Beijing is making some much-needed changes, but will they work?

A protester argues with a police officer in Wukan, where demonstrators upset over government land seizures had forced out police / Reuters

The Financial Times ran a piece on China reforming its so-called "resource taxes" that are levied on carbon-intensive commodities such as oil/gas and coal:

Broadly speaking the tax reforms will shift from volume-based taxes, set years ago and generally very low, to value-based taxes that will fluctuate alongside commodity prices. The new system was implemented for oil and gas late last year, and is expected to be extended to coal and other commodities...

...On November 1 the resources tax for oil and gas moved from volume-based (between Rmb8 ($1.30) and Rmb30 a tonne for crude oil) to a value-based tax set at 5 per cent of the value of the oil and gas produced. At today's prices that equates to a tax increase of 10-20 times for crude oil.

But the net impact on China's oil companies will be minimal because the government offset this increase with separate changes to the windfall profits tax - backdated to November 1 to match the day the resources tax was changed - that will largely balance that out...

This move has been anticipated for more than a year now, as China initiated a pilot resource tax in the resource-rich province of Xinjiang as far back as May 2010. Beijing always intended to nationalize the tax if and when the trial period proved successful. Although only levied on oil and gas so far, it seems fairly likely a similar ad valorem tax will be imposed on coal further down the road. In fact, the Chinese energy bureau is reportedly ironing out a plan now. But raising the price of coal, which is already expensive in China, is highly politically sensitive. For instance, the current resource tax on coal by volume is estimated at anywhere between $0.50 and $0.80 per ton. But if moved to 5% ad valorem, based on Qinhuangdao spot prices of roughly $152, the tax burden would rise to $7.50, or as much as a 15-fold jump. This explains the government's hesitancy in imposing such a tax on the lifeline fuel of the Chinese economy. 

The logic behind the tax is two-fold, with both goals aimed at restructuring the Chinese political economy. First, to facilitate energy efficiency by pricing carbon-intensive commodities higher and, second, to boost local governments' revenue, with the intent that those local governments then re-invest into cleaner energy and other useful projects. While the energy efficiency motive is obvious enough, as it comports with China's overall energy strategy, it is the second objective that I think deserves some elaboration because of a non-obvious linkage to the housing sector.  

Ever since China's major tax overhaul in 1994, which reformed the tax structure to better boost the coffers of the central government, provinces have struggled to sustain revenues. Not only were local authorities required to repatriate more taxes to Beijing, they were also responsible for funding expensive public projects on infrastructure, social welfare, etc. This seemingly contradictory dynamic has been blamed for local authorities turning to converting rural land for housing developments to cover revenue shortfalls. And for the last decade or so, it is no secret that much of the land was sold to property developers. For instance in 2009: 

Local governments generated 1.59 trillion yuan ($233 billion) from the sale of 209,000 hectares of land in 2009. Of that, 103,000 hectares was sold to real estate developers, up 36.7 percent year on year.

Land sale revenues for property development hit 1.34 trillion yuan, accounting for 84 percent of the total.  

The $233 billion figure is probably under-reported, as it is exceptionally difficult to account precisely for extra-budgetary revenue. But it is clear that money raised from expropriating land (mostly from farmers) went into the pockets of developers, rather than "virtuous" investment or social welfare spending, playing a major role in catalyzing the now infamous housing boom that has persisted since the late 1990s. And of course, it is also responsible for generating the negative social externality of numerous protests and even self-immolations over illegal land grabs, including the well-documented Wukan violence in late 2011.

And so, the resource tax, as well as planned future energy and environmental taxes, are in part intended to sever this self-reinforcing dynamic at the local level. In other words, the resource and energy taxes are something of a "nicotine patch" to gradually wean local governments off of their addiction to land sales to generate revenue. The nationalization of the tax couldn't have come at a more opportune time, as a slow down in the property sector has meant less fiscal revenue. For example, the Ministry of Finance reported that from January to September 2011, the housing sales tax, while still growing, has slowed in terms of year-on-year growth by a remarkable 23 percentage points. Meanwhile, resource taxes collected in 2010 perhaps constituted 10% of total local revenue, which is a whopping increase from a meager 1.3% based on the old volume-based system.

Just how effective these new taxes will be in helping to de-carbonize the Chinese economy and sufficiently incentivize local governments to exit housing developments remain to be seen. But at the very least, Beijing is doing it for the right reasons.