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Income Inequality and Economic Rebalancing

by | May 22nd, 2012 | 03:02 pm

The People’s Bank of China and China Southwest University of Finance and Economics released joint research collaboration this month called the Chinese Household Finance Survey (Chinese language). The headline picked up by locals newspapers was that 85 percent of Chinese households own their own home. According to the report, 69 percent of households in urban areas owned one apartment, 15 percent owned two apartments, and 4 percent owned three or more. Moreover, the average number was 1.2 homes per household. This statistic should give pause to those that believe China’s real estate boom is driven by a housing shortage.

There’s lots of good stuff if you dig further into the report, particularly on the composition of household wealth. One statistic that will surprise some observers is that only 1.1 percent of households have purchased wealth management products and these products account for just 2.4 percent of household financial assets.

Also of note are new estimates for savings rates which are quite different from those in the National Bureau of Statistics (NBS) household survey. The overall savings rate given in the China Household Finance Survey is 19.3 percent, significantly lower than the figure in the NBS household survey.

What’s interesting is that this new survey shows dramatic differences in savings rates between China’s different income brackets. Fifty-five percent of households have little or no savings. This is a stark contrast with the NBS numbers which show that even the 2nd decile of earners in urban China are saving 20 percent of their income. Those in the 90th percentile have an average savings rate of 61 percent and those in the 95th percentile save an average of 69 percent. Moreover, these groups accounted for a high percentage of total savings, with the top 10 percent of earners claiming 75 percent of the total savings.

If these statistics are correct it means that income inequality in China is worse than previously thought. It also sheds new light on how high levels of income inequality have contributed to low levels of consumption. As wealth disparities increase in China, money is disproportionately flowing to those who have the lowest propensity to consume, i.e. the upper income households that are saving 60 to 70 percent of their incomes. Efforts aimed at promoting consumption, like temporary rebates on energy efficient appliances and reducing the already small number of people affected by the income tax, are unlikely to have a major impact on rebalancing.

Rather engaging in small policy tweaks, changes at a more fundamental level are needed to achieve economic rebalancing. China must find ways to increase the income of households which are more likely to consume, i.e., those in the bottom income brackets. One way would be to promote more services-based growth and increase the wage share of GDP. Another possibility is to shift more of the tax burden from lower to higher income households.

China’s current tax system is regressive because most revenue is raised through the consumption tax and indirect taxes such as the value-added tax (VAT), business tax, and enterprise tax. This means individuals are taxed directly and indirectly every time they consume and the burden is therefore heavier on the poor who consume almost 100 percent of their income.  The 70 percent of income saved by the high earners in China is spared from many of these taxes.

Instead of reducing the income tax, it should be raising the income tax, especially on high income earners.  At the same time the share of government revenue coming from indirect taxes should be reduced. This would result in a more progressive taxation system and higher incomes for the poorest Chinese households. Policymakers should focus on putting more money into the pockets of China’s poorest citizens. This would be a good move for both economic rebalancing and social stability.