Joining the Hands of Government and Society to Leverage the Role of Public Finance and Charity

Abstract

This chapter examines how China can collectively leverage the role of public finance and charity to promote common prosperity. China’s fiscal redistributive effect is not salient because of poor progressivity in taxation and the low level of spending on public services and transfers. In terms of the tax system, taxation is dominated by indirect taxes such as value-added tax (VAT), which is mainly levied on consumers. The corporate tax burden is also partly perceived as a burden on employees, so the effective tax rate for corporate owners is lower. Structural tax cuts both raise economic efficiency and help improve the redistribution of the tax system. To this end, China can reduce VAT, reform individual income tax rates on capital and labor income, and introduce a real estate tax while cutting taxes on property transactions. In terms of public expenditure, fiscal spending is biased towards economic development, with room for improvement in the input of public services and transfers targeting specific groups of people to promote both efficiency and fairness. China has a broad fiscal sector that includes state-owned enterprises (SOEs), land finance, and social insurance funds. SOEs should increase their dividends and allocations to the social security fund to provide for redistribution. As the aging population increases and GDP per capita grows, China’s social security levels should and can rise. The basic pension insurance system has two major challenges: Large urban–rural disparities and poor financial sustainability. More fiscal support should therefore be enacted, while parameters should be adjusted. To address the urban–rural disparity, financial resources can be used to revamp the basic pension scheme for rural and non-working residents and to establish a non-contributory minimum pension to provide basic protection for the poor elderly population. To address the issue of financial sustainability, the policy has improved the financial position of the basic pension scheme for urban employees through financial subsidies and transfer of state-owned assets, and fiscal policy can do more in the future. An important variable for parameter adjustment is the setting of the retirement age. At present, the retirement age in China is low, so delaying retirement would significantly improve the financial position of the pension system and reduce the intergenerational gap. This would also increase the total labor supply. The intensity of social giving to charity in China is low. The public’s perception of charity is limited, and charitable organizations operate inefficiently. The root causes of the problem include the unique origins of charity development in China, the current low level of economic development, the imperfect legal and regulatory systems for charity, and the lack of incentives such as taxation. Therefore, China may focus on long-term institutional development, guide social awareness, and encourage corporate social responsibility.

Authors: Yang Zhao, Sharon Xiaohui Wu, Lei Xu, Zhao Li, Huimin Wu, Dong Liang, Rong Dai, Wei Qi, Enduo Xu, Xiaoqing Yang. We are grateful to Professor Zheng Song, Department of Economics, Chinese University of Hong Kong, and Professor Yikai Wang, Department of Economics, University of Essex, for their research support and contribution to this chapter on the forecast model of the pension system.

The hand of the market determines the primary distribution of wealth according to the value of factors of production such as labor, capital, and land, but the outcome is often accompanied by a series of inequalities because of all the reasons described in previous chapters. In order to reduce inequality, two other “hands” are needed to correct for market outcomes. The first is the hand of the government, which is responsible for secondary distribution through the power of public finance, regulating disparities with public revenue such as taxes, and providing the public goods through government expenditure and social security. The other is the hand of society, which supplements the quasi-public goods not fully provided by government through the philanthropic actions of private organizations, individuals, and enterprises.¹ Market exchange is the use of private means to address private ends, taxation is the use of public means to address public ends, and philanthropy is the use of private means to achieve public ends, and it effectively add to both markets and government.²

This chapter examines how China can collectively leverage the role of public finance and charity to promote common prosperity. In China, the scope of fiscal instruments goes beyond the ordinary taxes and expenditures and covers SOEs, government-managed funds, and social insurance funds. Of these, government-managed funds are dominated by proceeds from the sale of state-owned land-use rights, which is discussed in Chap. 3. In addition to government revenues and expenditures, this chapter will focus on the pension system, an important component of the social security system which is of fundamental importance in safeguarding the well-being of the people.

7.1 Enhancing the Progressivity of China’s Tax Burden

7.1.1 Types and Incidence of Taxation in China

Taxation is not only a tool for drawing revenue, but also plays a role in institutional reform, social security, and equitable distribution. The position of China’s main taxes is shown in Fig. 7.1. The largest of these taxes is the VAT, which accounted for 36.8% of total tax revenue in 2020. If import VAT and consumption taxes are added, VAT and consumption taxes in China’s goods and services markets accounted for 54.0% of total tax revenue.³ The second largest tax in China is corporate income tax, which accounted for 23.6% of tax revenue in 2020, followed by individual income tax at 7.5% and taxes related to real estate transaction such as land value-added tax and deed tax, which together accounted for 12.8% (Fig. 7.2). These four tax categories accounted for over 90% of China’s total tax revenue in 2020.

Fig. 7.1

Source CICC Global Institute

Overview of China’s tax system within the macroeconomic context. Note Land related taxes include: increment tax on land value; stamp tax; land utilization taxes, and deed tax.

Fig. 7.2

Source National Bureau of Statistics, CICC Global Institute

Composition of domestic tax revenue (2020).

To understand the tax burden borne by different social groups, both the nominal taxpayer of the tax and where the tax incidence actually falls must be analyzed. Taxes can be shifted, so the actual bearer of the tax burden is not necessarily the nominal taxpayer. In China, VAT and consumption taxes account for more than half of the country’s total tax revenue, and a large proportion of this tax burden is borne by consumers, particularly low-income groups with high and inelastic demand for consumer staples. The effective tax burden of enterprises is affected by both VAT and corporate income tax, but the impact of changes in the tax rates of both varies depending on the industry. From the perspective of labor and capital, the two main factors of production, the former bears more of the tax burden. Employees bear the tax burden of VAT as the main consumers as well as part of the tax burden of corporate income tax as the provider of labor. In addition, the portion of China’s individual income tax from labor income far exceeds the portion from capital income. In 2019, 64% of individual income tax came from labor income (i.e., wages), which is borne by employees, and 28% of individual income tax came from property income, which is borne by capital owners. The remaining 7% of individual income tax came from business income, which is mainly paid by the self-employed (Fig. 7.3).

