What doomed China’s long-awaited real estate market reform plan? – The Diplomat

The 2022 National People’s Congress surprised many Chinese observers – not because of what happened, but because of what didn’t. The Chinese government has not approved a property tax. The government work report does not even mention the reform of the real estate market.

After the structural crisis of the real estate sector in 2021, the reform of the real estate market seems inevitable and the establishment of a property tax is the first step towards a reform of the real estate market. In an essay published in Qiushi, the official theoretical journal of the Communist Party of China, Supreme Leader Xi Jinping single a property tax as a flagship project of property market reform and vital to its “Common Prosperity” campaign. Following Xi’s trial, the National People’s Congress written and approved a decision to extend the property tax experiment. Finance Minister Liu Kun declared that the department must “prepare for experiments in property taxation”. As a result, a Chinese government insider confidently predicted that the central government will launch a property tax at the 2022 National People’s Congress.

In Xi’s eyes, the real estate market is the epitome of China’s unsustainable growth model. It almost supports 25 percent of Chinese GDP, a rate higher than that of Spain and Ireland before the eurozone crisis. Since housing market reform in the late 1990s, Chinese housing prices have risen so rapidly that a typical apartment in Beijing now costs 25 times the annual salary. Thus, high housing prices add a huge burden to the Chinese and suppress their consumption and innovation power.

Moreover, the collapse of Evergrande Group, one of China’s largest real estate developers, showed that the real estate sector could become a ticking time bomb for the Chinese economy. As a result, Xi has made real estate sector reform his primary focus for the Common Prosperity campaign, stating that “houses are made for living, not for speculating.”

The root causes of the distortion in China’s property markets are twofold. On the supply side, the 1994 reform of the tax system transferred tax money to central government without easing the burden on local governments. As a result, Chinese local governments cover more than 80% of all public spending while receiving only half of the tax money. Faced with local resistance, the then prime minister, Zhu Rongji, the engineer of this reform, reached an agreement with the localities which allowed them to increase their own government budget by any means. So, with Beijing’s acquiescence, local governments across China are using land sales as their main source of revenue and artificially keeping real estate prices high.

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On the demand side, a policy of financial repression that aims to benefit banks and state-owned enterprises deprives Chinese households of viable investment options. Thus, the Chinese middle class sees the booming housing market as the most profitable place to put their money. As one Chinese observer put it, only the housing market consistently generates positive returns for investors.

On paper, a property tax is a perfect solution to correct market distortion. This discourages people from looking at real estate as an investment tool and increases the budget of local governments. Accordingly, Xi entrusted Han Zheng, executive vice premier and potential successor to Premier Li Keqiang after the 20th Party Congress, with the task of rolling out a comprehensive property tax plan. However, Xi’s property tax plan has received negative comments from CCP elites and grassroots members; even senior retired party leaders have petitioned against the new tax. They Argue that since many party members own more than one property, the tax will add an unnecessary burden and become a problem of social stability.

Moreover, Xi’s ambitious goal of taming the real estate market does not align with the interests of local officials, who see economic growth, securing government budgets and preventing social chaos as their priorities. Shanghai executives have stressed that “stability” is the most important goal of their economic work in 2022. For them, the emphasis on stability means that the Shanghai government will bail out property developers to avoid a collapse in the market. estate market. An official said, “The price of real estate in Shanghai will never go down, just like the price of real estate in New York.” Another economic planner said the Shanghai government needs to increase infrastructure investment by 14 percent to compensate for the shrinking housing market.

However, Shanghai is unlikely to meet this target of increased infrastructure investment, as most of the infrastructure has already been built. Therefore, the government will support the housing market by freeing property developers from regulations on converting land rights, obtaining bank loans, selling houses and issuing bonds.

What is the rationale for this plan, which essentially undoes the debt reduction campaign of the past five years? After all, Xi has Express that GDP growth is no longer the sole indicator in executive assessments. The new five-year plan also abolished the annual GDP growth target in favor of slower but more balanced “quality” growth.

The Shanghai official admitted that the city had not been given an economic growth target by the central government. However, the executive also said the importance of economic performance is ingrained in the minds of officials as they suffer from comparisons with other local leaders. Generating higher GDP growth remains the best way for ambitious public servants to outperform their competing peers and secure promotion. This consideration could be especially true for Shanghai Party Secretary Li Qiang, a rising star in Chinese politics who aspires to run for the post of vice premier, or even a seat on the Politburo Standing Committee, in the 20th Party Congress this fall.

Moreover, the emphasis on stability prevailed over the urgency of reform. The central government’s working meeting on economic affairs in late 2021 moved away from Xi’s reluctance to create moral hazard by bailing out real estate giants. The meeting underline stability in the run-up to the 20th Party Congress and instructed local governments to prevent any economic crisis. Following the meeting, Chinese banks are ready to soften the “three red lines” to promote a soft landing for several real estate companies.

The complexity of China’s real estate market problem, which has accumulated over decades, is another challenge Xi faces. The current institutions are so intertwined that a step-by-step reform, which Beijing prefers to a drastic and comprehensive “shock therapy” reform, becomes impossible. An old Chinese saying sums up the current situation perfectly: “pulling a hair will make the whole body move” (牵一发动全身); changing a policy will lead to unintended social chaos.

Construction accounts for 16% of urban employment. MacroPolo, an internal think tank at the Paulson Institute, predicts that a collapse in the construction industry following a downturn in the housing market would cause 15 million people without work. The sudden rise in unemployment would certainly have an impact on social stability. In addition, Chinese banks have granted 30% of their loans for housing construction, and 60% of bank loans are backed by real estate as collateral. So, if the property market crashes, China will experience a financial crisis.

Thus, a property tax will conflict with other major social programs and create unintended social instability. It will increase, rather than reduce, social inequalities unless it is accompanied by a reform of the hukou (household registration). The hukou system institutionally separates city dwellers from migrant workers, who remain officially registered as residents of their rural hometowns. Thus, migrant workers cannot access social protection programs in cities, such as pensions, health care and education for their children. The purpose of a land tax is to provide an alternative source to finance social welfare programs so that local governments can move away from the traditional scheme of selling land for financing. There are 376 million urban migrant workers, and they will become major contributors to any property tax. Even those who cannot own homes in cities will pay property tax through higher rents. Without hukou reform, the property tax will force these migrant workers to pay for social services that they cannot benefit from. This could exacerbate conflicts between urban arrivals and former residents.

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Xi’s failure to reform the property market illustrates the challenges of his campaign for common prosperity. Xi sees the campaign as necessary not only to improve social equality, but also to rebuild China’s economy. Its main objective is to rebalance the Chinese economy from the current growth focused on investment and exports towards a more sustainable development model. The campaign is bound to meet resistance from special-interest groups, who fear the reforms could potentially harm them. Concern for social stability, which has been a dominant theme of the Xi administration, will also offset the urge to reform.

Xi once described the current stage of Chinese reform as “crack the bone after eating meatmeaning that his predecessors completed the easier parts of reform and left the difficult parts to him. Xi will certainly face enormous resistance and challenges, much like reformers throughout Chinese history. Whether he can push through that resistance is an open question.

Penny D. Jackson