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How Can China Cut Taxes And Maintain Low Budget Deficits

Mar. 12 2019 — The Chinese government plans major tax cuts for 2019. At the same time, government leaders at last week's annual National People's Congress (NPC) affirmed the country's longstanding commitment to low budget deficits. S&P Global Ratings believe these goals will not be reconciled without substantial cuts to spending.

In short, we expect the economic impact of tax cuts will likely be smaller than headline figures suggest. By our forecasts, tax cuts could amount to Chinese renminbi RMB1.5 trillion (US$223 billion) in 2019. This would be higher than last year's RMB1.3 trillion reduction. However, our estimate is below the RMB2 trillion figure targeted during last week's NPC session.

Moreover, we believe a substantial portion of the tax cuts will have to be financed by curbing expenditure if the government is to meet its fiscal deficit target of 2.8% of GDP. We estimate that potential spending will need to be cut by around RMB680 billion, including possible restraints on growth in infrastructure budgets.

Our estimates already consider a planned RMB800 billion increase in special bond issuance, in line with official targets. The special bond program also aims to compensate for less-aggressive off-budget borrowing by local government financing vehicles (LGFVs), a policy stance pushed by the central government.

If China's tax cuts are smaller than headline figures suggest, the direction of the stimulus still indicates an important shift in fiscal philosophy. We also believe the budget shows government wariness of relying on stimulus measures backed by non-transparent credit creation. The government's credit metrics are more likely to remain stable, or improve, if it continues to prefer more transparent means of providing support to the economy in times of need. In this article, we answer key questions on the execution of this fiscal journey.

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