Wang Tao: What Does ‘Common Prosperity’ Mean for China’s Policies and Economy?
“Common prosperity” has become a key theme in China’s policy documents and recent speeches by senior leaders. What does it entail and what are the likely policy implications?
What is “common prosperity”?
Common prosperity is not a new theme. The 18th Party Congress in 2012 already stated that China should stick to “the path of common prosperity,” which is “the fundamental principle of socialism with Chinese characteristics.” This marked a turn from earlier years when the government encouraged “some people, some regions to get rich first.” The “Decision on Several Major Issues of Comprehensively Deepening Reform,” the 2013 reform blueprint of the Third Plenum, specified ways to achieve common prosperity. They include supporting labor income growth, pushing for more equal basic public services, reforming the income distribution system through tax reform, social protection enhancement, and transfer payments, expanding the size of the middle-income population, and narrowing the regional, rural-urban and sectoral income gaps. The decision also called for multiple channels to increase household property income and encouraging a big role for charity donations. The 13th Five Year Plan (FYP) in 2016 implemented some specific measures to further the objective of common prosperity, including reducing poverty, expanding the coverage of pension and health insurance and reforming personal income tax and consumption tax.
But its importance has increased in the 14th FYP and beyond. The 19th Party Congress in 2020 set out China’s long-term development plan to become an advanced modern economy by 2050 after the country has achieved “moderately prosperous society in all respects.” China is to make “solid progress” towards common prosperity by 2035 and “basically achieve” common prosperity by 2050. In our view this means a more equal society with better social welfare as the country becomes richer and more advanced. President Xi emphasized in a January speech and again last week that common prosperity is not just an economic objective, but also about the party’s “governing foundation.” That said, the top leadership has repeatedly emphasized that common prosperity is not egalitarianism, and is an objective that will be achieved in multiple phases over time, and through experiences from regional pilot programs. In line with this long-term plan, the 14th FYP (2021-2025) called for the formulation of an action plan to facilitate common prosperity, highlighting the increased emphasis on the theme and imploring various governments to roll out accompanying policy measures.
What’s new and what’s not? What has not changed in the government’s common prosperity drive are calls for increasing labor income share and creating channels for various property income growth, including through capital market investment; increasing the provision and equity of public services; enhancing the social safety net; reforming income distribution, including through tax reforms; expansion of middle-income population and increasing incomes of low-income people; and encouraging the development of so-called “third distribution” — charity and donations. What’s new in the 14th FYP is the assertion of the government’s “principal role” in providing basic public services while the 13th FYP said that any service that can be purchased by the government should not be operated by the government. However, the private sector is still encouraged to provide “inclusive” services in non-basic public service areas. This shift is consistent with recent regulatory changes in public service areas, including education. In addition, the 14th FYP mentioned restricting income from “monopolies and illegitimate competition,” expanding from the 13th FYP’s call for restricting “income using power and administrative monopolies,” again consistent with recent regulatory tightening on internet platform companies.
People buy agricultural products in Jinhua, East China's Zhejiang province.
What policies can we expect?
Consistent with the government’s long-term plan, we should expect reforms and policy changes to support household income growth, increase of public services including healthcare and education, expand pension and other social welfare, adjust income distribution through tax reform and regulations, and encourage corporate to play a bigger role in common prosperity. As emphasized in the August meeting of the Central Finance and Economics Committee, we expect these changes to be gradual and the emphasis to be more on increasing household income and improving basic public services and social protection rather than major income redistribution. Indeed, policy guidelines for Zhejiang’s pilot program are very much along these lines. Of course, there is a risk that policies could take a more populist turn from the general guidelines provided by the 19th Party Congress. Even so, we do not expect major personal income tax reform soon or a quick implementation of a nationwide property tax. More details below:
Income policies: Supporting employment growth will remain a top priority, and this means continued support for private sector development, small- and medium-sized enterprises, and the services industry, which are main contributors of employment and key to increasing the share of labor income. In addition, the government will work on improving labor protection and the wage growth mechanism. Meanwhile, to create more channels for household property income growth, we expect gradual land use rights reform in rural areas and further development of capital markets. To help expand the middle income group population, the government said it would focus on college and vocational school graduates, skilled labor and migrant workers. For example, the 14th FYP plans to provide 75 million instances of subsidized vocational training, of which 30 million are for rural residents.
Tax reforms: Reforming personal the income tax system is necessary given that it has a narrow base, high marginal rate (45%), is regressive and collects less than 1.5% of GDP in revenue (1.1% of GDP in 2020, or 7.5% of total tax income). However, personal income tax reform that will result in increased income tax revenue will always be difficult, and any reform will be very gradual — even the 2013 Third Plenum reform blueprint was modest on this front. The recent reform in 2018 (effective Oct. 1, 2018) raised the income tax threshold to 5000 yuan ($771)/month (from 3500 yuan/month before), added deductions, and expanded the coverage to include a few other forms of mainly labor income. Future reforms may include more types of income as taxable income (for example, currently capital gains and dividends are not taxed) while also adding deductible items (for example, child credit or cost of child care), though we expect this to be very gradual.