Fig. 7.3

Source China Taxation Yearbook 2020, CICC Global Institute

Sources of individual income tax in China.

In general, enterprises are the main nominal taxpayers in China, but employees bear a larger share of the actual tax burden. Although the majority of employees do not pay individual income tax directly and do not have the title of “taxpayer” because of their low monthly income, they actually bear a significant tax burden. At the same time, high-net-worth individuals in China have a relatively low tax burden (see Chap. 1). Apart from the VAT and consumption taxes borne by their consumption behavior, this group mainly pays for the property-related income component of individual income tax, the part of the corporate tax burden borne by capital (VAT and corporate income tax), and a portion of real estate-related taxes. The tax rate on property income individual income tax is a proportional one at 20%; in contrast, employees rely on salary income but have a marginal tax rate of up to 45%.

7.1.2 The Current Tax System Is Not Very Effective in Redistribution

The redistributive effect of public finance in China is low, and the difference between the Gini coefficient before and after tax and transfer payments is relatively small (Fig. 7.4). Two main factors determine the redistributive effect—namely, tax size (average tax rate) and progressivity. The tax size in China is not high. The ratio of tax revenue to GDP in China was 16% in 2019, compared with an average of 25% in OECD countries.⁴ China’s government’s budget covers government-managed funds, state-owned capital management, and social insurance funds, with the combined total government revenue to GDP ratio reaching 35%, compared with the OECD countries’ average of 33.4%.⁵ As a result, the main reason for China’s low tax redistributive effect is not the small tax size, but the low progressivity of the overall tax system (Table 7.1).

Fig. 7.4

Source SWIID, CICC Global Institute

Gini coefficients before and after tax and transfer payments in select countries (2019). Note The value of BRICS is the average of Brazil, Russia, India, and South Africa; data of Japan, South Africa, and Brazil are all from the latest available years.

Table 7.1 Redistributive effect of the overall tax system and individual income tax

The main reason for the low progressivity of taxation in China is that indirect taxes such as VAT account for a relatively high proportion of total revenue, while more progressive taxes such as individual income tax account for too low a share. VAT is mainly levied on consumption, and the higher propensity to consume among low-income groups makes the burden of VAT more heavily borne by low-income groups, resulting in VAT being regressive. Conversely, the scale of individual income tax is small (i.e., the low average tax rate shown in Table 7.1), making it difficult to play a redistributive role to offset the regressive nature of VAT. Apart from individual income tax, China also has fewer property taxes levied directly on individuals, which also affects the strength of the tax system in regulating income and wealth inequality.

Based on the above analysis, both cuts to and increases in the tax structure should be implemented to enhance the progressivity of taxation in China. In terms of tax cuts, VAT should be further reduced, especially on goods and services that are consumed more by low-income groups. In terms of tax increases, the government could raise individual income tax, especially those based on property income. At the same time, real estate tax, inheritance tax, and gift tax should be introduced to regulate the distribution of wealth.

7.1.3 Direction of Tax System Reform

7.1.3.1 Reducing VAT Rates Is a Prerequisite for Improving the Tax Structure

By reducing VAT, macroeconomic flows are automatically reflected in more corporate and personal income; in the absence of larger tax loopholes, the associated tax revenues will automatically increase. VAT occurs in the most basic of commodity transactions, and is collected at the same time that GDP is produced. Following the imposition of VAT, the income stream into a business becomes smaller, and thereafter, both business income and various personal incomes are correspondingly smaller. A reduction in the VAT rate would increase the flow of income into enterprises and households during the primary distribution. Conversely, without a reduction in the VAT rate, efforts to raise direct taxes would only lead to a larger tax burden.

When reforming the VAT, there is a need to accommodate low-income consumers by reducing the rates on some consumer staples more significantly, which would help alleviate the regressive nature of the VAT itself. Although China also applies low rates to consumer staples (9% for food, vegetable oil, edible salt, tap water, and heating, and 6% for education and healthcare in 2022), there is still room to reduce the rates when comparing the VAT rates of countries around the world such as Australia and France.¹²

7.1.3.2 Individual Income Tax Reform: Lower Marginal Tax Rates on Labor, Higher Tax Rates on Capital

Since individual income tax is the most progressive of all taxes, most of the efforts to improve fiscal redistribution have been geared towards increasing the proportion of individual income taxes, especially the individual income tax based on property proceeds (income from the transfer of property such as personal equity and property, and dividends, etc.). It is true that China’s individual income tax has a small tax base, with taxpayers accounting for only 15.3% of the working age population, far below the 50% or more of developed countries.¹³ This is mainly due to the fact that most individuals earn less than the threshold of exemption (see Chap. 1).

We suggest lowering the marginal tax rate on labor income and raising the rate on capital income. The highest marginal tax rate in China is 45% for wage income, compared with 37% in the US (in 2021) and on par with Germany, Japan, South Korea, and South Africa, but higher than most countries in the world.¹⁴ It is also much higher than the 20% proportional rate for property proceeds. The highest marginal tax rate of 45% on wages corresponds to a monthly taxable income of Rmb80,000 (or an annual taxable income of Rmb960,000), but income from property transactions, equity cash out, and dividends to major shareholders (which can amount to millions of dollars) are only taxed at 20%. Most of the property proceeds belong to high-net-worth individuals, but their tax rates are much lower. Therefore, the marginal tax rate on labor should be set lower than that on capital income in order to reduce income inequality.

