China's fiscal and taxation system has experienced important changes in past decades.
Great achievements have also been witnessed in fiscal and taxation reforms.
The system has laid a solid foundation and provides strong financial support for the government to effectively implement macro-control measures.
However, the present fiscal and taxation system is only a transitional one and cannot meet the demands brought about by the development of a socialist market economy.
The reforms in fiscal revenue management, the expenditure management system, and the central and local budget management system are not complete.
The fiscal system has accumulated a lot of experience in adjustment of the total economic volume. But it has played a weak role in adjusting the economic structure, including the industry structure and income distribution. The existing fiscal and taxation systems need further reform.
Public service first
Government finance should focus on social public services, rather than developing the economy and fostering financial sources. The government does not need to collect money to develop the economy first, then provide public services.
The government should rely on the market to develop the economy, while government finance should be used to meet the expenditure demand of the public sector.
First priority should be given to expenditure on national defense, government administration, the provision of a basic education, basic medical and basic social security.
Emphasis should also be given to expenditure on higher education, science and infrastructure.
Expenditure system
In the coming decades, the ratio of government expenditure on economic construction should be reduced. Expenditure on infrastructure should also be gradually cut back.
Substantial reforms should be conducted on supply and management of government expenditure for institutions in sectors such as healthcare and higher education.
Market mechanisms should be introduced and non-government funds should be used to develop science, higher education and part of the healthcare undertakings.
Tax system reform
The tax system plays an important role in macro-economic control.
The government should try to enhance the role of income tax and raise the ratio of income tax revenue to total revenue.
This would be beneficial for the sustainable development of the country's fiscal revenue.
It would also be beneficial for the adjustment of income distribution.
The fiscal system could then better play the role of an automatic stabilizer for the economy.
Since China initiated its reform and opening-up in 1979, the government has conducted two major comprehensive fiscal and taxation reforms, in 1983-1984 and 1994 respectively.
These reforms achieved great success, but there are also many problems.
The third reform, which is expected to start next year, could improve some of the existing tax varieties first, then gradually improve the whole system.
This will help stabilize tax revenue, reduce risks and improve the efficiency of the reform.
Value added tax
The government should first shift the current production-based value added tax (VAT) system to a consumption-based one.
Then it should replace the business tax with VAT.
Under the existing system, fixed assets are classified as consumer goods and are subject to the tax.
As a result, business cannot claim tax deductions for the purchase of fixed assets such as equipment and machinery.
The system places a heavy burden on those businesses seeking to increase their fixed asset investment, especially for those capital- and technology-intensive companies.
But if the government shifts the production-based VAT to a consumption-based one, it will lose 60 billion to 80 billion yuan (US$7.2 billion to US$9.6 billion) of fiscal revenue.
The government could, however, first shift the production-based tax to an income-based one to reduce fiscal revenue loss and later shift the income-based tax to a consumption-based one at the appropriate time.
Replacing the business tax with VAT is quite complicated, because it involves the reform of the tax co-sharing system between central and local governments.
The reform could be conducted step by step, starting with industries such as finance and railways.
Enterprise income tax
Since China has become a World Trade Organization member, it is imperative that the country should unify business income tax policies.
The country currently has dual-track enterprise income tax policies for domestic and foreign-funded companies.
The income tax rate for domestic firms is 33 percent, while that for foreign-funded companies stands at 17 percent.
The country should implement an equitable system so that both domestic and foreign enterprises can compete on an equal footing. The new tax rate could be set at 27 to 30 percent.
Personal income tax
Personal income tax should become a major tax variety of any future tax system.
The role of the tax is more important than enterprise income tax.
The government will have to particularly focus on its improvement.
The existing personal income tax system is unfair and has many loopholes which tax evaders exploit.
Experts and government officials have basically reached a common consensus on the reforms needed.
Construction of a nationwide credit-rating system and information sharing between banks and tax departments should be speeded up to facilitate the personal income tax reform.
Social security tax and property tax
The country should levy a social security tax at the proper time.
Existing social security fees should be replaced by a tax and collected by tax departments.
The government should also introduce a property tax, again at the right time.
Along with the rapid growth of property owned by individuals, the property tax system should be improved.
Levying of such taxes is not only beneficial for adjustment of income distribution, but also beneficial for exploring new tax sources for local governments.
Import and export tax and agriculture tax
Under the existing tax system, development of foreign trade places increasingly greater pressure on fiscal revenue.
Tax rebates have resulted in a considerable threat to the balance of fiscal revenue and expenditure.
The government should take measures to improve the existing import tax system, tax rebate system, processing trade tax system and management system of import and export tax.
The tax system should reduce reliance on VAT and raise the ratio of income tax.
The government should set a sound tax rebate rate and ensure timely repayment of tax to companies to support exports.
And it should gradually do away with the agriculture tax system.
The government is currently placing greater emphasis on the "tax-for-fees" reform in the rural areas and is gradually lowering the agriculture tax rate.
The reform of the agriculture tax should eventually lead to its abolition and a unified tax system, such as that which exists in the cities.
Distribution mechanism
The central government should try to rationalize and regularize the distribution relationship and management system between central and local finance.
The local government could start by levying new taxes, such as a property tax, to improve the local tax system.
Local governments should also be given the freedom to levy some taxes of their choosing.
Meanwhile, the budget law should be revised at the right time.
The government should reform the existing expenditure management system, increase budget transparency and improve management of expenditure.
Economic structure
The next 10 years are an important period for the Chinese Government to build a xiaokang society.
Government finance will have to try to solve the problem of the gap between urban and rural areas, the income gap and the gap between east, central and western areas.
The government must help reduce the burden on farmers, raise their incomes and increase input into rural areas.
The government should also effect a series of measures, including tax breaks and payment transfer, to support development in central and western areas.
Today, China's economy has entered a new period of rapid growth. Market forces have begun to play an important role in propelling economic growth.
In the coming five years, the necessity to fuel the economy through a pro-active fiscal policy will weaken.
The existing fiscal policy should be phased out to reduce the fiscal deficit and the volume of treasury bonds issuance.
The authors are researchers with the State Council's Development Research Center.
(China Daily July 21, 2003)
