China should adjust its tax policies on interest income from personal savings to protect the interests of small and medium depositors, experts said.

Zhang Peisen, Taxation Research Institute senior researcher at the State Administration of Taxation, said the tax policy does not conform to the country's present macro-economic situation.

"The 20 per cent tax rate on interest earnings reduces the purchasing power of medium- and low-income residents who must bear increasing inflationary pressure amid the country's fast growing economy," he said.

Chinese residents are still suffering from negative interest rates, despite the People's Bank of China, the central bank, raised the benchmark interest rate on one-year deposits by 0.27 percentage points late last month.

Figures from the National Bureau of Statistics suggest that China's consumer price index (CPI), policy-makers' key inflation gauge, rose a year-on-year 4.1 per cent during the first 10 months of this year.

But the benchmark interest rate on one-year deposits stands at 2.25 per cent after the recent interest rate hike -- the first time in nearly a decade.

"If China's CPI rose to more than 5 per cent, which means the country might start to face high-level inflation, it would have a big impact on ordinary residents' consumption behaviours," Zhang said.

The country's CPI rose to 5.3 per cent in July and August and slowed to 4.3 per cent in October.

The higher prices for food and public utilities such as water and natural gas have begun to put increasing pressure on medium and low-income families.

The government should adjust the tax policy on interest in a timely way, in co-ordination with the recent adjustments in the interest rates, Zhang said.

"Smooth co-ordination between monetary policy and fiscal policy is important for China to establish a market-oriented economy," he said.

The government could choose to call off the tax policy, or reduce the tax rate, or set a threshold for such taxation, to protect the interests of medium and low-income depositors, he said.

Qi Jingmei, a senior economist with the State Information Centre, agreed there was a need to adjust the tax policy.

"The tax failed to meet its original goal to stimulate investment and consumption," she said.

A lack of investment channels have curbed the use of private money, she said. "People still put their money in bank accounts."

Although the country imposed the tax on interest and has cut interest rates eight times since 1996, the growth of societal consumption was far less than those of bank deposits, she said.

Weak consumption was mainly because of residents' low expectations for their income growth, Qi said.

An unsound social security system has forced most Chinese to deposit their money in banks for future expenditures in housing, medical treatment and their children's education, she said.

For most of China's residents, especially laid-off workers and farmers, interest rate earnings have become an important source of income, she said.

However, Qi said recent interest rate hikes minimize the possibility of any changes in the tax policy.

"The rate hike is more symbolic than actual," she said.

It was a signal that the central bank might further raise the interest rates, she said.

The government has seldom before used both monetary policy and fiscal policy simultaneously to adjust the economy, she said.

Xie Fuzhan, deputy director of the State Council's Development Research Centre, said early this month that interest rates still need to be adjusted, because interest rates are negative.

But the government needs some time to observe the impacts of recent rate hikes before taking new actions, he said.

Ni Hongri, a senior researcher with the centre, agreed that pressure on tax policy adjustments was alleviated after the recent rate hike.

The CPI is also expected to drop in the fourth quarter.

Meanwhile, fiscal revenues are still not enough to meet expenditure demands.

"The government is unlikely to give up the tax," she said.

A perfect tax system also needs such tax variety, she said.

(China Daily November 15, 2004)