Beyond the business tax cut

The suspension of VAT and turnover tax could benefit 6 million businesses, but steps should be taken to ensure they actually do

The business community has welcomed the suspension of value-added tax and turnover tax for small businesses with monthly sales of less than 20,000 yuan ($3,230) from Aug 1. The move was announced in a statement released after a State Council executive meeting, which was presided by Premier Li Keqiang, on July 24, and is another preferential tax policy to boost the development of small businesses.

The tax exemption is expected to benefit about 6 million small businesses and boost the employment and income prospects of more than 20 million people - and thus help stabilize the economy in transition. On the individual level, it can help a small business save between 600 and 1,000 yuan a month.

According to the Ministry of Finance, the tax exemption will amount to about 30 billion yuan, a small percentage of the total national tax revenue, which was about 10.6 trillion yuan last year. But despite that, it is expected to boost the morale of small businesses in times of economic downturn.

The impact of the global financial crisis has been slowing down the Chinese economy. Of course, China's GDP growth increased to 7.6 percent in the first half of 2013, which was excellent compared with other economies. But the fact is that the microeconomic situation in the country has worsened lately. In July, the HSBC Purchasing Manager's Index fell to an 11-month low of 47.7 from 48.2 in June. Disturbingly enough, the employment part of PMI dropped to 47.3 in July, the lowest since March 2009.

Perhaps that is why the market has taken the tax exemption to mean that the government will issue more favorable policies for private small and medium-sized enterprises.

That the central government has simultaneously taken measures to boost trade and further reform railway investment and financing means that, apart from using fiscal expenditure to stimulate the economy, the government is also trying to adjust the economic structure and promote more reforms to realize "steady economic growth".

The positive impact of this move could be seen both at the macroeconomic and microeconomic levels. Since SMEs contribute about 60 percent of China's industrial output and account for 80 percent of the jobs, the tax cut is crucial to employment promotion. For example, it will encourage more small startups and thus create more jobs. Also, the policy can lessen the stress of small businesses by reducing their tax burden and increasing liquidity in the market.

But we should not overestimate the impact of the policy, because much depends on its proper implementation. The government first needs to ensure that most of the about 6 million small businesses in the country are covered by and benefit from the policy.

The problem is the criteria applied to identify businesses that qualify for the tax exemption could prevent many small businesses from benefiting from the policy. Companies in the construction, transportation and real estate sectors that have - and more importantly, expected to have - monthly revenue of more than 20,000 yuan will not get any tax exemptions. So the actual number of beneficiary companies may be fewer than expected.

The government also has to determine how the policy would simulate small businesses. Since many small and micro businesses are run on such a modest scale that they are not subjected to paying corporate tax, they will not benefit from the tax exemption policy. To boost the real economy, therefore, the government should also reduce the individual income tax and capital gains tax - perhaps on the lines of the United States - and legislate a systematic preferential tax policy.

If the government wants to boost the development of small and micro businesses, it has to provide them with a good business environment and solve their urgent problems. Their biggest problem today is getting funds. Commercial banks and other financial institutions are reluctant to give them loans because they do not have enough mortgages. Although the tax exemption can solve part of small businesses' fund problem, they need more favorable policies to realize their true potential and innovative capabilities.

To permanently solve their fund problem, the government should take measures to standardize their business operations, which will encourage banks and financial institutions to increase their investment in small businesses. The government should also cultivate a multi-layered financing system, like giving more tax benefits to commercial banks that provide loans for small businesses, increasing loans with lower interest rates and guarantees, and expanding the bond financing and private equity base for small companies.

If the above measures are taken together with the tax cuts, they will build a thorough support system for small companies, which can then help boost the national economy. By giving small businesses the tax relief, the government has taken a welcome step to stabilize the economy. It should now use the policy's impact on the economy to implement further policy reforms.

The author is an associate professor in the School of Economics of Central University of Finance and Economics.