By Xi Si (席斯)

Economic Observer Online

Oct 27, 2011

Translated By Zhu Na

Original article: [Chinese] 

 Reform of value-added tax has been under discussion for years, but it is finally about to be realized, starting with a pilot program in Shanghai from 2012.

Shanghai has always been on the list for pilot fiscal and tax policies. Sometimes the city’s leaders were keen to be included, sometimes they weren’t, but VAT reform is exactly what Shanghai needs.

The Ministry of Finance spent four years trying to press cities to pilot new property taxes, but no one was willing. Some of them feared that the policy would drive developers to surrounding cities.

At that time, the Ministry of Finance spoke to major cities, and pushed the pilot harder. Shanghai, Chongqing and a city in the Northeast China agreed, and each developed their own version. However, for a variety of reasons, these three programs were either canceled or delayed.

When it came to the pilot project for local bond issuance, Shanghai tried hard to take part. Many major Shanghai businesses are finding it hard to borrow, but infrastructure and municipal projects still require huge funds, and the bond issue will help resolve the problem.

VAT reform is one of those pilot projects that suits Shanghai. The city wants to be a global hub for shipping and finance – two industries that belong to the service industry and pay business tax. However, business tax if often duplicated whereas VAT isn't.

VAT is one of those taxes whose proceeds are split between the local and central governments. Currently VAT is split 3:1 between central government and local governments, unlike business tax which all goes to local governments, and has generated more than a quarter of tax revenue over the last 15 years. Replacing business tax with VAT will severely reduce local governments’ fiscal revenue.

Since local governments fight to preserve their tax revenue, they’re naturally reluctant to accept take part in the project. However Shanghai, which stands to lose 10 billion yuan in tax revenue, is an exception.

Other local governments have their own interpretations of Shanghai’s unexpected open-mindedness “Shanghai is very special, their tax, fiscal and transfer payment system are different from ours,” said one. Shanghai as a special financial zone; unlike other cities, its national and local tax and financial departments are a single institution, so it is easy for the city to coordinate with central government.

For this reason, some of those governments say Shanghai’s pilot project is unlikely to have many lessons for the rest of the country. Even so, they’re watching closely.