Tax System Reform: What's on the Agenda?

By Xi Si
Published: 2010-09-23

News, Cover, Issue 487, September 20, 2010
Translated by Tang Xiangyang
Original article:

China’s taxation system may witness a great change in the following five years. The EO has learned that the taxation reform plan created by 12 ministries has been reported to the State Council and currently those ministries are soliciting recommendations about the plan. The reform will be focused on completing the reform of personal income tax, property tax and repeat tax collection of value-added tax and sales tax. In line with suggestions, value-added tax, China’s largest tax, is likely to be expanded and replace the sales tax.

Currently the sales tax is a local tax, but it will become a tax shared between local governments and the central government after it is merged into the value-added tax, indicating that the taxation system will be reformed in the 12th Five-Year Plan period.

Personal Income Tax and Property Tax

“Many government departments and research organizations participated in the formulation of the plan and contributed many ideas,” a local academic who participated in the creation of the plan said.

The Chinese government had planned to reform its personal income tax and its property tax in the 11th Five-Year Plan period, but has not made any progress towards reform during the past five years.

According to Zhang Bin, director of the tax research office of the Chinese Academy of Social Science Institute of Finance and Trade Economics, the incomplete reform of the above two taxes has restrained the development of the Chinese economy and society. Both income distribution reform and the reining in of the property market are connected to reform of the personal income tax and property tax.

The biggest limitation of the current personal income tax is that it only taxes a single item of personal income while neglecting to tax other sources of income, and thus is unable to play a larger role in adjusting income distribution. Additionally, it is incapable of adjusting to the different situations of tax payers.

Liu Zuo, director of the State Administration of Taxation Tax Science Research Institute, said that the biggest difficulty will be reforming the taxation system.

Currently, the personal income tax is collected by local taxation bureaus; therefore it is difficult to share the revenue between local governments and the central government. For example, a woman may earn a salary in Beijing, a lecture fee in Shanghai and receive payment for a book deal in Guangzhou. At the end of the year, the Beijing Taxation Bureau will add up all of her income from the three cities and review the amount of taxes she has paid. Because her taxes were calculated separately in each of the three cities, she was taxed more than if she had earned all their money in one location. The State Administration of Taxation will then calculate her tax refund, but they only have the authority to refund the 40 percent of taxes that were collected by the local taxation bureau, the remaining 60 percent has already been given to the central government.

Only when all the information about the various types of personal income may be collected and calculated by the central government and full tax refunds are handed out at the end of every year will it be possible for the central government to launch a comprehensive taxation system. According to Li Yang, deputy president of the Chinese Academy of Social Science, it is impossible for any local government to collect all the information concerning personal income. Only the central government has that capability; personal income tax should be collected by the central government.

The Chinese government tried to issue a property tax at the beginning of this year. However, as Gao Peiyong, Director of the Institute of Finance and Trade Economics at the Chinese Academy of Social Sciences, notes, it is becoming increasingly difficult for the central government to implement the property tax as there is still no practicable plan to discuss.

Liu Zuo said, the property tax would progress steadily throughout the 12th five-Year Plan period, but people should not be over optimistic.

It is difficult to evaluate properties. The Shanghai government launched a pilot property tax in the first half of the year, but gave up on it only several months later. Though there are over 1,000 real estate appraisers in Shanghai, it would still take them years to evaluate all of the property in Shanghai even if they all worked eight hours a day, seven days a week.

Another problem is many urban housing management departments do not have access to the information collected by their rural counterparts. Therefore it is impossible to know how many houses an urban resident owns in the countryside. It is also impossible for local governments to share information concerning the ownership of houses, home appraisal and local tax administration. According to many experts who participated in the formation of the 12th Five-Year Plan, though the property tax has gained the most attention, it is the tax they are the least confident about implementing.

Value-added Tax to Replace Sales Tax

Value-added tax reform is viewed as the most urgent tax reform task to be completed during the 12th Five-Year Plan.

With the shift of the value-added tax, the tax ratio of sales tax has become too high. Though it is only five percent, it is still too high a ratio because what companies pay in labor costs and material purchases is not deducted. In construction and transportation along with other sectors which are linked to fixed assets, the repeat tax collection is more serious because the tax is not deducted.

Yang Zhiyong, director of the financial politics research office under Chinese Academy of Social Science Institute of Finance and Trade Economics, said the reform of the value-added tax would begin from the construction and transportation sectors. Then it would be expanded to cover all the sectors which used to be covered by the sales tax. An Tifu, deputy chairman of the China Taxation Association, said that his agency has three possible plans to expand the value-added tax. The first is to completely replace the sales tax with the value-added tax; the second is to gradually expand the coverage of the value-added tax or to collect the value-added tax and then deduct the sales tax from it, while maintaining the same system of allocating taxes and tax collection; and the third plan is to deduct the sales tax from the value-added tax and still have local tax bureaus responsible for collecting the tax.

“A detailed tax reform plan will not be written in to the 12th Five-Year Plan, it will be determined during the coming five years,” an expert who participated in the planning of the 12th Five-Year Plan said.

Value-added tax is already the largest tax in China. It is predicted that it will account for 60 percent of China’s tax income after it replaces the sales tax. It is not safe for a country to have one single tax item with too much weight in its taxation system. Liu Zuo suggests reducing the rate of the value-added tax while expanding its coverage so as to reduce its total scale along with increasing the tax rate of other taxes and issuing new types of taxes.

Reshaping the Taxation System

The expansion of the value-added tax will reshape the current taxation system. Currently, the sales tax is the largest local tax; by merging it into the value-added tax it will become a central tax.

According to a government finance official, any shrinking of the coverage of the sales tax will surely lead to a strong reaction from local governments, especially those in western China. With inadequate tax revenue, western governments are unwilling to see the central government take their largest local tax revenue source away. However, the Ministry of Finance plans to transfer more tax revenue to western provinces so that their total revenue will remain unchanged.

Many experts do not approve of this plan. One expert suggested after the sales tax becomes a value-added tax, to have the service sector part of the tax be collected by local tax bureaus; another suggestion is to readjust the allocation ratios between local governments and the central government, raising the 25 percent local governments receive to make up for the lost sales tax revenue.

Yang Zhiyong said, since the value-added tax would be transferred to ordinary consumers, it is necessary to reduce the tax rate of personal income tax in order to avoid over taxing them.

Liu Zuo said the reform of the different taxes was stymied by the current taxation system, including the tax revenue allocation system between local governments and the central government; the 12th Five-Year Plan will address these problems.

“The next step should be increasing central-government taxes and local taxes while reducing the taxes shared between the two,” he said.

The question of which taxes should be collected by the central government and which should be collected by the local government is still dominating the debates among the Chinese government and academic circles. As Li Yang suggested, taxes collected from individuals and enterprises should be central taxes while the consumption tax should be defined as a local tax. A higher proportion of the value-added tax should be allocated to the central government while the newly-issued property tax and environmental tax should be local tax items.

This article was edited by Rose Scobie and Paul Pennay