By Chan Kung and Junhui Chu*
To stimulate domestic consumption and boost economy in most countries, capital investments like bonds are heavily used to promote domestic demands. Meanwhile, real estate development has been made the main “engine” to drive economic growth in an attempt to boost investment and urbanization. The fact of the matter, however, is that none of these methods have brought sustained and healthy economic growth. There is nothing wrong with promoting consumption, but from the perspective of the consumer market, the middle class holds the greatest purchasing power.
In the United States, people with an annual household income of US$ 30,000 to US$ 200,000 are considered middle class. It is estimated that about 80% of Americans are middle class. This group of people spend money in the market for goods and services, and the money spent will eventually become tax revenue for the government which is then utilized to improve education and other public services to uphold social health and infrastructure.
These days, public policies in most cities do not pay enough attention to the middle class, who happens to be the majority group, which led to the gradual shrink in the class size. Take the U.S. for an example. The marginal tax rate paid by the average middle class in the United States is about 15% or 25%. The richer middle class may pay a 35% marginal tax. However, because the tax rate of investment income does not exceed 15%, the actual tax rate bore by many rich people who mainly rely on investment for profit is much lower than the middle class.
In 2018, the total tax revenue of the U.S. government was US$ 6.3 trillion, and nearly one-third of that amount came from personal income taxes. These taxes were contributed by middle-class families instead of the wealthy. In 2010, Warren Buffet found that he had received a tax bill of US $693.744 million in the previous year. “That was a huge amount of money, but the tax I paid only accounted for 17.4% of taxable income, which is still lower than the other 20 employees in my office.” Warren Buffet said that his employees’ tax ranges from 33% to 41%, with an average of 36%. Hence, he called on the Obama administration to raise taxes on rich people like him. To him, he found that the low personal income tax on the rich did not positively impact the market and only served to widen the wealth inequality between the rich and poor thereby leading to an eventual urban crisis that is fatal to the urban economy.
In the documentary Inequality for All featuring Clinton administration’s Secretary of Labor Robert Richie, it was stated that middle-class wages have not increased substantially for decades. Ironically, the taxes for middle class have increased steadily while the richer ones have paid lesser by the year. Consequently, the middle class could not increase their consumption besides their daily basic expenses, which in turn impact the consumer market negatively and increase unemployment rates. In fact, some people from the middle class would even fall into the low-income category. This means government revenue will decrease perpetually, and that the government would have to reduce their budget in education and other social services.
President Trump has cut government spending on education this year, resulting in subpar facilities and teaching staffs in public schools. Some public schools even struggled to proceed with their classes due to the deteriorating facilities. Tuition fees in California are already growing at an annual rate of 5% and many American children are attending colleges with the help of massive student loans, all which would take 30 to 40 years for them to pay off. Rising education costs have stopped many families from pursuing higher education and has, without a doubt accelerated the shrinking of middle class. While Trump intends to stimulate the market and promote the economy via tax cuts, Trump’s tax reform is mainly focused on corporate income tax, personal income tax, cross-border taxation and many more. Unfortunately, the reduction in U.S. personal income tax is moderate and while the reduction in the marginal tax rate is extremely meagre.
A simple estimate showed that tax reforms can reduce corporate income tax by US$ 120 billion per year while individual tax will be reduced by US$ 30 billion per year. From the perspective of the affected population, due to the adjustment in tax base, low and high-income groups will face a reduction in their taxes. Moreover, the higher the income, the greater the tax reduction. However, the middle-income groups (annual income of US$ 157,000 to US$ 420,000) may face an increase in taxes. Hence, the tax reform has failed to reduce taxes on the middle class and increase their consumption.
The shrinking of the American middle class has sounded alarm for the development of Chinese cities. Have the Chinese tax reduction policies paid sufficient attention to the middle-income groups? Data has shown that in the first three quarters of this year, China has a cumulative tax reduction of RMB 17834 billion. Among that amount, the newly added reduction was RMB 15109 billion. At the same time, there was also an increase of RMB 2725 billion in social security taxes. The taxpayers from the private sector has a tax reduction of up to RMB 9644 billion, and this accounted for 64% of the total tax reductions. The reform of personal tax income has received RMB 4426 billion in tax reductions, which accounted for only a quarter of the total tax reduction. Without proper policies in place, will China’s middle-income groups also decrease in size over time, thus leading to a decline in consumption and urban vitality?
China is slowly transforming into a consumption-oriented society. On the supply curve, there are many measures to improve consumption, promote evening economy and so on. That said, the demand curve has shown that most today’s consumers which is comprised of the middle-income group could not increase their consumption. This situation is guaranteed to worsen with heavier tax burdens and pressure from mortgages, pensions and medical care. The decline in physical commerce is correlated to the decrease in consumption. Bearing in mind that there are cheaper goods to be found in e-commerce, the consumption experience provided by physical businesses is no longer enough to drive consumption. Therefore, cities tend to lose urban vitality because the people could no longer consume that much anymore.
*Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Junhui Chu, is an Assistant Researcher of Anbound Thinktank. Master in the University of Southern California in the urban planning major of Social Policy School, which is the top 10 urban planning major, and top 2 public policy school in the US. Bachelor in the University of California Irvine in the Psychology and Social Behavior.