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    Should the U.S. Become More Like China in Regards to Business?
    The Vault

    Should the U.S. Become More Like China in Regards to Business?

    November 2011

    In a recent My Turn column in The Arizona Republic ("China is pro-business; U.S. should be, too"), Matt Salmon asserts that China's impressive economic growth rate can be attributed to low levels of business taxation and regulation and that the U.S. would be well-served by becoming more "China-like" in such matters. His assertion warrants some scrutiny. While it is true that China's nominal growth rate is indeed impressive, that growth rate has been accompanied by "eye-popping" inflation. After adjusting for inflation, the difference between China's GDP growth rate and its 2.5% counterpart in the U.S. is not terribly striking.

    But it is certainly the case that China has rapidly transformed itself into one of the world's economic powerhouses. In large measure, the speed of that transformation can be attributed to China's single-party system of government. There is no second political party standing in opposition to the Communist Party. Decisions to subsidize massive infrastructure projects such as the Expo Center in Shanghai and the country's high-speed rail system can be implemented in a relative heartbeat when there is no opposition party to challenge whether such subsidies are appropriate uses of taxpayers' money.

    China's official corporate income tax rate is indeed slightly lower than the counterpart U.S. rate of 35%. But there are a number of factors which render a simple comparison of these rates misleading. A careful analysis of the financial statements of Chinese corporations reveals that large numbers of Chinese companies actually pay taxes at approximately the official rate. In contrast, it is rare for large U.S. Companies to write tax checks amounting to 35% of income (think General Electric and Exxon Mobil). Why the difference? China does not have an army of lobbyists who have orchestrated a vast system of tax preferences favoring various special interests. In addition to income taxes, many Chinese companies also pay a business tax amounting to 5% of certain revenues—translating into an incremental tax rate on income well in excess of 5%.

    There are also indirect forms of business taxes. Many Chinese companies are at least partially state-owned. In some cases, these state-owned enterprises are required to purchase their inputs from other state-owned enterprises at above-market prices. Such above-market payments are essentially "shadow taxes" paid by some businesses to subsidize others. Upon contemplation of all taxes actually paid by Chinese businesses, it is far from clear that taxation in China is more pro-business than taxation in the U.S.

    Business regulation in China also occurs in forms many in the U.S. would find shocking. A fairly recent example involves financing of real estate development. In an effort to control rapidly increasing real estate prices in Shanghai, banks were prohibited from making loans to developers until such time as a project was 75% completed. A proposal by this country's administration to require such a significant amount of "skin in the game" on the part of investors would surely be met with opposition party claims of "chilling effects" and "job-destruction". Obtaining regulatory approval to engage in certain types of business activities can be a long and arduous process in China. In this country, financial institutions are essentially free to develop and market exotic derivative financial products posing potential systemic risk to capital markets (think credit default swaps on Greek debt). Not so in China. By design, the market for derivative financial products is small, has developed at a snail's pace with significant state oversight, and is highly regulated.

    Differences in other factors have contributed to China's economic transformation. In China, the health care and retirement systems are state-administered—sparing Chinese businesses the cost of providing these benefits directly. Also, the criminal justice system vigorously prosecutes those alleged to have engaged in financial misdeeds. Penalties are harsh.

    A resounding anthem heard in the political arena calls for lower taxes and decreased government regulation. Party hopefuls are often on the hunt for real world examples they can use to validate the soundness of these refrains. While such calls for changes in taxation and regulation may or may not have merit, the China comparison fails to ring true on these two key points. Business regulation and government control are pervasive in China, and arguably the taxes actually paid by its corporations are higher than the effective corporate rates paid in the U.S.

    This guest post is by Jim Boatsman, Phoenix.

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