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As a result of the WTO accession and rapid economic growth, China's current tax system lags far behind its economic development, making a new round of tax reforms essential. Observers, in fact, see the readjustments of the export rebate rates in the second half of 2003 as the prelude to these new tax reforms.
Tax is a major economic lever of macro control, as well as the main source of state revenue. For this reason, a tax system with rational structure and policies can effectively help adjust the redistribution of national income while promoting the flow of production means and guiding the optimum allocation of resources. In the process, economic growth will be strengthened resulting in much needed job creation, which will ensure social stability.
A series of statements recently made by Xie Xuren, commissioner of the State Administration of Taxation, indicate the official launch of this new round of tax reform, will be carried out according to the principles of "a simple tax system, wide tax base, low tax rate and strict administration of taxation."
The transition from a production-based VAT to a consumption-based VAT will spearhead this tax reform.
Ren Zhiqiang, president of the Beijing Hua Yuan Group, can't remember how much tax he has paid over the years. "When an immigration officer at the U.S. Embassy inquired about my income, I said I made lots of money and every year I pay millions of yuan in income tax. He asked me to show the receipts, I said I never got receipts from the government," said Ren.
According to Xie Xuren, commissioner of the State Administration of Taxation, problems perplexing taxpayers like Ren will be solved gradually, as China carried out its reform of the tax system step by step.
His view is echoed by Professor Gao Peiyong, deputy director of the Institute of Finance and Trade Economics under the Chinese Academy of Social Sciences. "As a matter of fact, readjustments of the export rebate rates in the second half of 2003 raised the curtain of a new round of tax reform in the country, which is characterized by structural adjustment," said Gao.
Tax reform mapped
At a forum on fiscal levy held in November 2003, Xie pointed out that the reform of the tax system should involve seven aspects:
--To transit the production-based value-added tax (VAT) to the consumption-based VAT;
--To bring the consumer tax into completion;
--To adopt a unified enterprise tax system;
--To improve the individual income tax;
--To reform taxes and fees on urban construction;
--To improve the local tax system; and
--To deepen the reform of taxes and fees in rural areas.
At a press conference held in mid-January, Xie specified a series of tax reforms, including:
--To practice the consumption-based VAT;
--To gradually adopt a uniform enterprise income tax system;
--To practice an individual income tax system that combines consolidated tax and classified tax;
--To cancel highway maintenance fees in the right time and to levy tax on fuel oil;
--To reform taxes and fees concerning urban construction and when conditions are mature, to levy uniform and standard property tax on real estate while canceling relevant fees; and
--To improve the local tax system by introducing some new tax items while canceling some old tax items, and under the prerequisite of uniform taxation, local governments will be granted with proper authority for the administration of tax revenue.
Rural tax and fee reforms will be experimented first in certain areas, which aim to phase out taxes and fees that should not be borne by farmers. Eventually a uniform tax system will be in place for both urban and rural areas. The government will abolish the agricultural specialty duty except on tobacco and gradually cut the agricultural tax rate. Meanwhile, three preferential tax polices will be adopted to help the reemployment of laid-off workers.
Reform can't be delayed
Both international and domestic situations call for the tax system to play a bigger role in the country's economic growth and deepening economic restructuring. In view of the international economic situation, economic globalization and regional economy are two main trends for the moment. In particular, the rapid development of international trade, the sharp increase of transnational investment and the enhanced coordination of international economy are exerting more and more impacts on the Chinese economy. In view of the domestic situation, China's socialist market economy is still at the initial stage and needs further improvement. Production and development still face many system-related obstacles.
However, the country's tax system is too complicated, the tax base is too narrow and the tax rate is comparatively high, in addition to loopholes in the administration of taxation. Because of these defects, the tax system can hardly suit the needs of opening to the outside world, deepening reform and accelerating economic development. It is necessary to make some adjustments to the current tax system.
During the 25 years since China adopted its reform and opening policies, it has carried out two major reforms on its tax system. The last one took place in 1994, which introduced the practice of tax sharing between the central and local governments, as well as the levy of VAT.
In November 2003, it was stated at the Third Plenary Session of the 16th Central Committee of the Communist Party of China that the country would "steadily push forward the reform of the tax system according to the principles of a simple tax system, wide tax base, low tax rate and strict administration of taxation.
In December 2003, China's Fiscal Policy Report 2003-04 was published, marking the determination of the general guidelines for the new round of tax reform. In 2004, China will carry out structural tax reduction in an all-round way.
"Structural adjustment, in simple terms, is the adjustment of income composition of different tax categories while the gross tax revenue remains unchanged, which means that tax on some items will increase and tax on some others will decrease," said Professor Gao Peiyong, adding that the most efficient way to optimize the country's economic structure is to adopt different tax rates for different trades.
As to when this round of tax reform will be officially launched and how long it will last, Professor An Tifu at the School of Finance, the Beijing-based Renmin University of China, said five years should be enough for the reform. With respect to VAT, the Central Government has chosen eight trades in northeast China for experiment, and experience drawn from there will be diffused nationwide.
The policy concerning the consolidation of the two types of enterprise income tax is expected to come out this year, given the long-time deliberation. The agricultural tax may be phased out in five years, but the levy of social security tax and death duty may take longer time.
