Zhongtong Finance and Economics App learned that Huatai Securities released a research report stating that the consumption tax reform may focus on adjusting the taxation range and tax rate, moving the collection point as appropriate, moderately lowering income distribution, or marginally relieving local fiscal deficits. However, the macro impact may be relatively mild. Among them, the shift in the collection point will bring a more obvious indirect "markup" effect to varieties with a large price difference between ex-factory price and retail and wholesale price. In addition, the consumption tax, in addition to being an important source of fiscal revenue, also bears the function of compensating externalities and regulating income distribution, and may affect some industry distribution, reshape the industry competition pattern, and also help adjust local government incentives and change the situation where local governments have emphasized production over consumption in the past.

Here are the main points of HuaTai Securities:

Current Status of China's Consumption Tax Levy

According to data from the Ministry of Finance, China's total consumption tax revenue in 2023 was 1.6 trillion yuan, accounting for about 8.9% of the national tax revenue and 1.3% of the nominal GDP, making it the fourth largest tax category in China after value-added tax, corporate income tax, value-added tax, and import links. China's consumption tax is an "in-price tax", including 15 product categories. The main revenue comes from four tax categories: tobacco (with revenue of 75.1 billion yuan in 2023, accounting for 53% of consumption tax), finished oil (33%), automobile manufacturing (7%), and alcohol (5%). Currently, consumption tax revenue belongs entirely to the central government and is mainly levied in the production link in the form of an "in-price tax", which is a 'hidden tax' for consumers. In 2023, China's domestic consumption tax revenue was 1.61 trillion yuan, accounting for about 8.9% of the national tax revenue and 1.3% of the national GDP.

From the perspective of categories, since the tax-sharing reform in 1994, consumption tax items have undergone multiple adjustments and gradually evolved into 15 items. The main contributors are tobacco, finished oil, small cars, and alcoholic beverages. Specifically, the tax serves three purposes: first, to restrict consumption demand for 'harmful' products, such as tobacco, alcohol, firecrackers, fireworks, etc.; second, to regulate income distribution by imposing taxation on luxury goods and high-end products, thus raising the tax burden of the high-income group, such as precious jewelry and jade, cosmetics, high-end watches, golf clubs and balls, yachts, etc.; third, to regulate the economic externality of consumer goods and consumption behavior by imposing taxes on polluting and resource-based products, such as motorcycles, cars, solid wood flooring, wooden disposable chopsticks, finished oil, paint, batteries, etc.

The current consumption tax collection is mainly at the production link, and is a tax exclusively enjoyed by the central government. Except for gold, silver, platinum, and diamond jewelry, which are levied at the retail level, cigarettes are levied at both the production and wholesale levels, and super-luxury cars are levied at both the production and retail levels, while other product categories are levied at the production link.

Consumption Tax Reform: Categories and Tax Rates

Compared with the world, increasing the tax rate of some products and sharing it between the central and local governments may be the key direction of future reforms. As for the taxable categories, further expansion of China's consumption tax may be limited, but among the main categories, the tax rates on tobacco, alcohol, and finished oil are relatively low compared with major countries in the world. However, considering the overall policy orientation of encouraging consumption, the potential increase in tax rates may be relatively limited. Compared internationally, China's consumption tax has a wide range of taxable categories, with products other than tobacco, finished oil, automobiles, and alcoholic beverages contributing less than 2%. Further expansion may have less effect on increasing tax revenue but may have a negative impact on consumption demand.

However, compared to the international level, China's overall tax rates for tobacco, alcoholic beverages, and finished oil are relatively low, according to WHO statistics. As of 2021, the ratio of tobacco tax to total retail price in China is about 54%, higher than the 40% and 39% of the United States and Vietnam, but significantly lower than the EU countries (60% or more), South Korea (74%), Saudi Arabia (74%), Japan (61%), and India (58%). Taking spirits as an example, China's consumption tax on alcoholic beverages accounts for 16.3% of retail price, slightly higher than Japan (16.2%) and Brazil (9.2%), but significantly lower than Finland (66.8%), Australia (56.5%), and the United Kingdom (47.2%), and South Korea (43.1%). According to OECD statistics, as of 2022, gasoline taxes in European countries such as Sweden, France, and Italy accounted for as much as 67% to 76% of retail prices, whereas the estimated consumption tax rate for gasoline per liter in China for 92-octane gasoline is about 25.1%, higher than the 14.1% of the United States, but lower than most other developed countries.

