n the past years, China’s taxation regime on personal income has been a source of contention. It is widely perceived to favor the rich and wealthy over the far larger working class. Dubbed a “wage tax,” the tax codes focus on labor income, rather than non-labor income such as capital gains.
In 2018, the government announced reform of the personal income tax system, increasing the monthly tax threshold from 3,500 yuan (US$538) to 5,000 (US$769), and introducing tax deductible schemes, which in the past two years has cut the tax burden of almost 60 percent of wage earners, amounting to a combined 500 billion yuan (US$76.9b).
But as living costs keep rising, there are renewed calls to lift the tax-free income ceiling. During the annual session of the National People’s Congress held in March, without directly addressing the calls, the government pledged in the 14th Five-Year Plan (2021-2025) that it will “establish a modern taxation system” by increasing the ratio of direct taxes. Yet as social equity becomes a policy priority in the next years, it is time to overhaul China’s personal income tax codes, rather than make incremental changes.
First and foremost, China needs to expand its personal income tax code to cover non-labor income. Under the current tax code, income tax covers four categories, including salaries and wages and income from labor services, manuscript remuneration and royalties. Most non-labor income such as capital gains, rental incomes and investment dividends are not included as a person’s consolidated income. Although there are separate arrangements regarding these incomes, the overall tax rate for non-labor income is considered much more favorable than wage taxes.
While the 2018 tax reform considerably lowered the tax burden on low-income earners, the middle class shoulder the greater part of the personal income tax burden. China needs more decisive actions to incorporate non-labor income under a unified progressive taxation system.
Second, given the vast difference in salary level and living costs across different regions, China should allow provincial and local governments to decide the level of taxable income. For example, the average salary in Beijing is about three times that of Yunnan Province, but a taxpayer in Beijing is subject to the same taxable income level.
For similar reasons, given the vast cross-regional differences in demographics, provincial and local governments should be allowed to decide on deductible items for expenses like childcare, education and aged care. The central government can play a supervisory role in the process.
Last but not least, China needs to strengthen its crackdown on tax evasion among the wealthy to ensure high-income earners fulfill their obligations to pay taxes. With favorable tax codes and lax enforcement efforts, the tax burden on China’s millionaires and billionaires is among the lowest in the world. The 2018 tax evasion scandal involving Fan Bingbing, an A-list movie star, whom along with the companies represented by her evaded a total of 255 million yuan (US$39m) in tax, which led to public outrage, is just the tip of the iceberg.
It is a global challenge for governments around the world to tax the rich and wealthy, as they can distribute their wealth across the globe. China should learn from the practices of developed economies, such as expanding the scope of tax codes to income earned overseas.
The choices China made about personal income tax codes have historical reasons. As the government’s priority is promoting the economy and boosting domestic firms, a low tax rate for the rich appears convenient. But as China vows to shift its focus from quantity to the quality of its development, and pledges to address the issue of social equity in the following years, it is now time to adopt different thinking.