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The abolition or major reduction of interest tax is much needed not only because it will help soak up excessive liquidity, but more importantly, because it complies with the country's economic reality.

It has been reported that lawmakers yesterday deliberated a proposal authorizing the State Council to reduce or cancel the tax on interest accrued from deposits.

Nominally, the benchmark one-year deposits pay interest of 3.06 percent. However, when the 20 percent interest tax and rising inflation, which hit a two-year high of 3.4 percent in May, are taken into account, the true rate is deep in negative territory.

Canceling the tax will have an effect equal to two interest rate hikes of 27 basis points each, the typical step the central bank has made to gradually rein in liquidity.

So, it is natural the possible removal of the interest tax would prompt the red-hot stock market to hold its breath for a while. With the removal of interest tax, bank deposits would be more appealing and thus some investors would be persuaded to step away from the stock market.

Given the immediate cooling effect of such a tax cut, it has to be worth a try for policymakers.

However, the key reason that such a tax cut has been much expected is because interest tax has proved largely irrelevant to the country's economic reality.

When the tax was introduced in 1999, its aim was to encourage people to consume more and save less.

These days, however, the country is dependent on investment and exports for growth, although domestic consumption has also grown recently. As long as public expenditure on education, healthcare and social welfare remains inadequate, people will try to save as much as they can for rainy days. The imposition of a 20-percent interest tax will not change that, but it will dent their purchasing power.

Besides, the rapidly ballooning national coffers mean the government can now afford to lose this source of funds. While the economy has been growing by about 10 percent annually in recent years, the country's tax revenue has soared by more than 20 percent.

Finally, the flat rate of interest tax is a barrier instead of a boost to the country's efforts to narrow the widening income gap. The single rate bites the poor much harder than it does the rich.

(China Daily June 28, 2007)