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China's tax cuts hit local govt coffers, may undermine stimulus

Stella Qiu and Kevin Yao

BEIJING, Aug 1 (Reuters) - China's $300 billion in tax cuts aimed at stimulating its slowing economy are starting to hurt the revenues of debt-ridden provincial governments, with poor western regions suffering the most from squeezed budgets, a Reuters analysis showed.

Increased fiscal strains on provinces and municipalities will likely hamper their ability to implement infrastructure projects, in turn affecting local businesses and jobs and ultimately clouding Beijing's efforts to support the broader economy after growth slowed to nearly three decade lows.

China rolled out billions of dollars in tax cuts, new construction spending and a slightly higher target for the budget deficit to GDP ratio - to 2.8% from 2.6% - as economic risks grew from a slowdown in domestic demand and a trade war with the United States.

Of the 22 provinces and municipalities that have published fiscal revenues for the first half, 10 reported a slowdown in revenue growth from a year earlier while seven showed a rare drop, according to official provincial data compiled by Reuters.

"The economic slowdown and tax cuts are the main factors behind the pressure on local governments," said Jia Kang, head of the China Academy of New Supply-side Economics, a Beijing-based think tank.

"The budget deficit ratio (for the central government) for this year is 2.8%, and we need to see whether it needs to be raised a bit next year," said Jia, former head of research at the finance ministry.

Western regions were the hardest hit, with revenues in Chongqing, a sprawling municipality in southwestern China, dipping 7.8%, followed by a 5.4% drop in the province of Guizhou and 3.7% fall in Qinghai.

Chongqing is embarking on a 53.5 billion yuan ($7.8 billion) railway project linking it with the southern city of Xiamen 265 km away. Guizhou also has plans for a high-speed railway to connect all of its cities with the provincial capital of Guiyang. Qinghai wants to expand an airport.

Gansu, a poor northwestern province with a similar plan for an airport expansion, posted a 2% decline in fiscal revenue. If it weren't for the tax cuts, fiscal revenue could have risen 4.3%, according to the local government.

In the first half of last year, Qinghai, Guizhou and Gansu all reported double-digit revenue gains.

Most western provinces remain under-developed, despite more fund transfers from the central government and benefits from a strategic push to develop the region.

DEBT BURDENS

Analysts said effects from stimulus measures have been slow, unlike the 2008/09 global financial crisis, as some cash-strapped governments are deploying tax revenues to repay debt.

Local governments have total debt of 20.55 trillion yuan as of the end of June, as well as an unknown amount of "hidden debt" racked up from a spending binge since the financial crisis.

"Debt repayment is a very important task, while infrastructure spending has to come in second. We still owe a lot of money," said a local government official in eastern China who declined to be named.

Finance ministry data show nationwide tax revenue rose just 0.9% in the first half from a year earlier, while non-tax revenue such as from sales of state assets and profits paid by state-owned firms jumped 21.4%.

The lack of sufficient funds has spurred local governments to dispose of their idle assets such as factories and land, as well as claw back unused funds from the previous year's budget, financial magazine Caixin reported.

Many provincial governments have sounded alarm bells about their deteriorating fiscal positions, with some saying they face difficulty guaranteeing social security payments and education expenditures.

NO QUICK BOOST

Among the 25 provinces and municipalities that have released economic growth figures, as many as 20 saw slowing growth in the first half of 2019 compared to the first quarter. Northwestern provinces were among the worst performers.

China's economic growth slowed to 6.2% in the second quarter, its weakest pace in at least 27 years, prompting Beijing to implement support measures to bolster growth.

Economic data for June showed recent growth-boosting efforts may be starting to have an effect, although analysts caution against optimism that the worst is over.

"We haven't seen a recovery in infrastructure investment, which is related to the debt pressure of local governments they don't have money to step up investment," said Tang Jianwei, senior economist at Bank of Communications in Shanghai.

Analysts believe local government may be allowed to issue more bonds in the fourth quarter if growth falters.

Finance ministry officials have also pledged to step up fund transfers for hard-pressed regions, and Jia from the think tank expects it will be sizeable: "The strength of payment transfers will be relatively big for the western region."

($1 = 6.8840 Chinese yuan)

(Additional reporting by Beijing newsroom; Editing by Jacqueline Wong)