On consumption tax, which is levied mainly on alcohol and tobacco, fuel, automobiles, and some luxury items, the government’s goal is to adjust the coverage and tax rates, and gradually move the collection from production and import stage to the retail/wholesale stage to give more revenue to local governments. However, the latter proposal faces a serious challenge as it would shift tax revenue from poor provinces where the producers tend to be to richer provinces, where consumers are concentrated. In the coming couple of years, we may see some high-end high pollution items subject to consumption tax in the future, but the overall revenue impact should be limited.
The legislation on property tax may see some progress in the next year or two. Property tax has been discussed for years and two pilots have been implemented in Shanghai and Chongqing since 2011, but little progress has been made towards a national property tax law. In fact, the 2020 and 2021 NPC meetings did not even mention property tax, and it was not included in this year’s legislative schedule of the Ministry of Finance or the NPC. As China’s post-pandemic recovery continues and as the government increases emphasis on common prosperity, the legislative process may pick up pace. Even so, from drafting the law to three readings at the NPC before the eventual passage will take time. Even after the tax law is passed, the immediate impact will likely be limited as local governments will likely have the discretion to decide on tax rates and coverage. We believe the principle of property tax application will be such that most people will not have to pay property tax, given the 90%+ homeownership ratio in China. Meanwhile, it is possible to see a few other cities trying some form of a pilot program similar to Shanghai and Chongqing in the next year or two. Besides property tax, the government will likely work on adjusting land supply policy and increasing rental housing construction to achieve its goal on providing basic housing access.
Public services provision: We have seen recent government actions to tighten regulations in basic public services areas to reduce the presence of profit-maximizing providers in these areas. Such policies are likely to continue to reduce costs and increase the equitability of public services. Meanwhile, to increase access and equitability, the government plans to increase state provision of public services, including basic education (expanding or building new kindergartens, primary and high schools, and vocational high schools), child care and old age care (providing significantly more such facilities), basic health care (enhancing regional public medical centers, infectious disease management, and medical research), sports and culture (building more public sports facilities, fitness facilities and cultural centers), and other social and community services (developing community service platforms, increasing community workers). Some of the new constructions may fall under urban development or infrastructure spending.
Social safety net and insurance: Enhancing the social safety net has been deemed a core part of achieving common prosperity. The government plans to further increase pension coverage (from 91% to 95% to include more flexibly employed people), unemployment and work injury insurance coverage, and health insurance coverage in the next few years. In addition, the government will improve the system of transferring state capital to fortify the national pension, and aim to largely achieve national pooling of pensions by 2025, which will make them more portable across provinces. The government will also encourage the development of corporate annuity plans and commercial insurance.
The third distribution: The so-called “third distribution” refers to charity and donations. The government explicitly encourages companies and individuals to donate to charitable causes, as this is relatively underdeveloped in China compared to other countries (according to the Harvard Business Review, Fortune Global 500 companies spend about 1.8% of their total profits a year on corporate social responsibility efforts). We think the government is more likely to encourage corporation to shoulder more social responsibilities through moral suasion and tax incentives on donations, and do not expect any rule or legislation mandating charity work or donations like India did in 2013. While the government said it will “consider conducting research on levying an inheritance tax,” we think an inheritance tax is very unlikely in the coming few years.
Likely impact on the economy
Common prosperity related policies could have major impact on the economy over time, including:
Facilitating economic rebalancing towards consumption. China’s progress on rebalancing the economy has been slow in the past decade and stagnated more recently. Common prosperity policies that support employment and labor income growth should be positive for consumption, and a better social safety net can help lower precautionary saving. Increase in public services provision, especially in rural areas, should directly contribute to more services consumption, while a more equal income distribution should help lower the total household saving rate. Meanwhile, higher de facto taxes (through more strict collection or expansion of taxable income) and tighter regulation in services areas may discourage investment. The net impact on growth is difficult to gauge as it will depend on actual implementation of various policies.
Sectoral adjustments. Within consumption, common prosperity related policies may boost consumption of stables and some discretionary goods but limit the growth of high-end luxury items. In services, consumption of improved public services would increase but of private-sector provided services will face restrictions. Within investment, as the private sector faces tougher regulations in some services areas, private capital may seek opportunities elsewhere, either in government-encouraged technology, renewable energy or advanced manufacturing sectors, or even opportunities abroad. Meanwhile, public investment will likely increase in public services areas and move away at the margin from traditional infrastructure and construction.
Changing household and government balance sheets. As the government tries to keep property prices stable and discourage investment from flowing into the property sector excessively, household wealth may move to build up more long-term financial assets through investment in mutual funds and insurance. Meanwhile, the government will have to shoulder the fiscal burden of increased public services and social welfare, with China’s aging population adding to the challenge. This may bring more pressure for the government to keep local government debt in check, gradually reduce the government’s other investment activities, divest from some SOE shares or transfer an increasing amount to cover future pension liabilities.
Wang Tao is the head of Asia economics and chief China economist at UBS Investment Bank.
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Wang Tao is the head of Asia economics and chief China economist of UBS Investment Bank.
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