Sharing Risk
One important consequence of the city government's mission to compensate for "objective conditions" is the provision of a kind of insurance against the risk of industrial undertakings. This is an ironic consequence of the new stress on having enterprises repay investment loans. The bank examines every feasibility study and loan application for the firm's ability to repay out of increased profits. Not uncommonly, an application will be flagged by the bank as having too much risk (fengxian ) and as unacceptable, without awarding the firm favorable conditions.
At this point, industrial decision-makers are faced with a conflict between two principles, which they refer to as "economic efficiency" (jingji xiaolu ) and "social utility" (shehui xiaolu or shehui xuyao ). The prevailing attitude among those I interviewed is that the former is a rather narrow, blind, and calculating criterion, whereas the latter takes into account the greater public good. By the time a project application is rejected or flagged by a bank as unprofitable, it has already been approved by the industrial bureau involved, placed in the plan, and if it is large, already approved by the planning commission. In other words, the planning apparatus of the city has already pronounced upon its social utility.[35] There follows a protracted negotiation among industrial bureau, bank, tax bureau, finance bureau, and planning commission. The usual result is a set of "favorable conditions" (youhui taiojian ) that will allow the venture to succeed.
The finance and tax bureaus have four mechanisms that, in combination, allow them to fashion "favorable conditions" of widely varying attractiveness. The first is to reduce or eliminate the interest rate on the loan. The financial system simply pays the interest directly to the bank, and the enterprise repays only the principal. This is an "interest free loan" (wuxi daikuan ) or a "subsidized interest loan" (tiexi daikuan ). The second mechanism allows the enterprise to deduct its annual debt repayment from the profit subject to taxation. But it is common practice on construction loans financed by budgetary funds ("special project loans," texiang daikuan ) to allow up to a 100 percent income tax deduction on the debt repayment, or as the Chinese put it, to repay loans before taxes (shuiqian huankuan ).[36] Since the various taxes on enterprises usually add up to a nominal tax rate of 70 to 85 percent, this can be a large subsidy,
equal to the percentage the factory is allowed to repay before taxes times the tax rate.[37]
The third mechanism is to allow the enterprise an exception from the principle that it repay a loan out of new profits generated by the investment project. Enterprises whose projects are judged to be economically unprofitable but socially necessary will be granted the right to repay their loans out of their "old" profit, in addition to the new. The fourth mechanism, usually used only in projects with urgent social justification but poor financial prospects, is simply to treat loan repayments as taxes (shitong shangjiao renwu ).[38] In this case, loan repayments are simply counted toward the factory's tax obligation, releasing them from their normal tax obligations until the loan is repaid. With so many mechanisms at their disposal, local officials can tailor tax breaks of any size. They can, and do, fine-tune loan and tax packages to create in advance the conditions for repayment.[39] One might reasonably ask, given this ability to fine-tune financial conditions, whether there is any criterion financial bureaus use to determine how much preferential treatment to give a firm, and if so, what.
The only clear standard that I was able to discover was evident in all the cities I visited: the factory's bonus and welfare funds shall not be allowed to fall below the level of the year reforms began (1983 or 1984). Even if, in extreme cases, the factory must use all of its reserve funds to repay loans or cover losses, wages and benefits must not be allowed to fall.[40] This standard was usually justified by the argument that "objective conditions" necessitate tax breaks in the first place, so the work force should not suffer from circumstances beyond their control. Others stated the point more baldly and said that workers' incomes should not be allowed to suffer in the course of reforms.
These practices reduce significantly the element of risk in enterprise operations. Enterprises can depend on leading organs and other agencies to devise an investment package designed to secure success. If the enterprise still runs into difficulties repaying because the feasibility study
was too optimistic, or because of objective conditions, a firm can apply for a "hardship tax break" (kunnan jianmian ). The plea of "objective conditions" is ruled out in only three cases: if labor costs go up; if materials use rises; or if sales go down because of poor quality of product. The loan repayment contract is viewed as legitimately open to renegotiation. After confirming this, one enterprise manager said, "Usually this is no problem if you are a well-run factory and aren't a chronic money loser."[41]
If poor financial performance can be traced to "subjective factors," this is a blight on the manager's record. But tax breaks are still given, usually for one year but sometimes longer, to help turn the situation around: "Whether it is due to bad management or not, we still reduce taxes if we want to save the enterprises in a certain line of production. We are after all a socialist country, and we don't want enterprises to go bankrupt."[42] If the problems persist, local authorities may eventually decide, if the plant is important, to give the firm a large renovation project to increase its technical productivity and start with a clean slate.