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China is now actively discontinuing strategies to minimize taxes or outright avoid them. The party has announced and taken serious measures to restrict overseas income, offshore assets, and carefully crafted trusts that many Chinese citizens use to shield their money from taxes, as well as simply to shield their money from the government. The recent law enforcement actions have been so widespread and far-reaching that even HSBC shares have been hurt, as much of their business is conducted across the thinning border between Hong Kong and mainland China. At first glance, most economists and commentators point out that these repressions are somehow justified.
International tax evasion, especially by wealthy individuals, is obviously not a problem unique to China, but their motivations for combating it may be. These problems are not new, and they have been a pretty open secret for decades. So, while it's possible that the country is now correcting this injustice because it's only now becoming aware of it, it's still worth asking why it suddenly became a priority. So, how did China's tax system typically work in the past? What exactly are these repressions supposed to fix? And finally, why is this happening now? Support for this program comes from today's sponsor Sales Closer Technologies, a public company that builds infrastructure for generations, entrepreneurs have moved the
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constitute financial advice or a recommendation to buy, sell or hold any securities. Any forward-looking statements in this video are based on assumptions that may prove to be incorrect and should not be relied upon. Investing in small-cap companies involves significant risk, including the potential loss of some or all of your invested capital. Past performance is not an indicator of future results. Viewers should conduct their own due diligence and consult with a qualified financial professional before making any investment decision. Read the full information in our description. So China collects fewer taxes relative to the size of its
economy than almost any other major country on Earth, and it collects them from almost no one. In 2024, China's tax revenue as a share of GDP was only 7%, down from a historical high of just 10%. By comparison, US tax revenue is just under 11%, and even that stands out somewhat, as the OECD average is closer to 15%. So, paradoxically, a country ruled by the Communist Party collects proportionally much less than average. And it gets even stranger when you look at where this money actually comes from. Sales taxes generate the largest portion of China's tax revenue-39% of the total. Personal income tax, on the other hand, yields just over 8%. For comparison, again, in the United States, personal income taxes account for almost half of all federal
revenue. So, what's going on here? Well, to begin with, it's worth recognizing that a very large number of Chinese citizens are still relatively poor by the standards of developed countries. GDP per capita is now around $13,800, slightly below the $14,005 threshold that the World Bank uses to classify a country as a high- income country. China is almost crossing this line, but has not done so yet. This is great, but there is still a huge economic gap between coastal cities and rural areas, where much of the economic activity takes place informally. A small farm selling produce at a local market typically doesn't create a paper trail that the tax office can audit, and even if it did, searching for that paper trail would cost more
than the tax it collected. For the most part, the government has always been quite happy with this. These people don't have much in taxes anyway, and because services are so region-dependent, actual government assistance in many rural provinces lags far behind that high-end cities. Allowing people, especially farmers, to keep what little they have is usually a cheaper way to keep them happy. Even above that, for working-class people in proper formal positions, the income tax structure is so progressive, and the deductions so generous, that many people end up paying virtually nothing. This, again, is not necessarily a coincidence. The government is
intentionally pushing more and more people out of the tax base. Major reforms in 2018 raised the monthly tax-free threshold from 3,500 yuan to 5,000 yuan, and then added deductions for children's education, elderly care, mortgage interest, and rent. The estimated number of people paying any personal income tax at all has decreased from 187 million to about 64 million. In a country with a population of 1.4 billion, this is less than 5% of the population that bears the entire personal income tax base. And even most of those who technically contribute still don't pay very much. This is actually very similar to proposals being floated in the United States, where the bottom half of income taxpayers also contribute such a small share of total
revenue that there is a strong argument for not taxing them at all and saving both sides the paperwork. We're actually going to be publishing an article about this whole discussion and some of the ulterior motives behind it in our newsletter, so we don't want to get too carried away, but if you're interested, you can subscribe using the link in the description. If not, the parallels are still worth acknowledging. You might think that everything we've described so far sounds pretty reasonable. Poor people don't pay much in taxes, working people pay a little. The problem in China is that rich people also don't pay any taxes. On paper, China's top marginal tax bracket is 45%, and it amounts to about a quarter of a million US dollars. But in practice, very
wealthy Chinese have historically paid significantly less. This is partly due to the vast number of ways to convert salary income into something that is subject to lower taxes, by registering as a sole proprietorship in one of the low- tax development zones, routing commissions through a shell company, or writing a second contract that states a lower amount than what is actually paid. Again, this is not unique to China, but it happens often there. And part of the problem is that enforcement has been, to put it politely, uneven. Many economists and commentators have argued that this arrangement functions as something of a Faustian bargain, a way to keep a legal leash on wealthy people who would otherwise be very difficult to control.
