Abstract: The structural monetary policy instruments China adopted in recent years have improved the financing environment for SMEs. Going forward, the government should ensure that these instruments are set at a scale in line with monetary aggregate goal, target vulnerable areas that are strategically important, and are used in a flexible way. In terms of tax and fee cuts, the programs implemented so far did reduce the tax burden of SMEs, but didn’t generate a strong sense of gain. Preferential tax policies suitable for long-term implementation should be institutionalized and standardized, but local fiscal capacity must be also taken into account. The government should act only when market failures occur, and avoid policy misalignment in practice.
I. Structural Monetary Policy Instruments to Support SMEs
In recent years, the People’s Bank of China (PBC) has been actively exploring structural monetary policy instruments to bolster the development of small and micro businesses.
According to data of the recent two years, the financing environment for small and micro enterprises has improved. By the end of 2022, seven structural monetary policy instruments have been made available for small and micro businesses, with an outstanding balance of 2.8 trillion yuan, accounting for over 40% of all structural monetary policy instruments; the outstanding balance of inclusive lending to micro and small businesses grew by 23.8% year on year, 12.7 percentage points higher than the growth rate of other loan balances; a total of 56.52 million small and micro businesses received inclusive credit grants, up 26.8% year on year. China has mitigated the challenges facing small and micro enterprises in accessing cheap finance more effectively than many other countries.
Some experts have proposed three principles to guide the use of structural monetary policy instruments.
1. The scale should be reasonable and moderate.
The size of structural monetary policy instruments should be set in line with monetary aggregate target to avoid undermining the decisive role of market in allocating resources. At present, the outstanding balance of structural monetary policy instruments hovers around 15% in the balance sheet of the central bank, a proportion similar to the financing structure of many developed economies including the United States, Japan and the eurozone.
2. Support should be given to areas that need it most.
Structural monetary policy instruments should be limited to vulnerable areas that are strategically important for national economic development, such as inclusive finance, green development, and science and technological innovation. By establishing incentive-compatible mechanisms, structural monetary policy can encourage financial institutions to provide support to the above-mentioned sectors. In other areas, the decisive role of market in allocating resources should be upheld.
3. Structural monetary policy instruments should be used in a flexible way.
Phased structural monetary policy instruments may be required in different stages, cycles or environments of economic development. Timely evaluations of these instruments after their expiration and a sound withdrawal mechanism can help avoid excessive instruments being used at one time and thus prevent fragmented management and disorderly use of such instruments. Withdrawal should be gradual, with transitional arrangements in place to avoid sharp policy turns.
Some experts pointed out that regulators should moderately deregulate financial institutions, so that these institutions can and have the willingness to lend. A policy synergy between structural monetary policy and regulators has increased the amount of and expanded the coverage of financing for micro, small and medium-sized enterprises and reduced their financing. Nevertheless, the long-term use of certain quantitative assessments should be avoided so as to prevent deviation from the market-oriented direction.
Regulators need to moderately increase their tolerance to the ratio of non-performing loans which can constrain bank lending to SMEs. Banks are reluctant to lend because of complex factors. Policymakers should make coordinated arrangements to encourage inclusive finance without compromising the commercial sustainability of bank loans to enterprises. That’s also the reason why some experts suggested an extension of the VAT exemption of financial institutions’ interest revenues from SME loans.
In addition, the application of information technology such as fintech should be encouraged to alleviate "old problems" of the traditional financial market. Inadequate access to cheap finance is a long-standing constraint facing SMEs not only in China, but also worldwide.
Fintech and other information technologies can effectively reduce information asymmetry between the traditional financial market and SMEs and alleviate the associated credit risk problems, helping banks expand market space for inclusive financial services. Improper use of fintech may magnify the systemic risk. Nevertheless, we should still support, regulate and guide the use of fintech so that it can better serve the real economy.
II. Assessment of Tax and Fee Cuts for SMEs
In recent years, China's tax and fee reduction has been unprecedented in its scale and coverage.