7.1.3.3 Introduction of Real Estate Tax, Inheritance Tax, and Gift Tax

As Chap. 3 of this book argues, a real estate tax may help to make the overall tax system more progressive. In addition, inheritance and gift taxes reduce the solidification of intergenerational wealth and have been proven to promote equity of opportunity, while also promoting charitable giving and regulating the distribution of wealth.¹⁵ Leading economists such as Oliver Blanchard, Jean Tirole, and Joseph Stiglitz have argued that inheritance taxes are an important tool for promoting equity of opportunity and reducing the negative effects of capital accumulation. Inheritance and gift taxes are generally characterized by high exemptions, small size, and a relatively small share of total tax revenue, making up an average share of only 0.36% in OECD countries in 2019 and less than 0.8% in the most countries, with the highest being only 1.6% in South Korea.¹⁶ China could follow the example of OECD countries by setting a high exemption threshold at the onset. When the personal property registration system is established, we believe that inheritance tax will play a greater role.

7.2 Rationalizing the Structure of Government Expenditure: More Equality in Public Service and Transfer Payments

7.2.1 High Expenditure on Economic Affairs, but Low Expenditure on Public Services and Welfare

According to the IMF’s classification of government spending, China’s spending on economic affairs (including direct operations and indirect subsidies in agriculture, forestry, transport, communications, construction, minerals, energy, etc.) accounted for 23% of total expenditure in 2019 (Fig. 7.5), about twice as much as in the US. In the same year, the share of expenditure on economic affairs was about 7% in Germany and about 9% in Japan and the UK.

Fig. 7.5

Source IMF, CICC Global Institute; OECD, CICC Global Institute

Structure of government expenditure in China (left panel), and transportation infrastructure investment as a percentage of GDP (right panel) in 2019.

Specifically, China spent 7% of GDP on infrastructure development in 2019, much higher than OECD countries’ government investment at about 3.1% of GDP (including infrastructure and other fixed asset investments).¹⁷ In China, transportation accounts for the bulk of the government’s infrastructure investment, which according to OECD data, was 5.6% of GDP in 2018,¹⁸ also well above the general level in OECD countries (Fig. 7.5). China has already achieved a large degree of catch-up with developed countries in terms of infrastructure. The World Economic Forum’s Global Competitiveness Report 2019 shows that China ranks No. 36 in the world for overall quality of infrastructure, already ahead of developed countries such as Norway and New Zealand, and ranks as high as No. 2 and No. 10 regarding airport connectivity and road connectivity.

In contrast to infrastructure investment, China’s public service and welfare spending diverges widely from that of developed countries. On an IMF comparable basis, China’s education and healthcare spending account for 11% and 8% of total government expenditure respectively in 2019, compared with 15% and 19% in the US. In terms of social protection spending, China and the US spend almost the same proportion, but there is a considerable gap compared with European high welfare countries. For example, the share of social protection spending is 36% in the UK, 43% in France, and 44% in Denmark in 2019.

Overall, China’s fiscal spending is large on economic affairs but relatively inadequate on public services and targeted transfers to specific groups. To improve the structure of China’s fiscal spending, it is necessary to moderate government spending on economic affairs, which should be delegated more to the private sector. Fiscal spending should be directed more toward public services such as education and health care.

7.2.2 Transfer Payments Targeting Specific Groups of People

In addition to social insurance, the government’s transfer payments are mainly for social assistance, which is the provision of financial benefits to members of society who are in hardship so as to meet their most basic needs to survival and development. People receiving social assistance are usually selected by the government on the basis of low income and vulnerability criteria. Social assistance can be divided into cash transfers and in-kind assistance.¹⁹ The core of China’s social assistance system is the minimum living standard guarantee system (MLSGS), which is a no-strings-attached cash transfer program that provides cash subsidies to households whose per capita incomes fall below the low-income guarantee threshold.

China may expand coverage of MLSGS. A study shows that it has a good effect on poverty reduction in both urban and rural China [3].²⁰ The main problem with China’s MLSGS is the high rate of underinsurance, especially in rural areas.²¹ If the total budget for MLSGS in China is tripled, the poverty reduction effect as measured from different perspectives (i.e., breadth and depth of poverty, and inequality among the poor), would be substantially improved.²² Does the increase in the scope of the low-benefit scheme lead to laziness, or so-called “welfare dependency”? Scholars have argued that China’s MLSGS does not reduce the working hours of urban and rural beneficiaries, with no significant negative incentive.²³ Both real and potential welfare dependency can be addressed by improving institutional design and working methods, and should not be an obstacle to expanding coverage of the system.

Therefore, we believe the forms of social assistance can be expanded. In addition to the unconditional cash transfer of the MLSGS, there are many other forms of social assistance such as conditional cash transfers, fee waivers, non-monetary transfers, free school meals, and social pensions, among others. Compared with other developing countries, China’s means of transfer spending is still relatively homogeneous with more room for expansion.²⁴ In terms of increasing education spending, the government can also use conditional cash transfers (e.g., requiring beneficiaries to make commitments guaranteeing children’s enrollment and completion of schooling) that are conducive to human resource development.

