When China’s ruler, Xi Jinping, began calling for “common prosperity” in 2021, he made investors nervous. The stated goal was to reduce inequality. But the term became wrapped up with something edgier: a morale-destroying campaign to browbeat billionaires into displays of charity, tighten regulations on big tech firms and curb what Mr Xi called the “disorderly expansion of capital”.

Although talk of common prosperity has receded, the need to reduce inequality has not. Indeed, it now has a new justification. China’s economy is mired in deflation, a sign of weak demand. To boost consumer spending, many prominent economists want the government to divert more income to households. And to reduce China’s high saving rate, they want money redistributed from the rich, who tend to save it, to the poor, who are more likely to spend it. The aim is not just social justice, but also macroeconomic efficiency. Higher spending would help China’s output fulfil its potential. It would help close China’s output gap by narrowing its income gaps.

The IMF’s annual report on China, released last month, pointed out that a better social safety net and a more progressive tax system would strengthen demand. Similar prescriptions appeared in a recent issue of Red Flag Manuscript, published by Qiushi, the communist party’s journal of ideas. An article called for improving the “income distribution system”, including tax, social security and transfer payments.

These recommendations raise a pertinent question: how effective is China’s fiscal system at reducing inequality? On the face of it, the system does little. China, unlike, say, Brazil, skimps on cash transfers. Its income tax looks progressive: rates climb from 3% to a grabby 45%. Yet precious few earn enough to pay the top rate. In reality, many people pay no income tax at all, owing to a generous standard deduction. A big chunk of China’s tax revenue comes from indirect taxes, including VAT, which do little to narrow inequality. After all, taxed goods cost the same, whether the buyer is rich or poor.

The combined effect on inequality is assessed in a new working paper by five economists: Maria Ana Lugo, Veronica Montalva and Sailesh Tiwari of the World Bank, as well as Nora Lustig and Yang Wang of Tulane University. Drawing on a survey of over 14,000 households in 2018, the authors find that China’s taxes and transfers by themselves do little to narrow inequality. These measures reduce China’s Gini index—a common measure of inequality—from about 54.5 to 51.6.

But redistributing cash is not the only way to help the poor. Governments can also provide things the poor would otherwise have to buy for themselves. China’s public spending on education and health care is, for example, highly redistributive (see chart 1), according to Ms Lugo and her co-authors. It reduces inequality by another seven percentage points or so, lowering China’s Gini coefficient from 51.6 to 44.2.

How does this redistributive effort compare with other countries? The Red Flag article cautions that China is still in the early stage of socialism. “The Party and the state cannot take on too much responsibility,” it says. “We must avoid…excessive welfare” and act “within our capabilities”.

The author need not have worried too much. China’s fiscal system takes on less responsibility than its counterparts in most rich countries. In America the combination of taxes, transfers and in-kind benefits reduces the Gini index by almost 15 points (see chart 2). But China’s redistribution is significant in comparison with other countries that are at a similar stage of development. Indeed, its fiscal system was a bit more redistributive in 2018 than you would expect given its GDP per person, according to our analysis of the numbers produced by Ms Lugo and her co-authors. China’s social spending may also be more cost effective than that in some of its peers. Although Brazil and Colombia devoted more of their GDP to health and education, this spending got less bang for its buck in lowering the Gini index, which suggests China’s social spending is better targeted towards the poor.

Can China redistribute its way out of deflation? That would require quite a bit more ambition than its leaders have shown thus far. Increased spending on education and especially health would certainly help. The Red Flag article argued that health is “an important symbol of socialist modernisation”. And Mr Xi himself remarked in a speech last year that “a country will prosper if its education prospers”. The speech is one of 47 of Mr Xi’s sermons that are collected in a new book on education which went on sale this week. Perhaps the tome will prise open the wallets of some of China’s reluctant shoppers. ■

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