Tax reform is one of the major issues in ongoing economic reforms. It has a long-term influence on the economy.

Some of the measures have been under way for quite some time.

The reform to rebate export tariffs was initiated at the beginning of 2004. Many provinces have decided to stop collecting agricultural tax from farmers.

A pilot project on reforming value-added tax (VAT) was also carried out in Northeast China. By replacing the current "production-based" VAT with "consumption-based" VAT, the pilot project has substantially reduced costs for capital investment in relevant industries in three provinces in the northeast.

However, opinions are still divided on whether the tax reform should be sped up or slowed down. Some even think the tax reform should be held up and target new objects.

Challengers of the tax reform argue that it will have negative effects on the central government's endeavour to cool down the overheated economy.

They base their reasoning on the claim that tax cuts and VAT reform will spur investment growth.

If the tax reform is furthered, they think, it will pour oil on fire and make the economy even more heated.

Their statement sounds solid to some extent. But the problem is that only several sectors of the economy are over-heated and the government's policies to rein in the momentum have hit home.

The rise in bank credits is checked, the money supply falls to normal level, and investment growth is curbed.

Investment in fixed assets grew by 30 per cent in 2004, 13 percentage points lower than that in the first three months of the year.

Bank credits grew by 13.5 per cent by the end of last November, 7.6 percentage points lower than that at the end of 2003.

And the broad money M2, an index indicating the money supply, grew by 14 per cent by November, 5.2 percentage points lower than that in the first three months of last year.

As a matter of fact, it is too simple to summarize the challenges facing the economy with the simple words, "hot" or "cool."

The major economic problems to tackle are lopsided structure, absence of effective systems and policies and low efficiency in resource re-allocation.

Further tax reform will lend a strong hand to resolve these problems.

First of all, the tax reform will help upgrade economic structure. With a less-than-developed tertiary sector and huge differences between regions and urban and rural economies, China's economic structure calls for a timely upgrading.

By reforming VAT and raising the tax-deductible costs on research and development, the reform will provoke the development of high and new technology sectors, upgrading the industrial structure.

By imposing unified tax rates on domestic and foreign-invested companies, it will narrow the disparity between regions with different degrees of penetration of foreign investment.

The reform will also bridge the urban-rural difference with its unification of tax items and rates for rural and urban residents and economic units.

The tax reform will also help establish a more effective tax system, a key part in the whole economic and social system.

An "effective" tax system can take care of both fairness and efficiency in society. The tax reform is obviously orientated to such an end.

The tax reform will eliminate the items that are repeatedly calculated in tax collection, which will improve the efficiency of resources re-allocation.

It will also lower the rates of income taxes for businesses, reduce the chances for them to evade taxes and elevate the efficiency of tax-collection.

The VAT reform and unification of tax rates for domestic and foreign businesses would offer a fair ground on which they compete with each other.

When both fairness and efficiency are boosted in society, it will definitely bring us closer to the goal of establishing a market-economy in the country.

Finally, the tax reform will promote the flow of resources to the non-government sectors by dramatically cutting down the taxes. This way, the market will play a bigger role in resources re-allocation and boost the efficiency of using resources in the country.

Worries abound on whether the tax reform will harm the country's efforts to lure foreign investment, for the favourable treatment for foreign-invested businesses will be eliminated.

It is true that the tax authorities will give the same tax rate to domestic and foreign-invested businesses after the reform. And the tax rate will probably stand between the current levels for the two, hence lowering the rate for domestic and raising it for foreign ones.

To make the businesses profitable, the investment destinations must have facilitating banks, transportation, telecommunications, insurance and fairly high efficiency.

Only after these factors are all met would the investors consider favourable treatment, such as tax cuts.

In other words, the tax rate is a factor ranking quite low in investors' decision making. And a favourable tax rate could only make an already good investment environment better.

Removing favourable tax treatment to foreign businesses may have some influence for small and middle-sized businesses, but it will have only minor effects on the decisions of the large multinational ones.

Currently, the Chinese economy is taking an upward curve, offering an excellent chance for furthering tax reform.

In recent years, the growth rate of tax revenue has been far higher than the GDP growth.

The tax revenue rose to 2.57 trillion yuan (US$310 billion) last year, 25.7 per cent higher than that in 2003. That has enabled the government to consider reducing taxes at this moment.

It is estimated that the tax reform will cut taxes worth 200 to 250 billion yuan (US$24.1 to 30.1 billion) in five years. On average, tax revenue will only be reduced by 40 to 50 billion yuan (US$4.8 to 6 billion) every year, less than 10 per cent of the growth in tax revenue achieved in 2004.

Certainly the State coffers can withstand this reduction.

By reducing the taxes in the tax reform, a more rational proportion between the revenue growth and economic growth will be achieved.

(China Daily January 24, 2005)