7.3 Bringing in SOEs for Common Prosperity

After years of reform, China’s SOEs have gradually become dynamic market participants with significantly increased profitability. At the same time, a great deal of the social responsibilities previously borne by SOEs have been effectively divested. For the government, SOEs have been transformed from former burdens into beneficial assets and are pivotal to the Chinese economy. By the end of 2020, SOEs’ total assets were around Rmb592 trn, equivalent to nearly six times GDP, and net assets equaled about Rmb99 trn, close to GDP. The total assets and net assets of non-financial SOEs reached Rmb269 trn and Rmb76 trn²⁵). According to calculations by the Chinese Academy of Social Sciences, SOEs account for 35.8% and 14.6% of total assets and net assets of society as a whole.²⁶

Income from SOEs has become an important source of funding for public finance. In 2020, SOEs contributed Rmb4.6 trn in taxes, accounting for 34% of all tax revenue, making them an important source of public finance.²⁷ In addition to tax revenue, the proportion of state-owned capital operation paid to the treasury has continued to increase. Total state-owned capital operation accounts for between 2 and 4.5% of total government revenue,²⁸ with the proportion of state-owned capital operation going to the general public budget revenue rising from around 5% to 40 over the past decade.

Further increasing the distributional contribution of state-owned capital operation to total government revenue can be fulfilled in two ways. First, compared with local SOEs, there may be some room for central SOEs to allocate profits to state-owned capital operation. The proportion of profits allocated to local SOEs has been increasing year over year, reaching 20% by 2020, compared with 10% for central SOEs. Second, the proportion of cash dividends paid by SOEs needs to be significantly increased. The cash dividend distribution ratio of Chinese SOEs hovered around 16% between 2017 and 2020,²⁹ while the average dividend distribution ratio of A-share listed companies was above 35% for the same period.³⁰ In comparison, the proportion of dividends paid by SOEs is low. According to a World Bank report, the majority of SOEs in OECD countries pay dividends of more than 30%, with many countries paying more than 50%.³¹ According to China’s current regulations, most non-financial central enterprises are only required to contribute 15–20%, with the highest being China National Tobacco Corporation (CNTC) at 25%; all non-financial central enterprises have room for increases.³²

In addition, we believe considerable potential scope exists for state-owned capital to be added to the Social Security Fund (SSF). In 2017, China stipulated that the proportion of state-owned equity transferred to the SSF was a uniform 10%. Based on the disclosed Rmb99 trn of state-owned capital, if the 10% transfer is implemented, the SSF could hold up to Rmb10 trn of state-owned equity. The average ROE of state-owned enterprises was about 5.4% in 2020³³; if the cash dividend ratio of state-owned enterprises is raised to an average of 36% of A-shares, the SSF could receive an estimated annual cash inflow of Rmb180 bn, according to our analysis.

However, at the actual implementation level, the transfer of state-owned assets has been slow despite further room to increase the transfer ratio. The State-owned Assets Supervision and Administration Commission of the State Council released data in February 2021 showing that central SOEs completed the transfer of Rmb1.21 trn of state-owned capital as of end-2020. According to the state-owned equity of central SOEs that equaled up to Rmb40 trn in 2020 and given the 10% transfer ratio, the scale of the transfer should be approximately Rmb4 trn. Thus, the progress in transfer is slower than expected.

7.4 Social Security: Returning to Pay-As-You-Go, Improving Sustainability, and Enhancing the Redistributive Effect

7.4.1 Fundamentals of China’s Social Security System

China’s social insurance system currently consists of four subsystems—pension scheme, medical insurance, unemployment insurance, and work-related injury insurance. The basic pension scheme for urban employees and the basic pension scheme for rural and non-working urban residents are the most important subsystems; they constitute the first pillar of China’s pension system, accounting for 69.5% of total social security fund expenditures in 2020. Basic medical insurance ranks second in terms of SSF expenditures, accounting for approximately 26.8%. Unemployment insurance and work injury insurance account for a very small proportion of total social security expenditures (Fig. 7.6).

Fig. 7.6

Source Li and ZhengFootnote

Li and Zheng [11].

: “China Statistic Yearbook, China Labor Yearbook”, CICC Global Institute. Wind, CICC Global Institute. Note Social security level is spending as a percentage of GDP

Expenditure structure of China’s social security system and spending as a percentage of GDP in 2020. [11]

Social security receipts and payments constitute a mechanism for redistribution. In European countries, 80% of the reduction in income inequality results from the role of the social security system.³⁵ Since pensions and healthcare account for the majority of social security receipts and payments, social security mainly acts as an intergenerational transfer. Of course, social security systems also affect the distribution of income between different income groups and act as redistributive agents within the same generation.

The ratio of China’s social security expenditure to GDP (known as the “social security level”) has been increasing in line with economic development, from 1% in 1989 to around 11% in 2019 (Fig. 7.6). However, compared with the average social security level of around 20% in 2019 in OECD countries, China still has a gap. Nearly half of this gap is due to differences in the degree of aging. According to World Bank demographic data, the proportion of China’s population over 65 years old was 11.97% in 2020, compared with 17.46% in OECD countries (equivalent to 1.5 times that of China). At present, China’s private sector, fund-based pensions are still in their infancy, and the country mainly depends on the basic pension insurance system which makes up 5.4% of fiscal expenditures—a significant gap with the OECD average (Fig. 7.7). As the population ages and GDP per capita continues to grow, there is still demand and scope for improving China’s social security levels, in our opinion.

Fig. 7.7

Source OECD, “Society at a Glance (2019)”, Ministry of Human Resources and Social Security, CICC Research

Public pension expenditure as a share of GDP in China is lower than the OECD average level. Note China’s data is from 2020, and data for others is from the latest available years or 2017.

7.4.2 Core Issues of the Basic Pension Insurance System

China’s basic pension insurance system faces two primary challenges: The intra-generational gap and the inter-generational gap. The former is reflected in the high individual differences in pension benefits as well as urban–rural and regional disparities. The latter is reflected in the financial unsustainability of the system. As the population ages, there is a risk that the pension balance will be depleted and might not meet the retirement needs of the future population.

