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China needs more systematic tax reform

While the reform appears set to lower the tax burden of low-income earners and the middle class, it does little to address the problem of an overall tax mix that favors the rich over the poor

By NewsChina Updated Oct.1

After months of contemplation and debate, China’s State Council has finally released a new tax reform plan that will cut individual income tax. The plan raises the taxable threshold to 5,000 yuan (US$730) per month from 3,500 yuan (US$511). It also alters the structure of income tax rates. In effect, the payable tax of those with a monthly income of 10,000 yuan (US$1,460) will drop by 70 percent, and those earning 20,000 yuan a month (US$2,920) will get an effective tax cut of 58 percent.  

The changes also allow personal tax deductions for spending on children’s education, continuing education, medical fees for critical illness and interest on housing loans and rent, although there were no details on how the deductions will be applied.  

While the authorities claim this change will substantially reduce the tax burden of low-and middle-level income earners, public response has been muted. The reform falls short of expectations.  

During the drafting stage, many argued the minimum rate should be 7,000 yuan (US$1,022) or 10,000 yuan (US$1,460) per month, or even higher. And there were also calls for it to be pegged to inflation and other economic indicators to avoid bracket creep.  

China last increased the income tax exemption level in 2011, when it went from 2,000 yuan (US$299) to 3,500 yuan (US$511). Government revenue from personal income tax has more than doubled in recent years from 582 billion (US$86.9b) yuan in 2012 to 1,196.6 billion yuan (US$178.6b) in 2017, a rate far faster than national GDP and wage growth.  

In the first half of 2018, income tax revenue ballooned by 20.6 percent compared to the previous year. Without a fluctuation mechanism the newly announced tax cuts will likely dissolve before long. 

And while the reform appears set to lower the tax burden of low-income earners and the middle class, it does little to address the problem of an overall tax mix that favors the rich over the poor.  
China’s personal income tax has long been dubbed a “wage tax.” The reform does not change the overall tax rate structure.  

Under the new tax law, the highest tax rate for wage earners remains 45 percent, while the maximum business tax rate is 35 percent, and for capital gains, zero to 20 percent.  

Last, the reforms have raised concerns among businesses. Earlier this year, China conducted an institutional reform, which requires firms to pay social security expenses to the central tax office, instead of provincial and local agencies.  

In the past it was common for Chinese businesses to calculate and pay social security fees based not on the actual salary of their employees, but on the minimum monthly salary set by local governments.  

The practice, which is illegal, has been widely tolerated by local authorities. It is believed the latest reform will accompany more strict collection of social security fees, something already reported to be going on in some places.  

Experts say strict enforcement will significantly increase expenses for small- and medium-sized businesses. Social security accounts for 40 percent of labor costs for businesses operating in China, but this fund also faces mounting challenges from a rapidly aging population.  

When he announced the reform, Chinese Premier Li Keqiang said the government would explore the possibility of lowering the social security expenses. But given the uncertainties over the  
enforcement of tax codes, there is nonetheless anxiety in the business community.  

Facing this tangle of challenges, the Chinese government must take a more systematic approach focusing on establishing a fair, mature, and sustainable tax structure and an established mechanism to address the new situation, instead of responsive, ad hoc, arbitrary solutions to single issues.  

As with many issues in China, the fundamental approach should be to reduce the ever-increasing administrative expenses of the government and increase the ratio of spending on social services.