China’s “Subprime Mortgage Crisis” Avoided? Downscaling Real Estate Tax Might Have Saved China

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Hello, everyone. Welcome to Zooming In China. I’m Simone Gao.

There is always a great deal to talk about in China, but perhaps the biggest topic right now is the real estate tax that Xi Jinping wants to implement and the resistance to it.  The topic is not new. Neither is the resistance. Since 2003, well before Xi Jinping’s rule, the Chinese government has been considering this tax. In 2011, they implemented pilot programs in Shanghai and Chongqing, but those programs taxed only higher-end apartments and second homes, at rates between 0.4% and 1.2%.

Now, a decade later, the State Council, the top decision-making body of the Chinese government, has announced it will roll out a pilot of a broader real estate tax in some regions. They declined to name the regions or to provide more public details about the properties that would be taxed or the amount of the tax, but many experts expect real estate hot spots Zhejiang, Shenzhen and Hainan to be targeted. The pilot program is expected to last for five years before the government determines whether or not to roll the program out to the entire country.

This smaller-scale rollout is a far cry from the original desire of Xi Jinping and the Communist Party government to create a tax that some experts say would lead to one of the most profound changes to the country’s real estate policies in a generation. So, why would Xi trim down a country-defining change when he has the power to implement and enforce it? Might the timing of this change show a compromise meant to appease Communist leadership ahead of the Sixth Plenary Session in which Xi will likely be granted a level footing with Mao Zedong and Deng Xiaoping, the party’s widely recognized supreme leaders?

I do not believe this compromise is related to the Sixth Plenary Session. The battles for that session have already been fought and won by Xi Jinping, as we have seen with the October 18th announcement published on the official website of the Chinese government. In that report, they announce that the Political Bureau of the Communist Party of China Central committee held a meeting to discuss the resolution to be submitted for the Sixth Plenary Session and the result was the resolution was approved.

The resolution says that the Chinese Communist leaders, with Mao Zedong, Deng Xiaoping, Jiang Zemin and Hu Jintao as the main representatives, had led the Chinese people to great achievements, but Xi Jinping led the country to new achievements and to new valuable experiences, providing a system to guarantee a great rejuvenation of the Chinese nation.

The feeling in this passage is that although prior leaders had some major achievements, the new, more complete, more reliable power for China is in Xi Jinping’s hands.

The resolution continues by saying that China has ushered in a great leap from standing up, getting rich and getting stronger. Standing up, getting rich, and getting stronger represents three people: Mao Zedong made China stand up, Deng Xiaoping made China rich, and Xi Jinping made China strong. This statement makes Xi Jinping stand shoulder-to-shoulder with Mao Zedong and Deng Xiaoping.

Another goal of this historical resolution is to reshape and unify the ideas of the top elites of the Chinese Communist Party, that is, to “pinch Mao and Deng together.”

In the Mao era, China was governed by communist fundamental principles. Those were expanded in Deng’s era to combine the market economy with the communist one-party political system. In the era of Xi Jinping, the Communist Party once again began to monopolize and control all parts of the country, including the market economy. The market economy is allowed to exist, but only under the strict control of the government. You can develop only as the government allows you to develop. There will be no more disorderly expansions like the big ecommerce platforms such as Alibaba.  And those who have benefited most from the market economy are now under the tightest scrutiny.

That scrutiny has now extended to the real estate market in China, especially after the near collapse of Evergrande and the end of a market built on the notion of growing big by borrowing big. That Xi Jinping is reigniting a conversation that had been put on hold for a decade, then, is not surprising at a time of clear power-grabs by Xi and his leadership team. What is surprising is his willingness to compromise and scale back that tax.

The Wall Street Journal says that, according to people familiar with the matter and with internal discussions, most of the feedback Xi received about his real estate tax plan was negative, from not only regular Party members but also the Party elites.

There are many reasons for the antagonism toward the new tax. One reason comes from older Party members who benefitted from real estate purchases at a time when prices were low and favorable to Party members but who now say they cannot afford the additional taxes. Many of those Party members own multiple properties and so may face a substantial tax bill. Who are the people likely to own multiple properties and so be most affected by this real estate tax? CCP officials and wealthy citizens. CCP officials gained multiple properties as a perk of the power they held. The wealthy purchase homes as an investment.

Speculation about the original tax plan indicated that a 0.7% rate was possible, a rate that would have yielded 1.8 trillion yuan (or $281 billion) of tax revenue in 2020 and that could generate revenue equal to roughly 75% of land sales revenues, money that could be re-invested into the public services and infrastructure that are desperately needed to boost the Chinese economy and ensure the safety of its citizens. Over time, the tax could help local governments reduce their reliance on those land sales.

But, according to CNBC writer Evelyn Chang, “A nationwide property tax would likely require disclosures of business and government leaders’ real estate holdings, which means such a policy could meet resistance even as the country has been cracking down on corruption.” Revealing just how deeply the Party elite have benefitted from those positions may be a problem not just for them but for Xi Jinping as well.

In addition to pressure from the Party elite, and his own personal interests, Xi must also consider the catastrophic consequences that a sudden increase in real estate taxes could bring to the economy. These consequences stem from a core reason for the real estate tax, one Xi announced in August when he said that pursuing “common prosperity” in China would mean reducing “excessive” income and encouraging the wealthy to give back.

The intent of “common prosperity,” is “to recreate a lot of new middle-class people who have affordable housing and affordable health care and affordable education. And in order to do this you need to make sure that housing is for living—that is, not speculation or for investment.”

Theoretically, China’s real estate bubble will reduce once a real estate tax is imposed, because people will no longer hold houses for investments, instead allocating funds to other investments, such as capital market investments. According to China’s central bank, Chinese citizens currently have nearly 60% of their urban household assets held in real estate with only 20.4% allocated to financial assets like stocks and bonds. U.S. households have, on average, over 40% of their wealth in financial assets.

But if common prosperity and the real estate bubble were the only concerns, real estate taxes would not have been placed on hold for a decade. This topic would have been addressed at the height of China’s real estate bubble, not as the bubble began to burst.

Instead, Xi Jinping is levying real estate taxes in order to solve financial difficulties. The central government has no money, and its reliance on land sales cannot continue indefinitely. Then came the Evergrande disaster with secret dealings that led to their loans being paid on time—a situation that strongly suggests some level of government bailout—and billions being funneled into Chinese banks to prevent a collapse of the market. The government is out of money and quickly running out of options.

But while the addition of real estate taxes may curb real estate speculation and drive prices down, if housing prices fall too sharply, many residents' mortgages will default. The logic is simple. When house prices fall many people will not be able to afford a mortgage because real estate is their biggest asset, especially if they use one house to pay for another house. For others, they will simply walk away from a devalued house. For example, if you borrowed $5 million on a 30-year loan but, two years later, found that the home was now valued at just $3 million, would you continue to pay on the loan and take the $2 million loss? Or would you default and walk away? Many will walk away, leaving the banks in possession of billions in bad debt and a number of houses that are not worth the money that was lent.

Up to 80% of some Chinese households’ wealth is tied to real estate; when real estate depreciates, people’s core assets will shrink and their spending power will drop sharply, driving the entire economy into a sharp decline. This is the rhythm of economic collapse. Xi Jinping is nicknamed Chief Accelerator of China meaning he is pushing China over the cliff in an accelerated way. But, this time, even the chief accelerator saw the cliff just ahead of him.

That’s all for today. Thanks for watching Zooming In China. Please like, share, subscribe and donate to this program if you like my content. Thanks again and see you next time.