7.4.2.1 The Problem of Intra-generational Disparities: Large Urban–Rural and Regional Differences

The basic pension insurance system differs between urban and rural areas, widening the income gap between them. Urban residents generally participate in the basic pension scheme for urban employees (BPSUE), while rural residents mainly participate in the basic pension scheme for rural and non-working urban residents (BPSRNUR). The replacement rate of the BPSRNUR is only 12%, much lower than that of the BPSUE at 56%; thus, there is a risk of further magnifying the difference in pensions between urban and rural residents (Fig. 7.8). Against the backdrop of the current exodus of young people to cities, the aging of the rural population, and the intensification of “empty nest” among traditional rural families, it is increasingly difficult for pension income to cover the basic needs of rural residents, in our opinion.

Fig. 7.8

Source Ministry of Human Resources and Social Security, Wind, CICC Research

Rural income levels and pension replacement rates are much lower than those in urban areas, resulting in significant differences between urban and rural pensions. Note Since the rural population has no wage income, the rural replacement rate is calculated using the rural per capita pension divided by the rural per capita disposable income. Urban employees’ pension expenditure and rural residents’ pension expenditure are calculated by dividing the total expenditure of BPSUE and BPSRNUR by the covered retired population.

In addition, the number of people who used to be migrant workers in China reached as high as 286 mn in 2020, including 170 mn who work outside their hometowns. Although migrant workers live in cities, there is a large gap in the level of their pension protection compared with urban residents. Migrant workers generally lack protection of stable jobs, resulting in a relatively low willingness to make individual contributions to the pension systems. According to the Ministry of Human Resources and Social Security, only about 21.6% of migrant workers participated in the BPSUE in 2017. Furthermore, the differences in contribution bases, contribution rates, and participation benefits for basic pension insurance between regions, as well as the problem of transferring pension accounts across regions, have severely affected the pension benefits of migrant workers.

There are large differences across provinces and regions in China in terms of economic development level and population age structure. With the gradual increase in the level of pension coordination (especially after the introduction of the central adjustment system in 2018), the social pooling account has played an obvious role in regulating the differences in pensions between regions; however, the pension gap between different regions remains wide. The per capita pension level in the eastern region, represented by Beijing and Shanghai, is much higher than that in the central and western regions. The replacement rate in the central and western regions, which are relatively economically underdeveloped, has fallen more sharply in recent years. This may mean that the redistributive ability of pensions to regulate the primary distribution between regions is decreasing.

China’s basic old-age insurance covered 92% of people aged 20 and above as of the end of 2020,³⁶ with BPSUE mainly covering those employed in urban areas and BPSRNUR mainly covering non-working urban and rural residents who do not meet the conditions for urban employment insurance coverage. For the remaining 8% of the population not covered by basic pension insurance, the old-age allowance system and the MLSGS can play a role in covering the bottom line. The former covers about 3.6% of the population and the latter about 4.5%, but there is some overlap with the population covered by the basic pension security system. Thus, a few groups continue to lack basic insurance (Table 7.2).

Table 7.2 The pension and social security system of China

7.4.2.2 The Problem of Intergenerational Differences: Future Pension Reserves May Be Depleted

According to the 7th National Census, the percentage of China’s population aged 65 and over rose by 4.63% between 2010 and 2020, reaching 13.50%. The aging of the population has led to a year-over-year increase in the old-age dependency ratio.³⁷ The current old-age dependency ratio of 18.5% is lower than the OECD average (30.4%), but it is likely to rise to nearly 50% in 2050 and rise further to 60% in 2080 (Fig. 7.9), gradually approaching the OECD average. Thus, we believe the burden of old-age support will increase significantly in the future.

Fig. 7.9

Source UN World Population Prospects (2019), CICC Research

China’s aging population continues to grow; the old-age dependency ratio likely will approach the OECD average level.

China’s basic pension insurance system is nominally organized in the form of “combination of accounts”, consisting of social pooling accounts and individual accounts. However, because of the intergenerational pressure on pension payments during the policy change process of pension institution and the historically low level of pooling, it is difficult to realize the potential of individual accounts, and the actual operation of pensions is similar to a pay-as-you-go system. Within the current parameters of the system, as the population ages and the proportion of the working population declines in the future, China’s basic pension system may face financial unsustainability. In fact, the problem of financial sustainability has already manifested itself in recent years, evidenced by revenues from BPSUE beginning to fall short of fund expenditures in 2014 (Fig. 7.10). In order to maintain the fund’s normal operations, government subsidies at all levels have been increasing year over year. Nevertheless, a shortfall of nearly Rmb700 bn was recorded in 2020 even with government subsidies, and the cumulative fund balance fell for the first time. Regarding the BPSRNUR, only individual accounts are funded by contributions, while pooling accounts are funded by the government, so the income from contributions has been always lower than expenditure since its inception (Fig. 7.10).

Fig. 7.10

Source Ministry of Human Resources and Social Security, CICC Research

The cumulative balance of BPSUE (left panel) fell for the first time in 2020, and the collection income of BPSRNUR (right panel) is always lower than the fund expenditure.

