinese raised export tax rebates seven times between the fall of 2008 and summer of 2009.9 They also chose to support labor-intensive industries to help maintain China’s high level of employment, raising rebates for textile exporters in August 2008 from 11% to 13% and then again to 16% in April 2009.10

Changes in the value of export tax rebates clearly illustrate this pattern of using export tax rebates to help Chinese companies survive periods of depressed foreign demand. It is telling that even as Chinese exports were plummeting in 2008 with the near-collapse of the European and US economies, export tax rebates nonetheless surged: climbing 12% to a record high of 648 billion RMB (US $95 billion).

The use of VAT export tax rebates is a good example of how the Chinese have actually been quite transparent and open about deploying a variety of import and export taxes, quotas, regulations and subsidies to help China seize the advanced industries of the future. For instance, googling “Chinese export tax rebates” in Mandarin yields literally dozens and dozens of Chinese websites that offer to help companies maximize their export rebates. China has not practiced “free trade” since at least 1928 and it has hardly tried to conceal this fact. Across thousands of years of Chinese history the only period that China could be said to have practiced anything even resembling “free trade” was between 1842 and 1928 when its tariffs were fixed by European powers at 5%.

While some argue that China is adopting, or will adopt, American-style trade policies, the evidence says otherwise? After all, why mess with success? Chinese per capita income is now more than 40% higher than just five years ago, even as the US is well into its fourth year of high unemployment and twelfth consecutive year of declining median income.11

Better to ask: how much longer will it take before US policymakers recognize that German and Chinese-style managed trade should be neutralized and possibly emulated?

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End Notes

1 “Shangwu bu: Guojia jiang caiqu qi da jucuo cujin qiche lingbujian chukou,” The Central People’s Government of  the People’s Republic of China, September 5, 2009, http://www.gov.cn/jrzg/2009-09/05/content_1409975.htm.

2 See:  http://www.customslawyer.cn/

3China Statistical Yearbook 2010, see 6-4: Exports Value by Category of Commodities and 6-5: Import  Value by Category of Commodities.

4 “US exports by 5-digit end-use code, 2002-2010,” United States Census Bureau, http://www.census.gov/foreign-trade/statistics/product/enduse/exports/index.html.

5 Ibid.

6 Cui Zhiyuan, (2003) “China’s Export Tax Rebate Policy,” China: An International Journal, 1(2): 339-349.

7 “Beijing ziliao: Zhongguo chuokou tuishui zhengce lici zhongda tiaozheng yi lan,” cn.reuters.com, June 23, 2010.

8 Cui, p. 342.

9 “Beijing ziliao: Zhongguo chuokou tuishui zhengce lici zhongda tiaozheng yi lan,” cn.reuters.com, June 23, 2010.

10 Ibid.

11 U.S. Census Bureau. “Table H-13: Educational attainment of householder — Households with Householder 25 years old or older by median and mean income.” <http://www.census.gov/hhes/www/income/histinc/inchhtoc.html>

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