There is no doubt that tax differentials can cause distortions. China is not new to this game with the setting up of special economic zones effectively kick starting China's entry into world markets.
This article shows how government policy can quite quickly effect the location of firms and hence jobs within China. All countries undertake regional economic policy and this is just one example of how China is attempting to get the central and Western regions to "catch up" with the Eastern and coastal regions.
The trade off is always the same. Do Chinese firms relocate to benefit from lower VAT even if the infrastructure and transport networks are worse? Cost-benefit analysis should sort that one out. The same decision is made when MNEs decide whether to stay in the US or the EU or move to China to take advantage of lower costs/ wages/ regulations.
Manufacturers moving inland from Hangzhou as central province VAT reform kicks in [China Briefing]
Textile manufacturers in and around Hangzhou, long one of the region’s pillar industries, are beginning to move their operations inland as China reduces the VAT burden in the central provinces.
Beginning July 1, 2007, the Ministry of Finance and the State Administration of Taxation reduced the VAT burden in 8 sectors within 26 specified industrial cities in the six central provinces of Anhui, Henan, Hubei, Hunan, Jiangxi, and Shanxi.
The new system, which applies to both domestic and foreign invested enterprises in the central provinces, benefits general taxpayers engaged in the equipment manufacturing, petrochemical, metallurgy, automobile manufacturing, agricultural product processing, mining, electrical power, and high/new technology sectors within the 26 specific industrial cities.
The input tax can be deducted upon activities listed below:
* purchase of fixed assets (including fixed assets obtained as donation and capital injection)
* goods purchased or services obtained for self-produced fixed assets
* fixed assets obtained by financial lease and the lessor paid VAT as per the relevant tax regulation (Guoshuihan 514)
* transport costs paid for fixed assets
Younger, Peacebird and Progen, famous textile companies originally from Zhejiang, have already moved their manufacturing bases to the central provinces in a bid to cut costs. “The transfer of the textile industry from the east coast to the central and western regions is already going on, this VAT reform will expedite it,” says Mr. Han Licheng, vice chairman of the Zhejiang Provincial Clothing Association.
Some have complained however, that although production costs are reduced in the central provinces, the environment for manufacturing is still not as good as in Zhejiang province. While companies are looking to move their production facilities inland, many are keeping their operations base and supply chain in place in the eastern provinces.