# The Simulation Results of Scenario 2

Scenario 2 assumes that direct taxes are kept constant, indirect taxes go down, and the change in proportion of direct and indirect taxes is due to the decrease in indirect taxes. Therefore, the difference between the two scenarios is not only with regard to change in proportion of the two kinds of taxes but also decrease in total taxes of the national economy. The policy simulation results indicate the following:

First, there are strong promotional effects on economic growth. In 2012, 2013, and 2014, the growth rate of GDP increased by 0.09, 0.40, and 0.13 percentage points, respectively, compared with the reference values (Fig. 4.10), obviously higher than the deviation from the reference values in Scenario 1 (Fig. 4.2). This

**Fig. 4.11** Changes in CPI (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

shows that the direct and indirect tax structure adjustments are stronger with taxreducing effects than without tax-reducing effects for promoting economic growth. Tax reduction has extra promotional effects on economic growth.

Second, the decline range of price level is higher. Moreover, since the direct tax is constant, the growth rate of residents' consumption in comparable prices increases further. In 2012, 2013, and 2014, the CPI decreases by 0.52, 0.35, and 0.06 percentage points, respectively, compared with the base values (Fig. 4.11).

The relatively higher decline range of price leads a higher decline range of nominal growth rate of the social consumption goods' total retail sales. In 2012, the nominal growth rate of social consumption goods' total retail sales decreased by 0.6 percentage points compared with the base values; however, it increases rapidly later, by 0.3 percentage points, compared with the base values until 2014 (Fig. 4.12). The growth rate of residents' consumption in comparable prices obviously accelerates without an increase in direct taxes. It increased by 0.06, 0.31, and 0.16 percentage points in 2012, 2013, and 2014, respectively, compared with the base values (Fig. 4.13); the growth rate is obviously higher than the simulation results in Scenario 1 (Fig. 4.5).

Third, because of decrease in the national economy's overall tax, the increase in growth rate of urban fixed asset investment is more significant. The growth rate of urban fixed assets investment increased by 0.5, 1.7, and 0.5 percentage points in 2012, 2013, and 2014, respectively, compared with the base values (Fig. 4.14).

Fourth, as with Scenario 1, although the residents' consumption increases in absolute value, its proportion in aggregate demand structure appears to slightly shrink because of faster increase in investment, but the range of shrinkage is less than that in Scenario 1. The ratio of residents' consumption over GDP decreases by 0.01, 0.04, and 0.03 percentage points in 2012, 2013, and 2014, respectively, compared with the base values (Fig. 4.15); the decline range each year is lower than the results in Scenario 1 and the investment proportion increases further. The

**Fig. 4.12** Changes in growth rate of total social consumption goods' retail sales (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

**Fig. 4.13** Changes in growth rate of residents' consumption in comparable prices (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

**Fig. 4.14** Changes in growth rate of urban fixed asset investment (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

**Fig. 4.15** Changes in proportion of residents' consumption (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

**Fig. 4.16** Changes in proportion of gross capital formation (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

ratio of gross capital formation over GDP increases by 0.06, 0.27, and 0.31 percentage points in 2012, 2013, and 2014, respectively, compared with the base values (Fig. 4.16).

Finally, as with Scenario 1, following the recovery of economic growth, although a certain fixed amount of indirect taxes decreases each year, the growth rate of indirect taxes increased by 0.3 and 0.38 percentage points in 2013 and 2014, respectively, compared with the base values (Fig. 4.17a), but in 2012 there appears a relatively larger decline range, with a 5.31 percentage points decrease

**Fig. 4.17** Changes in growth rate of classified taxes. (**a**) Changes in growth rate of indirect taxes.

(**b**) Changes in growth rate of direct taxes (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

**Fig. 4.18** Changes in growth rate of gross tax revenue (Note: Baseline denotes basic simulation; Scenario 2 denotes the simulation results in Scenario 2; diff denotes the difference between the simulation results in Scenario 2 and the basic simulation results)

compared with the base values. The growth rate of direct tax is basically stable (Fig. 4.17b). In 2012, the growth rate goes down by 0.4 percentage points compared with the base values, but it increases by 0.1 percentage points in the following two years. The ratio of direct taxes to indirect taxes in the final simulation results is 0.55, 0.61, and 0.62 for 2012, 2013, and 2014, respectively, the same simulation results in Scenario 1.

In terms of gross tax revenue, affected by the large decline range of indirect taxes, the growth rate of gross tax revenue in 2012 decreased by 4.2 percentage points from the base values and then increased by 0.3 percentage points over the base values in both 2013 and 2014 (Fig. 4.18). Reducing the tax not only does not decrease the long-term growth rate of gross tax revenue, but, through the optimization of tax structure, maintains the sustainable long-term growth of the gross tax revenue.

In summary, the results of policy simulation are as follows:

1. The tax structure adjustment of reducing indirect taxes and increasing direct taxes helps in decreasing the price level; improves consumption; promotes investment, especially private self-financed investment; and finally boosts economic growth. This clearly illustrates that the current tax structure of China, which mainly depends on indirect taxes, dampens enterprise investment and residents' consumption. For the Chinese economy, further accelerating the tax structure adjustment, decreasing the indirect tax proportion, and increasing the direct tax proportion are the policy issues that needs to be solved as soon as possible if the economy is to enter the new development stage.

