China Law Blog

Forbes Magazine just did an article on likely impacts of China's July 1, 2007, changes to its Value Added Tax (VAT). In a nutshell, China has reduced the rebates on VAT it gives to exporters, leading to a net raise in the VAT tax on exports. The increase in overall tax payments tends to be greatest for low added value, high energy, and high polluting goods. Some really high tech, high end products are actually getting a reduction in their overall VAT payments. The article is entitled "China Moves to Slow Exports" and it does an excellent job explaining the possible policy reasons for China's increasing its VAT and some of its possible possible repercussions.

The article starts out by describing the VAT increases as "the Chinese government ... tapping the brakes on its export industry. Quietly."

Wingfield sees the VAT change as "intended to let the air out of China's ballooning trade surplus with the rest of the world" and to "keep some of the country's scarce natural resources within its borders and to boost production in high-tech industries." Or, as I so pithily put it:

"They [the Chinese Government] don't want [China] to just sell low-end plastic toys, they want to sell biomedical devices," says Seattle lawyer Dan Harris, who specializes in China business issues.

John Frisbie, president of the U.S.-China Business Council foresees China's VAT changes will have only a "relatively minimal" effect on U.S. companies "because most U.S. producers in China sell to the Chinese market instead of exporting." He sees "some American companies [being] impacted, but that's a far smaller group than Chinese companies or other Asian companies that have moved their production to China."

I disagree with Mr. Frisbie and I think it is because we serve a different constituency. The U.S.-China Business has many huge American companies in its membership, including Motorola, ...These companies do sell into China. But, the bulk of my firm's clients are small and medium sized enterprises (SMEs) and they mostly manufacture in China for shipment to North America and to Europe.

The article asks why Beijing would want to reduce its export when those are "its economic cash cow" and then answers that "it doesn't." Wingfield notes that if the Chinese "government plays its cards right, that cow might just become a little more lucrative" as it is "designed to boost income for the government (though the value isn't known yet) and create better jobs, especially high-tech manufacturing jobs that produce value-added tax revenue--not low-cost textiles."

The rebate changes are aimed to "curb production of low-tech goods (like cheap plastic trinkets) by reducing the tax rebate for exporters more than 50% in many cases. For producers of many chemical and energy products, which reduce the country's scarce natural resources and harm the local environment, Beijing has completely eliminated the rebates to keep those goods in China." By reducing exports in these industries, "China alleviates some of its friction with manufacturers in the U.S. and Europe" without impacting the higher end production it so much wants to cultivate. This slashing of VAT rebates on exports also may reduce "some of the U.S. pressure on China to let the yuan appreciate relative to the dollar."

I again pipe in:

But don't think China is increasing costs to exporters just to appease the U.S. or other countries. Beijing could stand to make a lot of money from collecting the tax on which it is curbing refunds. In fact, Harris, the Seattle lawyer who has chronicled the issue on his "China Law Blog," speculates that "honest and legal" companies--particularly American and European ones--could be left holding the bag if Chinese exporters don't pay the tax, as he says is often the case.

And if prices on exports go up for American consumers, he says, that's "more money going into the coffers of the Chinese government."

My concern about the change in the VAT tracks my concerns regarding all Chinese taxes: they are paid primarily by law abiding foreign companies and because of this, they tend to increase the competitive advantage of Chinese companies. If a foreign company is paying a 17% tax on its exports from China and a Chinese company making the same product is paying only 5% or less, the Chinese company has right there gained a large cost advantage that should allow it to sell and export more products than its foreign competitor.

I would love to hear from anyone with information (or even a good feel for) regarding VAT collection efficiency with respect to foreign and Chinese companies.