Economic slowdown crimps tax collections, key sources of funds for governments

Fiscal revenue growth decelerated at a quicker-than-expected pace during the first two months of this year, adding to China's economic woes.

Fiscal revenue rose 3.2 percent to 2.57 trillion yuan ($407.94 billion) in the first two months of the year, data released by the Ministry of Finance showed on Monday. Income at the central government level dropped by 1.7 percent.

Starting this year, China converted 11 funds, previously managed as "special-purpose governmental funds", to the general budget. Excluding the increase in income items, the actual fiscal revenue rose just 1.7 percent.

The fiscal revenue growth rate this year is far less than the 8.6 percent gain in fiscal income seen in 2014, which was already the slowest growth rate since 1994. The sharp decline in revenue growth has cast a dimmer outlook on the economy and put the government's ability to achieve an "around 7 percent" annual GDP growth in doubt.

The fall in government revenue growth coincided with other key economic data released last week, when industrial production slowed to 6.8 percent year-on-year in January and February, down from 7.9 percent in December. Fixed-asset investment fell to 13.9 percent while retail sales growth slowed to 10.7 percent. Electricity consumption in February dipped by 6.3 percent.

A major contributor to the slowdown is the downturn in the property market and related investment, which is also reflected in the tax data. Deed tax collected from property sales slumped 12.5 percent from a year ago, while land appreciation tax declined by 8.7 percent. Both the taxes are local government's major revenue sources.

What is worse, land sale revenue, a critical source of funding for local governments, posted a whopping 36.2 percent contraction－compared with a 3.2 percent growth last year.

Unlike Western countries, indirect tax, or taxes levied at the production sector, accounts for nearly two-thirds of tax revenue in China. This makes the rise and fall in revenue susceptible to industrial economy, particularly the producer price index. The PPI, a key gauge for factory-gate prices, has declined for 37 consecutive months.

"The sharp deceleration in fiscal revenue also reveals the growing deflationary risks," said a report by investment bank China International Capital Corp. The CICC said in its report that normally the revenue growth is a proximate of the nominal GDP. The decoupling could mean GDP deflator－a broad measure of inflation－probably declined: which means China is not on the verge of deflation, but in actual deflation.

Despite the deceleration in income, economists noted that expenditure growth accelerated, in an apparent attempt to counter the slowdown. Expenditure in the first two months grew 9.5 percent, faster than the 8.2 percent expansion last year. In particular, spending on transportation jumped a whopping 52.5 percent.

The foundering economy prompted a range of institutions to expect further monetary easing. China Securities Co Ltd even expects a reserve requirement ratio cut as early as this week.