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4.2 Scenario Design of Policy Simulations

Further to the above analysis, we use the CQMM to simulate macroeconomic effects and increase the ratio of direct taxes to indirect taxes to the world average (0.63) from 2012 to 2014. This helps us to verify the aforementioned qualitative judgment and give policy recommendations. Our policy simulation design is as follows:

1. Lower the indirect tax revenues from 2012 and gradually adjust the 2014 Chinese ratio of direct and indirect taxes in Fig. 4.1 to the world average (0.63).

2. To achieve our hypothesis goal, we design the following two scenarios:

Scenario 1: Keeping the total tax burden on the national economy unchanged, we adjust the ratio of direct and indirect taxes to the new scale by lowering the indirect taxes and raising the direct taxes. Therefore, the average annual decline in indirect taxes from 2010 to 2014 is 118.65 billion yuan, and the increase of direct taxes is the same amount each year. After adjustments, the ratios of China's direct taxes to indirect taxes for 2102, 2013, and 2014 were 0.55, 0.60, and 0.63, respectively. Considering the tax feedbacks on endogenous macroeconomic variables, the actual ratio of the simulation results may vary. In this scenario, the simulation adjusts only the structure of direct taxes and indirect taxes and does not reduce the overall national economy macroeconomic effects of tax burden.

Scenario 2: Keeping the direct taxes unchanged, we reduce the indirect taxes.

The direct and indirect taxes will adjust to the new scale, reducing the overall tax burden on the national economy. While the average annual decline from 2012 to 2014 in indirect taxes is 318.24 billion yuan, after adjustment, the ratios of China's direct taxes to indirect taxes for 2012, 2013, and 2014 will be 0.55, 0.60, and 0.63, respectively. Similarly, considering the tax feedbacks on the endogenous macroeconomic variables, the actual ratio of the simulation results may vary. Under this scenario, the simulation incorporates both the tax structure adjustment of direct and indirect taxes and the overall national economy macroeconomic effects of reducing the tax burden.

The economic logic behind these policy simulations is as follows. Under Scenario 1, on the one hand, the decline of indirect taxes would reduce fiscal revenue, which would in turn reduce fiscal expenditure and dampen GDP growth. On the other hand, the decline in indirect taxes would reduce business costs, expand production and sales, and lead to increased profits, expand the investment needs of self-financed business capital. Furthermore, the decline in indirect taxes would lower the price level and promote consumption, both of which stimulate economic growth and lead to the sustained growth of tax income. In contrast, increasing the direct taxes would reduce corporate income and self-raised enterprise investment. On the other hand, it would reduce the disposable income and lead to a decline in residual consumption. Macroeconomic changes occur as a result of both tax strategies together. Under Scenario 2, the decline of indirect taxes is based on exogenous assumptions, and so direct taxes are endogenous on the changes of economic growth.

 
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