Theoretically, they know they're circumventing the law, the government knows they're circumventing the law, but as long as everyone follows the rules, no one's looking too closely. However, if someone says something they shouldn't, or supports the wrong person, or becomes too visible, there is always the threat of a tax audit. And since essentially everyone at this level of wealth has something inappropriate on their tax returns, an audit is almost guaranteed to reveal something. Most people realize that this is at least partly political revenge, but also no one really feels sorry for wealthy tax cheats, so it has become a politically acceptable punishment. Of course, this is impossible to verify, but the pattern of celebrities and business people
running into trouble with the tax authorities shortly after a public mistake is well- documented enough to make it a genre of news in its own right. Actress Fan Bingbing has been ordered to pay an estimated $129 million in back taxes and penalties after being accused of double contracting while filming a film. Live streaming retailer Huang Wei was hit with about $210 million in back taxes and fines, and her accounts on all major platforms then disappeared within hours. These are also just the cases that made it into the news. For every Fan Bingbing, there were thousands of wealthy people who had never attracted such attention. Now, whatever the actual motivation for creating such a system, the result is that poor people don't pay taxes,
working class people don't pay taxes, and rich people don't pay taxes. So, if this scheme has worked this way so far, what exactly is being abolished? Well, the first thing to understand is that most of what has been implemented now was already illegal. Chinese citizens who are tax residents, meaning anyone who resides in China or is physically present for 183 days or more during a calendar year, have long been liable for tax on their worldwide income. Foreign dividends, capital gains abroad, rental income from an apartment in Vancouver - all of these are taxed, as a rule, at a flat rate of 20% with a credit for what they have already paid in the
country where the income comes from. Most wealthy Chinese citizens now qualify as tax residents and have overseas assets. The problem is that they simply never declared them, and they were never asked to do so, partly because the legal tools to combat undeclared foreign income did not yet exist. And that was a big problem for the trusts. Now, an offshore trust works by transferring your assets to a trustee, someone in Singapore or the British Virgin Islands, who becomes the legal owner. Your family still benefits as beneficiaries, but on paper, those assets are no longer yours, which has been the goal for a long time, as you can't tax what you don't own.
However, these recent changes mean that the tax authority can now directly verify legal ownership and ask who actually controls the assets and who actually benefits from them. If the answer was a wealthy resident of China, which was usually the case , then he now had to pay tax. Around the same time, China also signed up to the Single Reporting Standard and began automatically exchanging financial account data with other participating jurisdictions. More than 100 countries, including Singapore and Hong Kong, now provide each other with data on account balances, interest, dividends and sales revenue every year. So, for the better part of 7 years, Chinese tax authorities have been receiving detailed annual files on offshore accounts held by
their own residents. And what did they do with them? Well, for the most part they just sat on them until recently. Over the past few months, provincial governments have begun issuing enforcement notices residents who have not declared their overseas investment income, with late payment interest of 0.05% per day. It is impossible to verify 1.4 billion people, but verifying those few thousand whose names appear in a CRS file with a foreign brokerage account tied to it is possible, and it is cheap. At the same time, the anti-tax avoidance rule meant they could go after trusts and offshore holding companies regardless of what their technical ownership structure was on paper. Again, so far this all sounds great, to be honest. Even our own governments
could probably learn something from this. But it is also worth asking why China chose this particular moment to act. Well, part of the answer is that one of China's main revenue streams is drying up. At least for the past two decades, China has not actually had to pay regular taxes. He financed most of his operations simply by selling land leases. Almost all valuable urban land in China belongs to the state, while rural land belongs to rural collectives. So, local governments buy up rural land cheaply, repurpose it as urban construction land, and then auction it off for long-term lease to developers, usually for 70 years for housing construction. For a long time, it was an absolute never-ending money failure.
Land sales revenue peaked at around 8.7 trillion yuan, and in many cities it accounted for a third of all local government spending. It was also administratively simple. When selling a plot of land, there was only one very large check, rather than chasing the salaries of hundreds of millions of workers. But, as you all probably know, activity in the real estate market in China has slowed significantly in recent years due to the bankruptcies of major developers, which cut off this vital source of income. From a peak just four years ago, land sales revenue has now fallen by about 50% per year, representing a gross shortfall of nearly 4 trillion yuan, or about $530 billion, of money that the country now had to find elsewhere. The obvious solution would
be something like a permanent property tax. China has technically been running small pilot projects in Shanghai and Chongqing since 2011, but there are some problems with this. Selling land on a 70-year lease means the government is technically already taxing that land at a rate of 1.2%, but more immediately, taxing housing amid falling house prices is driving prices down even further, destabilizing this source of income, as well as what is still the majority of household wealth in the country. So they needed something different. Now the good news is that other parts of the Chinese economy are actually thriving. Last year, China had a trade surplus of about $1.2 trillion, the largest of any country in history, thanks to machinery, electronics, batteries and
vehicles. This is real income generated by real firms paying real people, which as a long-term tax base is much more sustainable than waiting for the real estate market to recover. There is also a demographic problem. China's population shrank in 2022 for the first time since 1961, and the city's main pension fund is projected to run out of reserves by around 2035. Beijing has since raised the retirement age and abolished national pension payments, which has pushed back the date, but it is also a tacit admission that this was a real problem. As the working-age population shrinks, the country needs a broader, more reliable tax base, and it needs to create it before the ratio worsens, not
after. This would already be enough to start collecting what is already provided for by law, but it would also be naive to rule out that part of this is only related to control. Controlling people's wealth is a very effective way to control people themselves. Someone whose money is in a Singapore trust or a Sydney apartment is somewhat more comfortable speaking out of turn, compromising, or simply walking away than someone whose entire net worth is within Chinese jurisdiction. This doesn't even necessarily have to extend to something as sinister as suppressing dissidents. It could be as mundane as making business owners more accountable for how their business is run by removing an escape hatch they could count on if they
deviate too far from plan. Realistically speaking, it's probably a little bit of both. China needs a new source of money and it wants control, but it will happily use the same policies to get both. Now, if you're interested in diving deeper into the other economic variables that define China right now, we've actually put together a good portion of all our work covering their fascinating economy, and you can click on it on your screen right now. Thanks for watching, friend. Goodbye.
