0.22 Savings, taxation and the private sector  (Page 5/5)

Another look at household savings in china

For example, we have earlier discussed some of the reasons why the savings rate in China was so high from 1990-2015. We have seen that high business savings (retained earnings) has been part of the answer. But, household savings have been huge, as Chinese gross savings hovered near 50%. Net savings (gross saving – depreciation) was around 40% - and households have been saving about 25% of their income. Why? In addition to the previous 12 factors cited earlier, we may also look to the MBA and Friedman life cycle savings hypothesis.

In the MBA hypothesis, consider b1, the parameter for productivity growth, and therefore income growth. Perhaps Chinese households have saved so much is because their incomes have grown so fast. The Friedman permanent income hypothesis also sheds some light on the matter.

Have most Chinese been treating their very rapid income growth as transitory income? Has income been growing so fast that peoples consumption habits haven’t caught up? Did Chinese households believe that GDP growth would eventually slow down? That would lead them to save more.

The MBA hypothesis may provide yet another for high savings rates in China. There has been a drastic fall in the dependency ratio due to the one child per family policy. Economic theory has long held that a fall in the dependency ratio would lend to a rise in savings rates because with fewer dependents to support a family can save more.

The Nobel Laureate A.K. Sen cites the possibility of a “million missing women” in China from 1990-2010. See Chapter ____________ Perhaps China’s rising sex ratio imbalance is contributing to high savings rates – “too many boys” relative to girls at birth, due to strong son preference and frequent abortions of girls. This sex ratio imbalance may have caused Chinese households to postpone consumption (i.e. save), so as to accumulate wealth – Why? With a shortage of females, some men may face a future of long-term bachelorhood. So the hypothesis goes, families hope to avoid the risk that sons will be perpetual bachelors, and this will increase their savings rates.

Higher wealth for sons, it is hypothesized make sons more attractive to increasingly scarce brides. Also households with daughters do not reduce their savings rate. Empirical studies at NBER confirm that this effect is stronger in rural areas, where son preference is stronger than in urban areas. See Chapter ____________ According to one study by Wei and Zhong, the increase in the male/female sex ratio accounts for half of recent increases in household savings in China. Not everyone would agree that this effect is so large, but it is worth considering.

Business savings

We may now expand our discussion on business savings.

Recall, business savings is of 2 types:

1. Retained earnings of corporations,
2. Savings from income of partnerships and single partnership.

The second component of business savings is already counted in household savings and should not be double- counted .

Corporate savings proper are retained earnings of corporations, as defined below. We begin with GROSS INCOME. Then we subtract three items to find retained earnings.

• Expenses (including depreciation) Net income
• Corporation Taxes After tax income
• Dividends (if any)

=Retained Earnings

Retained earnings in many nations, including poor ones, has sometimes the most important service of private savings. In 21st century China, retained earnings of State-Owned Enterprises (SOEs) have very important source of saving (see Chapter 13).

Clearly, taxes on corporate income decreases retained earnings in the private sector. A major reason for worldwide tax reform 1981-2001 in both rich and poor nations was the desire to increase private savings by allowing for more retained earnings and thus more private sector savings. Virtually every nation that instituted major tax returns in that period reduced corporate tax rates.

In some cases, corporate tax rates were reduced from 60% to 15%. More usually the reduction was from 50% to 20-25%. In a world of highly mobile capital, so many other countries reduced corporate tax rates that the U.S. by 2014 had the highest corporate tax rates in the developed world. And the U.S. rate is higher (35%) than all but a small handful of poor nations.

Chile is one example of a country that sharply reduced corporate tax rates in the 80s. In 1984, this nation reduced corporate tax from 50% to 10% . Subsequently, and as a result, empirical studies show, there was in Chile:

1. An immediate large increase in business savings, because with lower corporate-tax rates, retained earnings increased,
2. A very large increase in private investment, actually an investment boom.

In first year after the slashing of Chilean tax rates from 50% to 10%, investments grew by 4.5%. And the increase over the next five years was even more impressive. The ratio of investment to GDP in 1984 was only 15%. Hardly enough to sustain growth at even 2% year. By 1989 this ratio had increased to 25%, sufficient to support economic growth at 7-8% year.

The Chilean experience was repeated in Indonesia in 1984-1990 and in several former socialist nations after breakup of the Soviet Bloc after 1991 (Latvia, Estonia and Lithuania).

We now turn to a consideration of major analytical questions in relation to taxation, savings and capital formation.