2. A comparison of the two policy simulations (Scenario 1 and Scenario 2) shows that the adjustment of proportion of direct and indirect taxes with reducing tax effects (Scenario 2) has stronger effects on the economy's growth rate, residents' consumption, and investment in urban fixed assets than the adjustment without reducing tax effects (Scenario 1). This shows that while adjusting the tax structure, reducing the national economy's gross tax has better policy effects currently.

3. Reducing indirect taxes can lead to slightly adverse effects for the aggregate demand structure. While the residents' consumption increases in absolute terms, its proportion in aggregate demand decreases slightly. Benefiting from the accelerating investment, the proportion of gross capital formation will increase. However, since the growth rate of residents' consumption keeps stable and even appears to increase—this structure change mainly reflects that the decrease in indirect taxes promotes investment, rather than depresses consumption—as a whole, its effects on the economic growth is positive.

4. Although reducing the indirect taxes could cause the growth rate of the gross tax revenue to fall in the short term, the growth rate of residents' consumption and private investment will increase. Moreover, the long-term recovery of the economic growth rate ensures that the growth rate of the gross tax revenue does not persistently decline; it also assures the long-term sustainable growth of tax revenue.

From the policy simulation of the CQMM and analysis of the current Chinese economic issues, we consider a current moderate decrease in indirect taxes and a subsequent moderate reduction in the national economy's gross tax not only feasible but also necessary. We might even say that this is one of the key possibilities to recreate the Chinese economy's potential growth in the next stage.

First, the policy simulation results show that a decrease in indirect taxes will not produce serious negative effects whether the gross tax revenue keeps constant or moderately decreases but helps to stimulate the growth of residents' consumption and private investment instead and therefore boosts the economic growth. This shows that reducing indirect taxes has a positive effect on the macroeconomy and deserves to be given a try.

Second, the Chinese policy practices in the last three years show that the easing monetary policy is too weak to attract social investment and promote economic growth because of serious transmission barriers. The structural contradiction is the major sticking point of the current Chinese economy. This makes the monetary policy, which is good at gross controlling, especially inflation controlling, difficult to work. In comparison, fiscal policy is better for structure adjustment. Fiscal policy is nothing more than reducing tax and increasing spending; the increase in spending is limited to the tax revenue and government debts, and tax reduction is relatively uncontrolled. Moreover, the theory of the supply-side economist and policy practices of US President Reagan have already shown that reducing taxes is not equal to reducing fiscal revenue.

Third, from the perspective of implementing the government's fully covered budget, a decrease of fiscal revenue is not equal to a decrease of government revenue. Government revenue includes the government's fund revenue, social insurance revenue, and state-owned capital operating revenue. The Decision requires that the profit-delivering proportion of state-owned enterprises increases by 30 % percent. Based on calculations using the current data, in 2013, the gross profit of the central enterprises was 1.62 trillion yuan, the net profit was 1.17 trillion, and the profit after tax and deducting 10 % statutory reserves about 1.05 trillion yuan. ^{[1]} In 2013, the profit revenue of central state-owned capital operation was about 103.96 billion yuan and the turning-over proportion was about 9.88 %, which is still a bit far from the target value. Therefore, following the Decision's requirement, gradually improving the real profit turning-over proportion of the state-owned enterprises in the future 5 years would help in some degree to offset the possible decrease in fiscal revenue growth rate due to reducing taxes.^{[2]}

Fourth, the government's revenue-expenditure condition can be improved by further optimizing the fiscal spending structure, transforming the government function, specifying the boundary of government's responsibility and obligation, improving the capital utilizing efficiency, compressing the government's administration expenditure, and guaranteeing livelihood expenditures. In 2014, following the high pressure of anti-corruption, although the growth rate of fiscal revenue decreased, the growth rate of fiscal expenditure, especially the general public service expenditure, decreased faster. There was not lack of compression of the past extravagant waste spending.^{[3]}

Finally, fiscal deficit still has some space. In 2014, the fiscal deficit in China was about 1.35 trillion yuan, an increase by 150 billion yuan from 2013; the deficit ratio was about 2.1 %, which is still lower than the international deficit warning line of 3 %. If indeed necessary, the government can moderately increase the deficit rate and release the space for reducing the tax and increasing spending.

- [1] The after-tax revenue still needs to deduct the unrecovered deficit at the beginning of the year. Since complete corresponding statistics are unavailable, we do not consider it, and the real average turning-over proportion may be a bit higher
- [2] Only some state-owned financial enterprises turn over their profits to the government currently. The four state-owned commercial banks are the most profitable state-owned enterprises in China currently. In the first half-year of 2014, 16 listed banks achieved a net profit of 6907.81 trillion yuan; this covered about 51.63 % of the net profit of 2558 listed enterprises, with the four stateowned banks covering up to 35.34 %. However, in 2013, all the state-owned financial enterprises turned over profits of only 117 million yuan
- [3] The general public service spending rose by 2.0 % cumulatively in the first 11 months of 2014, falling by 9.1 % year on year. This accounted for 9.3 % of the total financial expenditure, a decrease of 0.8 % from the previous year