China moves to a more mature tax system as it adjusts the threshold at which income is taxed amid economic changes, and industry experts say this is more important than the actual rise in the threshold.
From March 1, the threshold for an individual's salary to be taxed will be raised from 1,600 yuan (US$219.48) to 2,000 yuan. For expatriates, the threshold is 5,200 yuan as they enjoy another deduction of 3,200 yuan.
The 31st session of the Standing Committee of the National People's Congress, China's top legislature raised the threshold on December 29.
The threshold has been set, yet discussions on it have not ended.
Bold signal
"The increase in the tax levy threshold amid China's economic changes signals a step forward as the nation builds a more mature taxation system," said Jason Mi, an Ernst & Young tax partner. "In a sense, such a trend (to build a more mature tax system) is more significant than the exact threshold change."
Joyce Xu, a Deloitte tax partner, shares the view. "The increase in the individual income tax personal exemption has taken into consideration the inflationary increases, cost of living factors and with a focus on alleviating the tax burden for the lower income group and this is well supported by China's increasing fiscal revenue," she said.
China introduced an individual income tax law in 1980 when paying tax was an alien concept to most people. Then the threshold at which an individual was taxed on his monthly salary was 800 yuan.
It took China more than two decades to adjust the threshold for the first time. In January 2006, the threshold was doubled to 1,600 yuan. The second adjustment came a lot quicker in December 2007.
"To adjust individual income tax threshold from an interval of two decades to two years is a very significant progress indeed. It is clear that China is making serious efforts to better align the country's individual income tax system with international 'best practice' and is drawing experiences from countries with a more mature tax system," said Xu.
"In developed countries such as the United Kingdom (where the individual income tax concept originated and the system created in 1799), the threshold is annually updated in its fiscal budget to keep pace with the economic environment and in particular the retail price index," said Xu who started her career in a "big 4" accounting firm in London 14 years ago.
Impact on revenue
Chinese Finance Minister Xie Xuren said although the country will lose 30 billion yuan due to the latest threshold increase, it is still acceptable.
Industry experts said the loss will not be severe for China's fiscal revenue on account of its growing economy and individual income growth.
Statistics seem to bear this out. In 2006, when China doubled the threshold of individual tax income, tax revenue jumped 17 percent to 245.23 billion yuan. In the first nine months of 2007, individual income tax revenue topped 241.38 billion yuan.
China's individual income tax has been growing by double digits for two decades, outpacing economic growth.
The latest threshold increase sends a signal to bread earners that the government will consider fully the burden of inflation, which hits medium- and low-income earners.
The latest rise in the threshold would exempt 70 percent of wage earners from paying income tax. The earlier threshold of 1,600 yuan exempted 50 percent of wage earners from paying income tax.
"Individual income tax is growing steady and is expected to remain so amid China's economic expansion," said Ernst & Young's Mi, a veteran with more than a decade's experience in the industry. He said that "the rise in the threshold will not cast a big shadow on China's tax revenue."
Meanwhile, the threshold increase can also boost consumption and be a catalyst for a consumption-driven economy, which the government encourages.
Deciding factors
Xie said every income earner would bear an annual expenditure of as much as 19,030 yuan, or 1,586 yuan per month, for a family's food, clothing, accommodation and transport. It's likely expenditure will further increase and so the individual income tax cutoff point was adjusted to 2,000 yuan a month, industry experts said, adding that factors including the consumer price index, medical costs, rents and education costs may also have been considered.
China's CPI, the main gauge of inflation, rose 6.9 percent in November, a more than decade high.
Deloitte's Xu said the threshold increase indicated the government is more conscientiously and confidently using tax policy as part of a macroeconomic leverage.
But some academics said the CPI is not enough as it doesn't include property prices. Ernst & Young's Mi has a different view. He said as buying properties is more for long-term investment, not for consumption, it is reasonable not to consider the property costs in the CPI. But he added it is worth discussing whether to include it as a factor in deciding the individual income tax threshold.
Other factors
Experts said China could also learn from other countries' practices. For instance, in the UK, there are additional tax relief for married couples, single parents, old people and people with disability.
"In addition to reducing the tax burden by introducing a higher income tax threshold, we may also wish to consider introducing additional tax relief in line with international best practice and experience," Xu said.
For example, China's single-child policy has seen Chinese parents' education expenditure on children accounting for a big proportion of family income.
"Some degree of tax relief in recognition of the significant education expenses that most Chinese families would incur in investing in their children's future could be considered under the individual income tax system," Xu suggested.
Also, relief should also be considered for people who support aging parents, Xu added.
"A multiple approach toward a tax relief system targeting differing fundamental needs may be effective as opposed to a total and sole reliance of an increase in the individual income tax threshold," Xu said.
Mi also suggested a floating system for the individual tax threshold - in cities with higher living costs, there can be a certain percentage of increase allowed on the threshold.
(Shanghai Daily January 7, 2008)