The total size of China’s basic pension reserves in 2020 reached about Rmb8.5 trn, of which the cumulative balance of BPSUE equaled Rmb4.8 trn. According to Zheng (2019),³⁸ the deficit of BPSUE will continue to expand and the cumulative balance may be depleted in the future. At the provincial level, differences in the level of economic development, the financial capacity of local governments, and the age structure of the population have led to an uneven regional distribution of pension burdens and fund balance levels. China’s eastern regions generally have more abundant pension reserves, while the northeastern, central, and western regions are under greater pressure. To ensure timely and full payment of pensions, national pooling of BPSUE was introduced from 2022 onwards, which we expect will alleviate regional financial pressure. However, we believe the national financial pressure will require further institutional reform. If the current institutional arrangements remain unchanged, there is a risk that future pension balances will be depleted and may not be able to fully cover future pensions, in our opinion.

7.4.3 External Adjustment: Fiscal Support Is Key

We believe fiscal support and parameter adjustments are key to solving the current problems of China’s basic pension system. In this section, we discuss financial support, referred to as “external adjustment” because it involves the mobilization of resources from outside to support pensions. In the next section, we address “internal adjustment”, which involves changing the structure of China’s pension system and its parameters.

7.4.3.1 Establishing an Ex Gratia Non-contributory Minimum Pension Through Public Finance

The problem of intra-generational disparity in China’s pension system and the disproportionately low incomes of the elderly population in rural and remote areas is a top priority in the current reform of the pension system, which requires clear institutional arrangements to meet the basic needs of the low-income retired population. Considering this group generally lacks the ability to contribute and, thus, is difficult to be covered by contributory pensions, public financial support is a more feasible way forward. Overseas experience shows that the financial cost of non-contributory pensions is relatively low.³⁹

Although China has not formally established a non-contributory pension system, the BPSRNUR already exhibits some functions of a non-contributory pension. BPSRNUR covers mainly the rural population, and also some of the urban population who are not covered by BPSUE. The pooling account of BPSRNUR is funded by government subsidies instead of participants’ contributions (Fig. 7.11). One possible idea for reform is to structure the BPSRNUR pooling account as the minimum non-contributory pension, while integrating the individual account with the individual account of BPSUE or even the fund-based pension account of the private sector to supplement the basic pension.

Fig. 7.11

Source Wind, Ministry of Human Resources and Social Security, CICC Research

The BPSRNUR pension is lower than the rural poverty line; the fiscal subsidy makes up a large proportion of its total revenue. Note The rural poverty line in 2020 is estimated from the data disclosed by the State Council Leading Group Office of Poverty Alleviation and Development.

At present, the BPSRNUR cannot yet afford the target positioning of a non-contributory minimum pension because the benefit is low and the coverage is not yet comprehensive. The average benefit level of BPSRNUR is only 52.2% of the rural poverty line (Fig. 7.11), which is equivalent to 5.2% of the average level of BPSUE, and the rate of pension growth is also slow. Considering that around 8% of China’s population was not covered by the basic pension system in 2020, BPSRNUR is far from meeting the social minimum pension standard in terms of coverage. We propose to significantly increase its benefit level and accelerate the coverage rate. According to our calculations, if BPSRNUR were to be extended to cover all urban and rural residents without contributory pensions and if the pension replacement rate were to be increased to 45%, assuming all costs are borne by the government, this would have corresponded to a per capita pension guarantee of Rmb7709 per year in 2020, and the ratio of expenditure to GDP would have been approximately 1.22%. China’s fiscal expenditure on the pension system is currently only 5.4% of GDP, compared with the OECD average of 7.7%; thus, China can afford the fiscal cost of a non-contributory minimum pension.

7.4.3.2 Enlarging State Support to Improve the Financial Sustainability of BPSUE

We suggest that the government improve the financial situation of BPSUE by mobilizing resources from outside the pension system. Currently, as fiscal subsidies for the pension system account for less than 4% of China’s total fiscal expenditure and the average annual growth rate of the subsidies is slowing, there is ample room for fiscal support for pensions. There are two main options for implementation of financial support for the pension system—namely, direct financial subsidies and the transfer of state-owned assets, of which the latter has already been discussed in the previous section.

Among the OECD countries that have adopted direct financial subsidies for their pension systems, six countries provide financial underwriting for social insurance, while the rest clearly define the scope and criteria for financial subsidies. In contrast, China has not yet institutionalized financial subsidies for BPSUE, and the division of the share between the central and local governments is not clear. From 2009 to 2015, the proportion of central government subsidies to its total expenditure rose to 5.19% from 3.40%, while the proportion of local subsidies to local expenditure fell to 0.28% from 0.97%. Due to the large inter-provincial disparity in the operation of BPSUE, the unclear division of powers and responsibilities could easily lead to a heavier financial burden for some economically underdeveloped provinces, and even impact local finances. Therefore, while increasing the overall financial subsidies, a clear and institutionalized set of criteria and planning for calculating financial subsidies needs to be formulated according to the financial condition of each province and the operating situation of pensions so as to improve the transparency and stability of the financial subsidy system.

To estimate the fiscal cost, we use the population model constructed by Song et al. (2015)⁴⁰ to calculate the demographic changes between urban and rural areas from 2020 to 2050 (Fig. 7.12). Assuming that the contribution and replacement rates for BPSUE remain unchanged and the adjustment of the statutory retirement age is introduced in 2023, the size of the financial subsidy and the financial cost of BPSUE are calculated. The model shows that between 2020 and 2050, the fiscal subsidy will increase from 1.1 to 3.2% of GDP, and the fiscal cost (fiscal subsidy + total pension contributions) will increase from 5.1 to 11.2% of GDP (Fig. 7.12). In addition to BPSUE, if BPSRNUR were to be extended to cover all retirees not covered by contributory pensions and the replacement rate of BPSRNUR were increased to 45% (completely funded by the government), the state’s fiscal subsidy would rise to 4.5% of GDP in 2050 and the share of pension expenditure would rise to 12.5% of GDP.

