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China’s government is about to institute a series of income tax reforms that won’t increase growth significantly, but will increase food price inflation, according to Citi.China’s elites are finding it easy to avoid their high taxes and the lower classes aren’t pleased, according to Citi. The government is now planning to reform the income tax system by cutting rates for its middle class. The perceived impact will be an increase in consumption.
And while consumer spending will increase as a result of the proposed changes, the key immediate term impact here will be a rise in food prices rather than any sort of economic stimulus.
The household survey showed food accounted for 40%-50% of total expenditure for low- and middle-income households in China. An increase in disposable income for this group may increase demand for food, thereby adding some inflationary pressures. On growth, if the government compensates the loss of IIT by increasing other revenues or cutting expenditures and leaves the fiscal balance unchanged, the IIT reform is not expected to have major impact on growth. Even if the government increases its deficit as a result of the tax loss, the stimulus effect on the economy should be much smaller than 0.12%-0.15% of GDP, as the fiscal multiplier of tax reduction is usually much smaller than 1.
So while income tax reforms will start to light a fire under the middle class Chinese consumer, they will have a significant negative impact in the short-term.
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