Caixin View: China’s Dilemma — Lower Tax Burden or Bigger Pension Hole

*Stricter enforcement of companies’ social security payments will come into force Jan. 1

*Governments will struggle to collect more dues while also supporting flagging private sector

As if China’s private sector weren’t already suffering enough, many beleaguered companies will be facing another challenge with the new year — finding the money to pay the social security contributions they may have been avoiding up till now.

Social security funds are controlled by provincial-level governments, and the responsibility for ensuring that the relevant levies are paid has been split between the taxation and social security authorities. But that will change on Jan. 1, when the power to collect dues will be consolidated with local taxation departments in order to stamp out evasion and make collections more transparent.

It’s widely acknowledged that companies, both private and state-owned, find ways to avoid or reduce their obligations, and millions of businesses pay less than they should. A survey by social-insurance information provider 51Shebao published this year found that only 27% of companies paid their full share of social security contributions, which cover payments for pensions, medical care, unemployment benefits, work-related injuries, and maternity.

That’s hardly surprising given the weight of the burden. Accounting firm KPMG, which compiles a data set of social security tax rates around the world, put China’s employer contribution rates alone at 32.9% in 2018, up to a maximum of 8,255 yuan ($1,190) per month, although that’s down from 44% in 2010. The rate compares with 9.35% in South Korea, 17% in Singapore and 7.65% in the U.S., with a global average of 15.75%. On top of these payments, employers in China are obliged to contribute to a housing fund, which employees can dip into when they buy a property.

The Jan. 1 change is likely to lead to much stricter enforcement and a higher collection rate as local governments try to bolster their pension and welfare funds as economic growth slows. This means more pressure on businesses at a time when many, especially those in the private sector, are struggling. If all companies met their social insurance payment obligations, average labor costs for businesses would increase by 30%, according to Wang Dehua, a financial analyst at the Chinese Academy of Social Sciences (CASS), a top state-backed think tank.

However laudable the government’s aims — after all, why should some companies get away with not paying? — this enforcement action is coming as private companies are being hammered by the slowdown in the economy; the impact of the financial deleveraging campaign, which has exacerbated the lack of access to financing; and deteriorating confidence fueled by the trade war with the U.S.

Anticipating the increased burden on businesses, especially private firms, the State Council in September asked local governments to look at ways to avoid increasing the overall burden on companies by reducing the amounts they are required to pay. But doing so would undercut the whole point of the reform, which is to increase the amount of money flowing into provincial social security funds, many of which are already in deficit, forcing the central government to pour in extra money to cover the gap.

Private companies account for half of the country’s tax revenue, 60% of gross domestic product and 80% of urban employment, according to government data, so supporting them has become a priority at the highest levels of government. On Nov. 1, President Xi Jinping promised lower taxes for small businesses and tech startups and greater financing availability for the private sector. He also encouraged local governments to offer financial aid to private companies with a “sound business outlook.” Earlier, in October, Vice Premier Liu He said those who do not support the development of private enterprises “must be resolutely corrected.”

The government has been lowering the tax burden on the corporate sector for the last two years, and in March, outgoing Finance Minister Xiao Jie promised their burden would be reduced by more than 1 trillion yuan in 2018 through actions including cuts to value-added tax and fees, although the corporate income tax rate of 25% has not been changed. In October, the new minister, Liu Kun, raised that target to more than 1.3 trillion yuan and promised further help in 2019.

But many business leaders and analysts say much more needs to be done for the private sector, and some have questioned the impact of the tax cuts. According to Chen Yongjie, deputy director of the Beijing Dacheng Enterprise Research Institute, tax revenue from private companies rose 35.6% from a year earlier during the January-September period, compared with 0.3% growth for SOEs. “The big gap raises one question: Does China really cut tax burdens? For whom?” Chen said in an interview with Caixin.

It’s unclear how exactly different provinces will approach the new system of collecting social security fund contributions in January. But whatever each province decides, officials will have to strike a balance between avoiding putting more pressure on private companies, and implementing reforms that could help ease the pain for China’s stretched social security system. Given that supporting private companies is now a top priority in Beijing, it seems likely local governments, faced with the choice, will attempt to avoid a sudden increase in tax burdens that may incur the public wrath of private enterprises.

The Chinese leadership is stuck between a rock and a hard place. On the one hand, it is under pressure to help the private sector, with tax cuts and temporary breaks being a fast and easy option to take. On the other hand, it is facing a long-term structural deficit in its pension fund and needs to beef up its social security buffers in the event of an increase in unemployment brought about by slowing economic growth and rising trade tensions.

The government has been attempting to overhaul and improve the provincial-based social security system for years, especially the pension system. The latest reform introduced earlier this year, the establishment of a national pension pool, can take a portion of money from provincial-level pension funds with surpluses, which tend to be the richer areas like Shanghai and Guangdong, and redistribute the money to other regions in deficit. But a fully centralized pension fund is a long way off.

Lou Jiwei, a former finance minister, underscored the precarious position of social security finances on Monday at the Caixin Summit in Beijing, describing the system as unsustainable given the rapidly aging population. Government subsidies to social security funds nationwide are increasing, reaching 1.2 trillion yuan last year, said Lou, who is now chairman of the National Council for Social Security Fund. Without these subsidies, the overall deficit in China’s regional pension funds will widen from 234 billion yuan this year to 534 billion yuan by 2022, according to research by CASS professor Zheng Bingwen. By 2020, more than 255 million Chinese will be aged 60 or older—almost 18% of the total population — rising to 320 million by 2030, he estimates.

The government may be betting it can set the pension and social security deficits to one side until the economy picks up again, and focus on helping private companies overcome what it hopes is a temporary blip. That may indeed be its best short-term option. But the pensions problem is only going to get worse and, with a population that’s graying as fast as China’s is, a long-term solution needs to be found sooner rather than later.

Calendar

November 27: National Bureau of Statistics releases data for October industrial profits