The Potential Impact of Consumption Tax Reform

According to the experiences of other countries, consumer taxes have become a supplementary source of income for some local governments, such as those in the USA, France, Japan, and South Korea, where the consumer tax is shared by the central and local governments. Under the background of declining local government income from land sales and local governments' financial pressure, the levy of the consumption tax in China may partially move to the later stages of the product life cycle, which could marginally supplement local government income. Based on international experience, the US and France share the consumption tax with the central and local governments. According to IMF statistics, the percentage of local government income sharing in 2022 was 65% and 37% respectively. Meanwhile, Japan and South Korea, which are also in the East Asia region, have 28% and 14% of consumption tax revenue sharing respectively.

The consumption tax levy in later stages of the product life cycle may have to consider the feasibility and incentive effect on local governments. It is highly unlikely that the sharing between the central and local governments would be executed by a specific ratio. However, it might be categorized by different stages of consumer products, or even specific categories of consumer goods. On October 9, 2019, the State Council issued the "Implementation Plan for Further Adjusting the Division of Central and Local Government Revenue after Implementing Larger-scale Tax Cuts and Fee Reductions", proposing reforms to the consumption tax: 1) gradually shift part of the existing consumption tax levied in the production (import) phase to the wholesale or retail phase. 2) Steadily shift down tax sources to local governments, guide local governments to improve the consumption environment.

HTSC believes that, with manageable tax regulations in place, some consumer taxes for certain goods could partially move to the wholesale/retail stage, and a certain proportion could be allocated to local governments to increase their revenue. However, application of the plan at the implementation level varies. It is harder to collect taxes from production than flow stage, and the effects of the tax reform need to be comprehensively evaluated. The thought process and focus for tax reforms may differ for different consumer goods categories. For the top four target categories, the following are discussed:

Alcohol (accounting for about 5% of all consumption tax revenue in 2023): some can be shifted to the wholesale stage for taxation, while retail level levies are more complicated. At present, the alcohol industry's consumption tax is basically levied at the production stage. In the short term, it is difficult for the alcohol industry to move the consumption tax collection to the retail stage, especially for the numerous and dispersed retail terminal enterprises. However, local governments may have the enthusiasm to start collecting at the external wholesale stage from dealers with limited quantity and low difficulty of management.

Tobacco (accounting for about 53% of the consumption tax revenue): it is possible to move the tax levy stage to the wholesale stage, or even further, the proportion of local tax revenue may rise. As a monopolized product, the tobacco industry is uniformly managed by the state from the production, sales, and import and export sectors forming a closed circuit to some extent. If the levy stage were to move back, with little difficulty in management and tax loss, the levy of taxes on tobacco could be shifted to the wholesale stage, and the proportions of revenue allocation between the central and local governments could be adjusted. For example, in Yunnan, the GDP ranked 18th in China, while the consumption tax revenue ranking reached fourth in 2023. With the levy stage shift, the concentration of consumption tax revenue in the production stage may be marginally relieved, and the proportion of local taxation will increase.

Autos (accounting for about 7% of the consumption tax revenue) has the conditions and motivations to postpone tax collection and share with local taxes. The automobile circulation system is short, and there are relatively clear vehicle registration management norms in different regions. Control in the retail stage is relatively easy and can effectively reduce the cost of levies. Therefore, it is relatively easy for the automobile industry to move the consumption tax levy stage back. Currently, the consumption tax of super deluxe cars has been added at the retail level. In addition, if the local government can obtain more revenue from the increased sales of automobiles, it will also be beneficial to the local government to improve infrastructure and the vehicle environment.