Fig. 7.12

Source Song et al., Ministry of Human Resources and Social Security, Wind, CICC Research

Demographic models predict an accelerated rise in China’s old-age population over the next 30 years, along with a decline in the working-age population and a rising share of GDP of financial subsidies to BPSUE. [18]

7.4.3.3 Fiscal Support Promotes Both Equity and Efficiency

Given that fiscal funding comes from government taxation, increased fiscal expenditure on the pension system will require the state to issue bonds for fundraising, which may be accompanied by an increase in future tax rates. Taxation generally distorts economic incentives and reduces future generations’ welfare, leading to a reduction in total social welfare and economic efficiency. However, in China’s current context, we believe that fiscal expansion to support the pension system may not reduce efficiency but rather increase it because it may reduce macro imbalances and avoid the inefficient savings trap.

Theoretically, increased savings provide capital to support economic construction and are conducive to economic growth. However, excessive expansion of savings and capital may reduce the efficiency of capital use, resulting in inefficient savings and even asset bubbles, which in turn undermine economic growth. China’s average personal savings rate is close to 50%, higher than overseas levels, and has a long-term upward trend. The figure is already above the optimal savings rate level mentioned in most academic articles, and the return on investment has declined. As a result, fiscal subsidies to the pension system will increase social consumption and reduce aggregate savings, which would improve macro imbalances and increase long-term aggregate economic output.

7.4.4 Internal Adjustment: Revision to Retirement Age Is the Focus

The parameters of the BPSUE need to be adjusted as soon as possible, in our view, with the establishment of the statutory retirement age an important variable. An important reference for setting the statutory retirement age is life expectancy, which is significantly correlated with the level of income (GDP per capita) of the population. As China’s per capita income rises in the future, life expectancy is expected to increase, creating the conditions for an adjustment to the statutory retirement age. At present, the statutory retirement age in China is 60 years for men, 55 years for female government employees, and 50 years for female employees, which is lower than the overseas average. In addition, the minimum contribution period is 15 years, which is also short compared with overseas standards.

Delaying the statutory retirement age would have a significant effect on the financial sustainability of the pension system by reducing the number of retirees and, hence, pension costs, while enlarging the working population and expanding pension income. We have modelled the impact of adjusting the retirement age on the financial position of BPSUE, assuming a policy adjustment interval of 2023–2037. Compared with the current institution as is forecasted, delaying the retirement age could significantly postpone the emergence of the financial gap of BPSUE by about 20 years, cumulatively reducing it by 70% before 2050 (Fig. 7.13). Our calculation is consistent with that of Zheng (2019).⁴¹ At the same time, it would allow the post-60s and post-70s generations who have enjoyed the dividend of economic reforms since 1978 and more social resources to take on more responsibility, which would also have a positive effect on promoting inter-generational equity. We note that while adjusting the retirement age can significantly ease the pressure on pension revenues and expenditures, it cannot completely solve the problem of financial sustainability, so fiscal support is equally important for future reforms.

Fig. 7.13

Source Ministry of Human Resources and Social Security, Wind, CICC Research

Postponement of retirement age could postpone the emergence of a financial gap of BPSUE by about 20 years, and reduce the gap cumulatively by about 70% by 2050.

There may be greater resistance to the implementation of other internal adjustment options for the pension system. First, on the income side, increasing the contribution rate puts greater pressure on workers and enterprises and significantly reduces social efficiency. Second, on the expenditure side, lowering the replacement rate and reducing the benefit to the elderly could easily give rise to social problems. Third, China’s pay-as-you-go pension system is already too large and the cost of switching is too high to make privatization of the fund system a viable reform. Moreover, after privatization, the government would shift the responsibility and risk to individuals, which could lead to a decline in pension coverage and a widening of the income gap, deviating from the goal of common prosperity. Moreover, the current rate of return on investment of private sector fund-based pensions in China is low.

7.5 Exploring the Path of Public Charity with Chinese Characteristics

7.5.1 Three Major Challenges for Public Charity in China

7.5.1.1 Challenge 1: Low Intensity and Willingness for Social Giving

Compared with most countries around the world, the intensity of social giving in China is still relatively low. In terms of flow, the scale of social giving in China equaled approximately Rmb152 bn in 2020, with a giving intensity of only 0.15%, far lower than the US at 2.1%, the UK at 1.7%, and Japan at 0.3%.⁴² In terms of stock, the net asset size of China’s charity organizations in 2018 was Rmb159.2 bn, accounting for only 0.17% of GDP, again significantly lower than that of the US, UK, and Japan. Corporate contributions are most prominent in China’s total social giving, accounting for 61.7% of the total. In contrast, Europe and the US rely more on contributions from individuals and charities, and Japan has relatively balanced contribution from individuals and corporations (Fig. 7.14).

Fig. 7.14

Source Annual Report of China’s Philanthropy Development, Giving USA, Philanthropy Services AG, Coutts, CSMAR, China Securities Regulatory Commission, Giving in numbers, CICC Global Institute

Structure of social giving in China—corporations account for a higher proportion, but there is still room to improve the intensity of their giving. Note The data for US real estate in the right panel is missing.

