There have been lot of questions raised over the years about the quality of economic data coming out of China in terms of reliability of the data collection methods, quality control, the statistical techniques it employs, data compatibility with the western methodologies and reporting systems, government influence in data reporting, and the reporting standards. Many of those questions may be legitimate, and some may be due to the misconception the rest of the world has about China, arising primarily from its opaqueness to the rest of the world. Moreover, the Chinese government manages its messages very tightly in order to advance its political legitimacy in the eyes of the Chinese people and the rest of the world.
On July 26, Wall Street Guru Dr. Ed Yardeni of Yardeni Research Inc. in his morning briefing to his clients emphatically confirmed that the Chinese economy is in a significant slowdown based on some year-over-year analytical tax revenue charts IMRA had developed for Yardeni Research from the June fiscal report, Chinese Ministry of Finance released in early July.
Here's what Dr. Yardeni said in his morning briefing:
Recently, lots of doubts have been raised about the accuracy of official economic measures released by China's government. Debbie and I don't doubt that the quality of much of the data is questionable. We regularly update our China chart book and try to assess the big picture as best we can using all the available data as a whole. We are constantly on the lookout for more data to add to our chart book….
I recently asked our consultant, Sailesh Radha, to work on China's official tax revenues. He found the latest official release in Chinese and used Google's translation utility to read it….
The data were released by the Ministry of Finance on Tuesday of this week and outlined in a story appearing in the English version of xinhuanet.com. The data confirm a significant slowdown in Chinese economic growth during the first half of this year:
(1) Tax revenues rose only 9.8% y/y during H1-2012, down from 29.6% over the same period a year ago. Growth rates were down across all 11 major revenue sources.
(2) Personal income taxes actually declined 8.0%. A year ago, they rose 35.4%. Corporate income taxes rose 17.3%, but that was down from 38.3% a year ago.
(3) Revenues from property transactions took a hit. The ones from "Land Value Increment" rose 14.7% vs. 91.1% a year ago. "Deed" revenues fell 9.9% after rising 27.5% a year ago.
Albeit he was right in his assessment of the economy, and was suspicious of the quality of data emanating from the Ministry of Finance, I believe that he jumped too quickly to his conclusion, which was based solely on the year-over-year analysis of the headline tax revenue and its major sources. The rest of this article examines the elucidations why analysts and strategists should be very cautious handling Chinese fiscal revenue data in their analysis, and in discerning the state of the Chinese economy using them. In illustrating the reasons, I would be using the recently released September report as well as the third-quarter's year-to-date report (a cumulative report covering the three quarters of this year) released by the Ministry of Finance to comprehend the various sources of the Chinese fiscal revenues as well as their taxation system.
My experience in parsing the Chinese monthly fiscal reports on their Ministry of Finance (MOF) website has been harrowing so far primarily for the following reasons:
a. The monthly fiscal reports show up only on the MOF's web-page in Chinese and you are at the mercy of the translation tools that web browsers provide (I used the chrome browser), as the translations are messy and half-baked. You will literally spend hours analyzing the translated reports to get the numbers for the various tax sources, and moreover, cross verification is impossible, as the media only reports the headline numbers and the numbers for some of the major tax-revenue sources. The Chinese National Bureau of Statistics only reports annual numbers for government finance, and not the monthly numbers. But, it would have been nice if it reported the monthly numbers because the bureau presents all its data in English and in a comprehensible tabular format. It also gives you an option to view all the data in Excel.
b. The report that is released in March every year combines the numbers for January and February, and I am yet to ascertain the reason behind it and I believe it could be because of the extended Chinese New Year holidays in January. As a result, fiscal numbers for the month of January and February are not available on a standalone basis. In fact, if you go back few years, sometimes December values are missing for many of the tax-revenue sources.
c. Of late they have begun to publish year-to-date reports every quarter, and sometimes that data is presented in a tabular format. In fact, you can look at the table at the end of latest year-to-date third-quarter report referred to earlier, even though the column headers as well as the name of the revenue sources are in Chinese. The norm is that data are reported by the MOF on an absolute basis as well as on a year-over-year basis for every month (barring January and February, as they are combined), and for some of the months, year-to-date reports are also published. For some revenue sources, year-over-year declines/increases from the prior year are also reported. In some of the reports, data relating to some revenue resources are never reported at all. So, the reports lack uniformity in presentation and content.