Oil products (accounting for about 33% of the consumption tax revenue): there is a certain difficulty in the short term for the move of levy stage to the retail side, which is mainly undertaken by local petrol stations, which are relatively scattered, but over time, after improving the tax infrastructure, it could slowly become more qualified for retail levy.

Potential impacts of the consumption tax reform.

The consumption tax reform may focus on adjusting the scope and rate of taxation, shifting levy stages, moderately shifting down tax sources, or marginally easing local fiscal shortfall, but the macro-level impact may be rather mild. With the weakening of the real estate cycle, local government income related to land sales has declined in the past two years. For example, in 2023, state-own land transfer income declined by 33.4% compared to 2021, and land-related tax revenue decreased by 17% compared to 2021. Compared with the scale of land transfer income, the incentive of the consumption tax to supplement local government income in the short term may be relatively limited. In 2021, the land use rights transfer income for local governments reached 8.5 trillion yuan, while the move of consumption tax to lower local sources could have limited growth and may not be sufficient to offset the drag of land sales on local government finances.

The move of levy stage will have a more pronounced indirect 'price hike' effect on goods with a relatively large price difference between the ex-factory price, distribution, wholesale and retail prices. Previously, consumption tax was levied in the production phase and advance tax payment was required. The move of the levy stage will help reduce the occupation of corporate operating funds, but commodity prices will gradually rise during production, circulation, and retail stages, thereby potentially increasing levy and collection costs. The increase in the costs of operation and sales channels might bring pressures to increase the terminal prices. Therefore, the short-term benefits of the manufacturers may be lower due to the increase of tax, which will suppress consumer demand, especially for goods with large price differences between the terminal and ex-factory prices, and the 'tax increase' effect may be more pronounced.

In addition, in addition to being an important source of fiscal revenue, consumption tax also plays the role of compensating for externalities and regulating income distribution. It cannot be ruled out that it will affect the industrial distribution of some industries and reshape the industry's competitive landscape. It can also help adjust local government incentives and change the previous situation where local governments emphasized production over consumption. For example, increasing the tax rate on finished oil or allocating a portion of the automobile consumption tax to local governments may help improve infrastructure and the car ownership environment in various regions, thus eliminating some inefficient restrictions on driving and car purchases.

Taking liquor as an example, the implementation of the consumption tax based on volume in 2001 has promoted the industry's transformation towards a more high-end market. However, if the tax rate on liquor is adjusted and the taxation point is moved downstream, it may have a relatively smaller impact on sub-categories with a small price difference between factory and wholesale/retail. Admittedly, high-end liquor brands with limited supply and high scarcity may have a higher premium and better ability to pass on the burden of the consumption tax, so the direct impact of the consumption tax reform on them may be relatively small (but may be greatly affected by macroeconomic environment changes).

Take gasoline and automobile purchase tax as an example again: if the tax rate on gasoline is increased or the new energy vehicles are marginally boosted by the tax reform, and at the same time, the taxation on automobiles at the consumption end is partially shifted downwards, it can help local governments optimize transportation-related infrastructure and policies such as traffic restrictions. This will also tilt the marginal focus of development from production to consumption and public services.

At present, the direct taxes related to the automobile industry include consumption tax, value-added tax, purchase tax, and vehicle and vessel tax. In 2021, the four taxes combined amount to about 62.59 billion yuan, of which vehicle purchase tax accounts for more than 50% and consumption tax accounts for about 16%, of which both are fully owned by the central government. The local governments only own 19% (some value-added tax and all vehicle and vessel tax). Considering that automobiles have a significant external effect in the sales process (such as air pollution and traffic congestion), if a larger proportion of this tax revenue is tilted towards local governments, it may be conducive to optimizing transportation-related infrastructure and policies such as traffic restrictions, especially in economically developed regions with a concentrated population.

Risk Warning: The progress of fiscal and taxation policy reforms may not meet expectations, and household consumption may decline more than expected.