Abstract

     Numerous countries cut payroll taxes in response to COVID-19, including China, which reduced employer contributions by up to 21 percentage points. We use administrative data on more than 800,000 Chinese firms to evaluate payroll tax cuts as a business relief measure. We estimate that the tax cuts cover 31.5% of the decline in business cash flow, but labor informality causes 53% of registered firms-24% of aggregate economic activity-to receive no benefits at all. We quantify the targeting of the policy in terms of how much benefits flow to small firms less able to access external finance and to sectors worse hit by COVID-19. We find that (1) small firms and vulnerable industries are comparatively more labor intensive, which leads to desirable targeting; (2) labor informality worsens, but does not eliminate, targeting by firm size; and (3) labor informality is uncorrelated with the COVID-19 shock, and therefore does not affect targeting by sector.

Policy background

     In the mid- to late-1990s, China adopted a mandatory “pay-as-you-go” pension system, Basic Old Age Insurance (BOAI), for employed persons funded mainly through employer contributions (see Fang and Feng (2018) for a history of pension programs in China). Likewise, in the early 2000s, a medical insurance (MI) program for employed persons was established, also funded by payroll taxes (Huang, 2020). These two programs are the largest components of the SI system. As of 2019, the nationally prescribed employer contribution rate for BOAI and MI was 16 and 8% of wages, respectively. BOAI and MI also require employee-side contributions-8 and 2%-which are recorded in notional individual accounts that are efectively pay-as-you-go.

Discussion and conclusion

     Many advanced economies responded to the COVID economic shock with fscal policies unprecedented in both scale and form. In comparison, China’s response to COVID by way of additional spending and foregone revenue is moderate as a proportion of its GDP and more typical for developing countries.28 Its payroll tax cuts amounted to about 1.68% of 2020 GDP, whereas in the USA the Paycheck Protection Program alone delivered government support equal to 4.55% of 2020 GDP.29 China’s choice of policy instrument was also conservative: instead of launching novel spending programs, it temporarily reduced rates under an existing tax.