As you can see from the reports, piecing together the fiscal revenue data to obtain the complete and a thorough picture is excruciating.
The Chinese government employs the five-year plans to provide broad outlines of the fiscal policy stance that would be maintained in the following five years to achieve its economic objective in that time period. It uses tax reforms primarily to fine-tune tax policies enacted prior, to enhance the existing ones, to mobilize revenue, and to respond to new economic shocks. Ever since China started its market reforms and began opening its economy, a series of major watershed tax reforms were enacted in the eighties and in the early nineties.
According to the Chinese Ministry of Finance, the series of reforms that began in the early eighties and ended sometime in the early nineties, focused on transitioning from a single tax system adopted in the traditional planning economy into a multi-category of taxes, multi-state and multi-level tax system, based on turnover tax and income tax and with mutually assorted other category of taxes.
In 1994, the Chinese government again undertook a major tax reform with the aim of establishing the socialist market economy system through fair and just taxation by reforming the turnover taxes and income taxes. If you look at Fig. 1, since the 1994 tax reforms, tax revenue had rapidly increased in China at an average annual rate of 12.9% till 2006, with the annual growth rate of GDP in the corresponding period at 9.9%. As a result, tax revenue as percentage of GDP has grown steadily at an annual rate of 2.3% since the reforms.
Since 1994, numerous tax reforms, structural tax reduction policies, and revenue mobilization programs have been undertaken as means of managing economic stability (see Table 3), including the major tax reforms that were undertaken since 2005 (Table 4 and Table 5). Numerous tax reduction programs and tax reforms were enacted as part of the fiscal stimulus to counter the global recession of 2008. With all those reforms, now the total number of taxes in China totals 19 (see Table 1). As of 2010, turnover tax revenues constituted 58.8% of the total tax revenues, income tax 26% and the rest 5.2% (see Fig. 2). As part of the 12th Five-year plan, many more tax reforms are envisaged (see Table 2).
Table 1: Classification of Chinese Tax System
Source: Ministry of Finance, People's Republic of China and IMF.
Table 2: Current and Anticipated Major Tax Measures during the 12th Five-year Plan
Source: Ministry of Finance, People's Republic of China and IMF.
Table 3: Tax Incentives as a Fiscal Policy Tool to Manage Economic Shocks
Source: Ministry of Finance, People's Republic of China and IMF.
Table 4: Recent Major Structural Tax Reductions
Source: Ministry of Finance, People's Republic of China and IMF.
Table 5: Main Tax Reforms for Revenue Mobilization (since 2005)
Source: Ministry of Finance, People's Republic of China and IMF.
Now to the point of Dr. Yardeni's conclusion and his thought process - it is perilous to opine on the state of the Chinese economy based on year-over-year analysis of the headline tax revenue numbers and the major tax revenue sources alone, without ascertaining and analyzing the underlying fiscal dynamics that are transpiring within the economy. The primary reason being, China as you can see (from Tables 2, 3, 4 and 5), albeit a blue-chip emerging country, is in a constant state of flux on the fiscal front attributable to: reassessment of fiscal policy every five years through the five-year plans, constant tweaking and improvisation of the existing tax system through tax reforms, constant improvisation of tax collection systems, recent spate of tax-revenue mobilization programs and constant addition and withdrawal of tax incentives to counter new economic shocks.