One of CF40’s research projects, A Study on China’s Tax and Fee Cuts to Support SMEs Growth, systematically evaluates the effects of tax and fee reduction. The main findings are as follows:
1. Compared with countries at similar economic levels, China's macro tax burden is not high, but social security costs undertaken by enterprises are huge. VAT accounts for a heavy share of the burden, followed by social security contributions, while income tax makes up a relatively light share. Trend-wise, the share of social security contributions of SMEs in China has been fluctuating upward, that of VAT has overall decreased, and that of income tax has remained stable.
2. While tax and fee reduction did reduce the tax burden of enterprises, it didn’t generate a strong sense of gain. Although survey shows that over 70% of SMEs indicated a decrease of tax burden in 2020 compared with 2019 and 38% reported the decrease to be over 20%, the surveyed enterprises are not that satisfied with the tax and fee cuts, possibly because of market players’ sensitivity to income decline and the rather high burden of social security costs and other fees. Relatively to SMEs, large enterprises are more satisfied with the tax and fee cuts. In general, enterprises find discounted loans and labor cost subsidies to be more satisfying than tax and fee reductions.
3. The role of VAT tax reduction is limited in supporting economic growth. With the tax rate policy of discontinuous changes around the registration threshold for China's general taxpayers as an identification tool, the output elasticity of the service, industrial and wholesale and retail sector is respectively 0.543, 0.415 and 0.208. It is measured that the VAT tax was reduced by over 1 trillion yuan in 2019, promoting economic growth by 0.75%.
4. The income tax reduction policy effectively reduced the actual tax burden of SMEs and eased the financing constraints of enterprises. It is found that a 10% average decrease in corporate income tax can reduce the size of current enterprises liabilities by 16.6%, the proportion of current liabilities by 1.65 percentage points, interest expenses by 21.9% and financing costs by 16.9%. In other words, the income tax reduction policy did ease the financing constraints for enterprises, optimized the scale and structure of their debts, reduced their interest expenses and financing costs, and facilitated the high-quality development of SMEs.
Some experts suggested that preferential tax policies suitable for long-term implementation should be institutionalized and standardized to optimize tax and fee policies and provide stable expectations for SMEs. Specifically:
1. Further extend the 1% tax rate policy for small taxpayers. SMEs in general have reported the 1% tax rate for small taxpayers to be one of the most effective policies to reduce the tax burden of enterprises.
2. Reduce the social insurance costs of SMEs and increase the number of enterprises paying social insurance.
3. Further advance the reform of the VAT system from 3 tiers to 2 tiers. To merge 13% and 9% into one tier is the best option for adjustments, which can significantly improve social welfare.
4. Further optimize the policy of VAT credit refund with the central government underwriting all the VAT credit refunds and its share of VAT revenues raised from 50% to 55%.
5. Enhance tax audits to prevent illegal tax evasion behaviors among SMEs and prevent large enterprises from enjoying tax benefits targeting SMEs by registering multiple companies and disguising as SMEs.
6. Provide more preferential tax policies for high-tech SMEs which spend heavily on R&D to ease their financing constraints.
Some experts, however, pointed out that local fiscal capacity must be taken into account when making tax and fee reduction policies. A good reform can achieve its intended effects only if it’s well-timed. When local fiscal sustainability is challenged, local governments may not be very enthusiastic about tax and fee cuts.
III. Some Thoughts on Macro Policy Support for SMEs
First, from the perspective of government-market relationship, while macro policies are rolled out to support SMEs, the decisive role of market in resource allocation should be upheld.
The government should create a fair environment for competition by providing better laws, more predicable policies, and more stable institutions and only intervene to overcome market failures.
Second, avoid policy misalignment in practice. Here misalignment refers to the situation where the government acts to correct market failures arising from a faulty legal or policy system, but the actual policies are introduced into areas where the market should have played a decisive role. Such misalignment should also be taken into account when structural monetary policies and fiscal policies reducing taxes and fees are assessed.
This article is part of the CF40 Policy Brief, authored by Zhang Jingchu, CF40 research associate.
