China’s Future is Dependent on This

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Aha!

That was my reaction after I saw an important report catch my eye this morning.

The rest of the news seemed unimportant, and, even worse, uninteresting.

Often the most important stories are the most obscure.

Today’s Profit Watch delves into one that we can guarantee no one else will even think about, let alone cover.

It’s to do with China’s tax system.

Please! No yawning.

This has huge implications.

What happens here will decide if China develops sustainably or if it continues to march towards the biggest property boom…and bust…of all time.

Read on to find out why…

Reuters reports [1] that a senior Chinese lawmaker has said that individual cities within China will be able to set their own property taxes.

A bit of background helps here.

For years, the central government in Beijing has mooted plans to install a property tax across the country.

I’ve read stories about it on and off for years.

These plans never seem to go anywhere.  

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Perhaps now is the time?

You see, for years China has tried to address several problems that could be solved through property charges.

A lot of social spending, for example, is the responsibility of local governments in China.

But they have few direct sources of revenue to fund any of it.

For a long time they relied on land sales — or bank loans secured against rising land values — to fund social services.

These methods have a natural limit.

A regular tax on property would give these local governments a sustainable and consistent source of revenue.

It would also discourage the Chinese passion for buying multiple apartments and leaving them empty. They hold them purely for a capital gain, and price out their fellow citizens.

You can’t blame them. Chinese investors have limited options to invest their money, because of capital controls.

And the culture of China is highly geared toward real estate.

Some real estate owners have enjoyed years of capital appreciation. In fact, for the supremely lucky, they have ridden one of the biggest wealth transfers in history.

It’s hard to believe, but all Chinese housing was state owned as little as around two and a half decades ago.

By 2003 it was privatised.

Some urban households were able to buy their apartments off the state incredibly cheaply — and then watched a decade-long housing boom take off. The result windfall was spectacular.

Those guys got lucky. Young Chinese today are shut out of the real estate market in major cities much more so than Australians.

It’s this biting inequality and need for revenue that drives the consistent push for the central government to install a property tax.

Reuters adds…

Beijing may be accelerating the process now as it just pledged to slash trillions in taxes and fees to spur growth in the economy, and as it enters the third year of its war on property speculation.’

This would be a very good development for China. But I’m not convinced it will happen…

The lesson of Greece

Naturally, the home owning class in China will resist it. We can assume the top honchos in the Communist Party are huge landlords themselves.

A property tax is very efficient — but also very difficult to avoid — hence why it’s hated so much.

You might be surprised to know that one reason the current Greek governing party, Syriza, was elected was because it promised to abolish a property tax installed during the Greek debt crisis.

The IMF recommended this to flush out revenue from the Greek rich, who, apparently, shifted half the economy to bank accounts in Switzerland and considered avoiding tax, a point of national pride [2].

The Greeks voted for Syriza in droves.

I don’t expect China’s society to be any less self-serving. Why do we care?

At some point in the future, unless China takes the heat of the property market, it’s going to develop a massive real estate bubble.

As more wealth is generated inside China, more of it will keeping pouring into real estate.

Consider the cultural setting: no one inside China will have any experience of major property downturn.

The old only knew the days of state ownership and no market for property at all. The young will have only seen prices go one way for years — up.

If the Chinese tax system keeps providing a free lunch in real estate, people will keep chasing it. They’ll use credit created by the banking system to do it.

Credit created for asset purchases are non-productive and eventually leads to major busts — see Greece again.

That’s what’s building inside China. The only way to stop it is to take away the incentive to speculate in real estate.

I know what I expect to happen. The only question is when.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

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