If you look at Fig. 3, the positive correlation between tax revenue as percentage of GDP and annual GDP growth rates, as was evidenced in the time period 1998 through 2006 (as see in Fig. 1), has been broken or does not exist anymore in the time period 2006 through third quarter of 2012. The economy so far is growing at an annual rate of 7.7% (based on the recent third-quarter GDP update); however, tax revenue is exhibiting higher growth rates and is currently around 22.7% of the GDP, compared with around 19% at the end of last year. The breakdown of this relationship alone underlines the need for analysts and strategists to do a thorough analysis of the fiscal report to make a confident judgment on the direction of the economy. Any judgment devoid of any such analysis is perilous to say the least. My point here is, considering the underlying fiscal fluidity, one has to thoroughly understand the premises behind the increase or decline of revenue from each individual tax source, before using them to determine the pulse of the economy.
Let's review the latest September fiscal revenue report as well as the third-quarter report:
1. If you look at Fig. 4, total fiscal revenue rose ¥826 billion ($132.270 billion) in September, ¥40 billion more than in August, and ¥78 billion more than that recorded in September last year. Fiscal revenue as you all know is the sum of tax revenue and non-tax revenue. Non-tax revenue, which includes special program receipts, charge of administrative and institutional units, penalty receipts and others, posted a total of ¥147 billion in September, while tax revenue came in at ¥678 billion (see Fig. 5).
2. Fiscal revenue for the three quarters ending September 30, 2012, recorded an all-time high of 25.6% of the GDP, with the tax revenue recording an all-time high of 21.9% after a previous high of 19% of the GDP recorded at the end of 2011. Domestic VAT (5.4%), CIT (4.8%), business tax (3.3%), and import VAT and consumption tax (3.2%) round up the top spots among the various tax-revenue sources. For the same time-period cumulatively, non-tax revenue sized up at 3.7% of the GDP (See Fig. 6). The elevated growth of fiscal revenue and tax revenue (as discussed earlier) compared with the below-expectations GDP growth rate of 7.7% (saar) so far this year is very disconcerting.
3. When viewed on a year-over-year basis using Fig. 7, there were some sore spots in the September numbers - import VAT and consumption tax revenue recorded a decline of 5.3%, corporate income tax recorded a -11.1% and personal income tax, a decline of 5.7%. The decline in corporate income tax revenue is in line with the declining industrial profits as discussed here (and here). However, the decline in personal income tax revenue is a surprise for an economy growing at 7.7% (saar), but if you look closely at item number four in Table 4, threshold for IIT was raised to ¥3,500 from ¥2,500 on September, 2011. So, logically the numbers for September are influenced by that tax code change last year apart from the slowing economy.
The most distinguishing aspect of that chart is the through-the-roof year-over-year growth of 52.8% recorded by non-tax revenue, which has driven the fiscal revenue to grow at an impressive 11.9% compared with the milder growth rate of 5.8% for the tax revenues. Export tax rebate (a form of subsidy) registered an impressive 36.2% growth, and is a good real-time indicator that tracks the Chinese exports. In September, business tax revenues registered an impressive growth of 26.5%. It indicates, after ascertaining that there were no changes in the tax code, the non-manufacturing sector is doing better than the manufacturing sector, whose VAT tax revenues posted a growth of measly 10.4%.
The abnormal growth of non-tax revenue is also reflected again in Fig. 8, which records the quarter-over-quarter growth of the tax revenues and the fiscal revenues for the first three quarters of this year. The local governments, facing sluggish tax income due to the slowdown are looking for new sources of revenues to meet spending goals, and non-tax revenues with flexibility in assessment and supervision have become a major source of income.
The decline of import VAT and consumption tax revenue by 5.3% signifies challenging economic conditions at home as well as abroad. We should not discount the fact the price levels are also declining - in September, CPI of China rose 1.9% compared to 2.8% for the same period last year. Tax revenues as you know are function of the tax base, which is also influenced by the price levels. Applying year-over-year analysis to data gleaned from the monthly as well as the quarterly fiscal report for smaller items like vehicle purchase tax, deeds (stamp tax), land appreciation tax, and other items listed in Table 1 under behavior taxes and resource taxes are definitely useful in gauging the strength of the various sectors in the economy - consumers, financial markets, property market, and the housing market. Barring vehicle purchase taxes, the rest of the small items are also known as "local small taxes."
