China’s lowering taxes should increase inflation
The Financial Times is reporting that China is attempting to address its wealth gap through a number of measures, the principal one of which is raising the tax exemption on income. As welcome as such a move is for consumers facing significant food and energy inflation, in the broader context of the Chinese inflation picture it is a net negative.
China has an inflation problem now, with real interest rates being negative while food and energy costs are rising. Moreover, there is increasing evidence that China may have reached the Lewis Turning Point where the excess supply of rural workers no longer supresses compensation. This means that China could face wage-push inflation as workers are compensated to beat the rise in commodity prices. Lowering taxes is another way of accomplishing the same. However, lowering taxes is stimulative.
The FT also reports that the top 1% of households control 40-60% of household wealth. If the Chinese really wanted to close the wealth gap they should also increase taxes on this bracket by more than they lower taxes in lower income brackets in order to cool down the economy. That is not going to happen. So it is clear to me that inflation will continue to be a problem for the Chinese, requiring more aggressive moves on the monetary policy front.