The lack of willingness of both corporates and individuals is the essential reason for the low intensity of giving in China, in our opinion. On the one hand, when evaluating corporate giving, although Chinese companies make a large contribution to total social giving, the average share of social expenditure (in pre-tax profits) by industry is significantly lower than that in the US. Even for the industries such as real estate and public utilities with high giving intensity, their share of giving expenditure (pre-tax profits) is only 1.1 and 0.6%, far lower than the level of around 2% for US utility firms (Fig. 7.14). The willingness to give by individuals is also generally low. According to the Charity Aid Foundation (CAF), the proportion of the general public participating in charity in China was only 11% in 2018, lower than the levels of 71%, 61%, and 23% in the UK, the US, and Japan, respectively. The China Household Tracking Survey (CFPS) also reveals that the proportion of household income spent on giving by Chinese households was 0.17%, on average, much lower than the US level of around 3.56%.⁴³

7.5.1.2 Challenge 2: Limitations in Public Perception of Charity

The general public’s perception of public charity largely determines the scale and use of social giving, further influencing the function and role of public charity. One indication of the focus of China’s social giving is the extent to which charitable action is equated with poverty alleviation and relief. Overall, in terms of direction of flow, compared with the UK, the US, and Japan, China’s donation mainly flows into education, poverty alleviation, and relief (Table 7.3). For example, in 2020, 70.4% of the expenditure of the China Education Development Foundation was used to directly support students in need, while 24.3% was allocated for hardware improvements. The general public subconsciously sees relief as an important anchor point for philanthropy. For example, on China’s highly visible “99 Charity Day” in 2020, 41% of donations were directed to social services, 29% to sickness, and 18% to education, totaling nearly 90% of charitable contributions.⁴⁴ Compared with a similar “Giving Tuesday” in the US, donations go more towards social services, education, health, arts and culture, the environment, and animal protection, areas that are relatively more fragmented and diverse. Consequently, the positive side of philanthropy in China is that the results are relatively equitable. For example, the economically disadvantaged western regions are clearly receiving more support from social giving.⁴⁵ But we note that too much focus is upon providing basic public services, and we should also pay more attention to the actual changes that donations make.

Table 7.3 China’s philanthropy funding flows more to education and poverty alleviation; comparison with select countries

7.5.1.3 Challenge 3: Inefficient Operation of Charitable Organizations

Charities act as the main body deploying charitable resources, and their operational efficiency directly determines the function and effectiveness of public charity. Charities that are more open, transparent, and efficiently run can further stimulate the public’s willingness to be charitable. However, due to the lack of liquidation and exit mechanisms, charitable organizations are not active enough, and the level of information disclosure is very low, in our opinion. Moreover, the financial operations of Chinese charitable foundations are also less efficient. According to the Hauser Institute for Civil Society, Chinese charitable foundations spend a sizable 32.9% of their total asset size on charity in 2020,⁴⁶ which is among the highest in the world. Higher liquidity needs also further constrain the investment choices of foundations, which are mostly based on low-risk, low-return investments whose yields generally concentrate at the level of demand deposit rates (0.35%), a low rate of return that constrains their long-term sustainability.

7.5.2 Factors Affecting the Development of Public Charity in China and Possible Solutions

First, China has a unique background of charity development. In the early days of philanthropy in China, government-run charities largely played an important role. To this day, systemic foundations (such as the Red Cross Foundation) are still the core force in China’s philanthropic sector, which may to some extent diminish the willingness of the social sector to participate. In addition, some instances of malfeasance in the past may also undermine public confidence in charitable giving and constrain the overall development of philanthropy. Moreover, compared with Europe and the US, Chinese charity employees are not paid enough, making it difficult to attract top talent for better development of the sector.

Second, China is still transitioning toward a middle-class society. Global experience shows that the intensity of giving rises along with income levels, and a solid economic base provides a guarantee for the development of public charity. China’s GDP per capita has just passed the US$10,000 threshold, indicating a gap between China and developed countries with high donation intensity. At the same time, Chinese society still faces the contradiction of unbalanced and inadequate development, and the proportion of low-income people who do not have the ability to give remains high. A survey completed by Peking University and other universities also shows that “not having enough money to donate” is the number one reason why the public believes they do not give.⁴⁷ The affluent have higher expectations on their assets in terms of security, appreciation, and value creation, and place lower priority on legacy and philanthropy.

Third, China’s charity infrastructure (legal system and regulation) is developing. The regulatory ideology of the Charity Law is still dominated by traditional regulation, focusing on the verification of the identity of organizations and the management of the normative nature of their operations. The law lacks regulation of their behavior and functions, and does not provide effective guidance for their development. In addition, the rating and assessment system for charitable organizations is superficial and lacking in transparency, standardization, and scientific rigor.

Fourth, incentives for social giving such as well-designed taxation is lacking. China’s taxation system is based on indirect tax, supplemented by income tax, which differs from the tax structure of other countries. Even in light of income tax, China’s tax incentives for philanthropy are inadequate. Not only is the tax deduction limit for individuals low (30%), but donations in excess of the tax deduction limit are not allowed to be deducted in subsequent years. Apart from this, China has not yet introduced inheritance tax or property tax, so the wealthy lack sufficient incentives to make large-scale charitable donations. China has not yet established a clear system for volunteer leave, making it difficult for working employees to fully participate in philanthropic activities.

Looking to the future, how can common prosperity be promoted through public charity with Chinese characteristics? First, the development of public charity is a long-term process and requires institutional development to fundamentally create an ecology conducive to the development of public charity and improve multi-level incentive mechanisms, rather than focusing on short-term mass production or setting donation targets. Second, it is important to guide social awareness, expand the connotation of public charity, learn from European and US experiences, and encourage public charity to play an active role in areas such as technological innovation and social development. Third, based on China’s predominantly corporate donation structure at this stage, China can encourage companies to establish more efficient and diverse CSR institutional arrangements, considering their own business characteristics. Finally, against the backdrop of the rapid development of the digital economy, we believe that the orderly development of new charitable models such as internet giving is conducive to increasing the ease of making charitable contributions and will encourage the public’s willingness to participate in public charity.