Dynamic CGE Model of the Chinese Economy for Fiscal and Financial Policy Analysis

Abstract

China is to become the largest economy in the world by 2020 according to the IMF forecasts. Annual growth rates of output remained around 9.3 percent on average during 1980 to 2015. It was made possible by the accumulation capital with steady flows of investment on average around 49.5 percent of GDP, increase in the human capital index from 1.8 to 2.6 in the country that has the largest population among all countries. Current account surplus stood around 3.4 percent of GDP. Such growth rates were possible due to macroeconomic stability. Market friendly growth strategy however has led to a sharp increase in the income and consumption inequality. Inequality is deeper in the rural areas than in the urban areas. A representative household in the richest quintile earns eight times more than an average household in poorest quintile. This is five times more in urban areas. The Gini coefficient was around 0.48. By this measure China has become the most unequal economy in the world. Similar disparities remain across provinces of China; per capita income of Tianjin was 99,600 Yuan compared to 22,921 Yuan of Guizhou. Chinese government has used public spending to create economic infrastructure and public services. The share of public spending and revenue has reached around 30 percent of GDP in China in recent years. Share of local government has risen steadily over years from 53 percent to 86 percent in 2013. Efficiency in the local governance thus is essential for correcting economic and social problems in China. VAT, corporation tax, business tax, consumption tax and income tax and tariffs are important sources of revenue. In 2013, these contributed to 26, 20, 16, 7, 6 and 2 percents of total revenue respectively. Compared to advance countries Chinese tax system still seems very regressive as the income tax contributes to the very small proportion of the total revenue. It is welcome to see that the share of VAT decreased from 36 to 26 percent and tax in corporate income tax rose from eight to 20 percent but the very low income tax that accounts about 6 percent of total revenue, has caused income inequality to deteriorate. The adverse consequences of tax composition are to some extent mitigated by a more reasonable structure of public spending. Education, social safety, agriculture, public services, community, transport and health had 18, 12, 11, 11, 10 seven and 7 percent of public spending respectively.