4. Figures 9, 10, & 11 are year-over-year analysis charts derived from the year-to-date Chinese fiscal revenues report covering the first three quarters of this year. If you look at Fig. 9 and Fig. 10, all sources of revenue have posted a decline this year on a year-over-year basis compared to the same time-period last year. The year-to-date fiscal revenue has registered a year-over-year growth difference of -18.6% (see Fig. 8) compared to that from the same time-period last year, tax revenue (-18.8%), VAT (-12.9%), consumption tax (-6.9%), business tax (-11.9%), import VAT and consumption tax (-29.9%), CIT (-21.1%), IIT (-42.8%) and non-tax revenue (-19.3%).
Personal income tax revenue with a growth difference of -42.8% is an outlier suggesting that a weaker economy as well as the structural tax reductions in the individual incomes taxes (discussed in Table 4) to promote income among low-income groups have acted as a double-whammy on the personal income tax revenue. Similar conclusions were drawn from the September report as well. Likewise, the growth difference of -21.1% for the corporate income tax revenue and -29.9% for import VAT and consumption tax revenue confirm slowdown of the manufacturing sector and the domestic economy respectively (including declining inflation), as was confirmed by the September numbers.
The fiscal revenue has done better than the tax revenue for the first three quarters of this year, and that means non-tax revenue, which has a significantly lower share of the fiscal revenue than the tax revenue, has registered an impressive growth this year (also see Fig. 8). Fig. 11 provides year-over-year analysis of the various tax sources for this year as of end of third quarter, while Fig. 12 reflects the year-to-date fiscal revenue collection in yuan for the same time-period.
From the above analysis, we can appreciate that in order to obtain apples-to-apples comparison using year-over-year analysis for comparing tax revenue across two consecutive years is very challenging to say the least, considering the fact we have to be cognizant of all the changes in the fiscal policies that have taken place in the time-period. Using the fiscal revenue data to do historical trend analysis, across years or across different time-periods, to predict the trends in the economy as a whole is futile, considering the questionable quality of data and the fluid nature of fiscal policies in China. In order to obtain an instantaneous pulse of the economy at a given point in time, it is imperative that apart from doing a year-over-year analysis, we apply refinements to the analysis by overlaying causal elucidations that accompany the headline elements as well as the individual sources of fiscal revenue in the fiscal reports.
It is not a surprise that fiscal policies change every year and from one five-year plan to another, as China is an emerging economy, and is long ways from maturing. So naturally, the fiscal reforms and tax revenue mobilization programs are ongoing phenomena. The key principles of Chinese tax reforms in the recent years have been:
More simplified taxation system
Broader tax collection basis
Lower tax rates
Stricter tax collection
The two elements outlined above - number two and number three - as well as the recent spate of revenue mobilization programs (as outlined in Table 5) may explain the disconnect between GDP growth rate and the increasing share of tax revenue as percentage of GDP as discussed earlier and outlined in Fig. 1.
The whole discourse so far has focused only on year-over-year analysis. However, month-over-month analysis is also feasible and could be a better option, as the underlying fiscal conditions are more stable on a monthly basis than on an annual basis. But, the biggest challenge in doing the month-over-month analysis is the need to construct a database of monthly raw values, before applying the month-over-month computations and not forget the monthly numbers for January and February are combined into one. Instead in the year-over-year analysis, the year-over-year values are already provided alongside the raw data by the Ministry of Finance. In spite of all caveats, the monthly as well as the quarterly fiscal reports house a ton of information that can throw tremendous amount of light on the underlying Chinese economy.
Disclosure: I am long GXC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.