Changes in the tax system are now mainly announced in the form of State Council regulations, but in future they will be subject to legislation by the National People's Congress. The making and revision of various regulations concerning fiscal levy will be in full swing this year. As they involve the balancing of various interests, a prolonged time period is expected.
Tax reduction imperative
According to Professor An Tifu, the core of this round of tax reform is tax reduction, which goes along with the current international tide of tax reduction. Under the circumstances of accelerating economic globalization, there are louder and louder voices calling for less interference of government and taxation in economies, as well as for the adoption of the principle of tax neutrality. Beginning from this century, Western countries, including the United States, Britain, France, Canada and Italy, introduced programs of tax reduction. At the end of 2003, the U.S. Congress adopted a plan of reducing US$1.35 trillion of taxes in 10 years. China, now a WTO member, has to consider such an international trend in order to enhance the competitiveness of its enterprises and attract more foreign investment.
According to the analysis of Professor An Tifu, a total of about 150 billion yuan (US$18.12 billion) will be reduced in tax revenue.
Due to VAT transition, a total of 60-80 billion yuan (US$7.25-3.66 billion) will be reduced, but the figure may be smaller if the reform is carried out step by step.
In the consolidation of the two types of enterprise income tax, as the new standard will approach toward foreign-invested enterprises, 20-30 billion yuan (US$2.42-3.62 billion) may be reduced from the tax revenue.
Following the reform of taxes and fees in rural areas, the agricultural tax and other surcharges, which amount to some 60 billion yuan (US$7.25 billion), will be cut. But due to lower export rebate rates, it is estimated that about 20 billion yuan (US$2.24 billion) will be added to the tax revenue.
Therefore, the tax revenue will reduce about 150 billion yuan (US$18.12 billion) in five years, with an annual reduction of 30 billion yuan (US$3.62 billion), which, however, will only account for around 10 percent of this year's additional tax revenue. Evidently, such tax reduction is within the capacity of the treasury. Moreover, with the improvement of the tax system and stricter administration of taxation, the figure of tax reduction might be smaller. In the long run, the tax revenue will surely increase.
Tax Reform Highlights
VAT Transition to Spur Investment. The transition from the production-based VAT to the consumption-based VAT is placed at the forefront of this round of tax reforms. According to Professor Gao Peiyong, the government hopes to spur the investment of enterprises and boost non-government investment. While the production-based VAT can only deduct the tax amount to be paid on the purchase of the means of production that belong to non-fixed assets, the consumption-based VAT allows enterprises to deduct the taxes contained in the investment in machinery and equipment in the current year's newly added fixed assets. That is to say, when an enterprise pays the VAT, it may deduct the taxes contained in the purchase of fixed assets. In doing so, the tax base is narrowed and repetitious tax levy is avoided.
The biggest beneficiaries of the VAT transition will be enterprises that have a large proportion of fixed assets investment, such as large and medium-sized state-owned enterprises and some hi-tech enterprises. In micro terms, the reform will give motivation to enterprises for increasing investment and engaging in technological upgrading. In macro terms, the reform will help promote the development of key industries and hi-tech industries, thus accelerate the industrial restructuring.
Though the reform will reduce revenue from VAT in the short term, it will render vigorous support to the development of relevant industries and motivate enterprises to increase investment and conduct technological upgrading, which is good for optimizing the industrial structure and enhancing the competitiveness of enterprises. Therefore, the reform will promote economic development and increase tax revenue in the long run.
Fair Principles. A uniform enterprise income tax system will display the principle of fairness and means uniform standards for the identification of taxpayers, the deduction of pretax costs and expenses, tax rates, preferential policies, etc.
Currently, there are two parallel enterprise income tax systems in China. The income tax rate is 33 percent for domestic enterprises and 15 percent for foreign-invested enterprises. Taking into consideration various preferential tax policies, the actual income tax for domestic enterprises averages at around 22 percent, while that for foreign-invested enterprises averages at around 11 percent. That means the income tax rate for foreign-invested enterprises is 50 percent lower than that for domestic enterprises.
At the initial stage of China's reform and opening-up drive, China provided many tax policies favorable to foreign-invested enterprises as an effort to attract more foreign investment. Today, the economic environment is much different and the tax discrepancy might hinder the fair competition among enterprises. Besides, tax discrepancy has also given rise to such phenomena as the tax evasion of domestic enterprises, bogus joint ventures and empty-shell enterprises over the past years. As a member of the World Trade Organization (WTO), China's current tax system is against the WTO principle of neutrality. It is also against the principles of free trade and equal competition advocated by the WTO.
Individual Income Tax. Individual income tax is a public concern. The new tax system will feature the combination of consolidated and classified individual income tax, with pretax deduction items and standards as well as tax rates to be adjusted. Western countries usually adopt the consolidated individual income tax system, by which an individual's total annual income are added up and a progressive rate is adopted on the individual income. China's classified taxation system currently in practice cannot reflect the true taxpaying capacity of residents. But as the consolidated tax system requires the support from the accounting department, the management and banks, as well as a relatively complete social credit system, all of which still lag behind in China, a combined system can be adopted for the time being.
The zero bracket amount, or the standard deduction of income which is not taxed for taxpayers, will probably be raised. The current amount of 800 yuan (US$96.62) is obviously too low. However, due to uneven development in different provinces, autonomous regions and municipalities, the standard to levy individual income tax may vary.
(Beijing Review February 11, 2004)
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