Grey Income in China

Grey income was first coined by the Chinese government in 1978 and refers to that portion of a person’s income that is unreported and realized from sources outside of salaries and bonuses. In other words, it’s income that the government doesn’t officially know about and where the recipient hasn’t paid any taxes. To some extent every country has some amount of grey income. In China, however, it comprises nearly 20% of middle class income. Moreover, the amount of grey income, as a percentage of one’s wealth, increases with the wealth of a person and is greatest for the top 10% of Chinese households. These households account for 70% of all grey income in China.

Moreover, grey income does more than just make the wealthy wealthier. It’s also, to some extent, an economic driver which is responsible for a portion of the economic growth that China has experienced. The grey income in China is estimated to be 10 trillion RMB, or 30% of China’s GDP. With such an enormous amount of money that’s unreported, the Chinese government is anxious to convert as much grey income as they can into taxable revenue. Consequently, the government is currently trying to implement laws to capture as much of this income as possible. But, as with anything else in China, this is not an easy task. Furthermore, there’s a downside. Since a majority of grey income flows into real estate and luxury goods, both of which are drivers for the economy, the government wants to be cautious and gradually implement its changes.

Because grey income is a soft number and the total amount of grey income can only be estimated, most Westerners tend to substantially under-estimate the size of the Chinese consumer market. Instead, many base their consumer spending projections only on wages, disposable income, and other hard economic numbers. To the Chinese consumer, since grey income is in essence tax free income which is unreported, most view it as disposable income and tend to purchase luxury goods and services with this money.

Given all this, one would believe that the Chinese government would not have a significant problem with grey income because a great deal of this money comes back into the economy and promotes growth. After all, the Chinese have never been known for paying their fair share of taxes in the first place.  However, while the Chinese government doesn’t object to the more positive aspects of grey income, it sees grey income as a threat to the continuing rule of the Chinese Communist Party (CPC). Let’s explain.

Since most grey income comes from undeclared income on everything from property transactions, to bribes, embezzlements of public funds, guanxi or favors among business partners, or other activities where the income is not reported to the government, grey income has tended to increase an already widening income gap between Chinese social classes. Furthermore, since most grey income flows to the upper levels of Chinese society, everyone else has a much smaller amount of grey income or no grey income at all. Instead, a great many people only have their wages as their sole source of income. As a result, the income gap in China continues to widen and social tensions continue to increase. The CPC, ever sensitive to keeping a handle on social unrest, is trying to compensate for the lack of grey income at the lower levels of society by increasing wages as well as decreasing the amount of grey income flowing into the economy. The government’s fear is that an increase in grey income, along with a widening income between social classes, will eventually lead to a demand by the people for new leadership.

In addition to widening the income gap, grey income also has increased corruption within China. As the economy has continued to grow, so has the amount of money involved in bribes and other corrupt practices. Examples include government officials, who are generally paid very little, receiving grey income for various favors granted; doctors increasing their income by receiving commissions on prescriptions and procedures; and company managers receiving kick-backs from vendors. These are serious issues for the CPC, as corruption is one of the main drivers for social unrest in China. Since Deng Xiaoping opened China to the outside world in 1978 corruption, and its associated grey income, has continued to increase. However, in the past, a great deal of corruption went unreported. All that changed with the advent of the Internet and the information age. The Chinese people are now able to more effectively communicate among themselves and publish corrupt practices that are uncovered. For this reason, the CPC is becoming more aggressive in trying to control grey income and limit social unrest.

As grey income increases, so will corruption as well as the income gap between social classes. Both of these issues provide fuel for unrest in China and cause people to re-think the continued governing of the country by the CPC. Given what’s happening in Syria and Egypt, the CPC is paying close attention and becoming aggressive in reigning in grey income. The government knows that grey income will never be eliminated. However, with a parallel between the rise in grey income and an increase in social unrest, the government is passing laws to try and limit the sources of grey income as well as becoming more aggressive with anti-graft enforcement.

If you have any questions please e-mail them to info@thornhillcapital.net

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