China Should Maintain Low Tax Rates, Says OECD

by Mike Godfrey, Tax-News.com, Washington

26 September 2005

In its first economic report on China, the Paris-based OECD has approved the country's low tax corporate rates and recommends a reduction in top marginal income tax rates.

Such changes would align China with a number of other transition countries that have found that a low tax rate encourages the declaration of income and improves incentives for economic activity, says the OECD. The corporate tax rate is currently 15% for foreign companies, while domestic companies can pay twice as much, but China is in fact planning to harmonize the two rates at some median figure, on an uncertain timescale.

Commenting on the report, Dan Mitchell of the Centre for Freedom and Prosperity says that the OECD's bureaucrats are 'schizophrenic'. 'This is the same bureaucracy that has a "harmful tax competition" project designed to persecute jurisdictions with low taxes,' says Mr Mitchell. 'Just because the OECD occasionally reaches the right conclusion, that does not mean it should exist. And U.S. taxpayers certainly should not be picking up 25 percent of the cost of a bureaucracy that frequently churns out anti-American policies.'

Says the OECD in its September report:

'China’s economic growth has averaged 9½ per cent over the past two decades. The rapid pace of economic change is likely to be sustained for some time. These gains have contributed not only to higher personal incomes, but also to a significant reduction in poverty. At the same time, the economy has become substantially integrated with the world economy. A large part of these gains have come through profound shifts in government policies. Reforms have allowed market prices and private investors to play a significant role in production and trade.

'The scope of private ownership has become substantial, producing well over half of GDP and an overwhelming share of exports. Private companies generate most new jobs and are improving the productivity and profitability of the whole economy. The government has restructured the state-owned business sector, resulting in a massive loss of jobs. Still, a large part of the state sector remains to be restructured; policies to facilitate this process have been identified and are being expanded. The performance of the business sector could be strengthened more through a further modernisation of the business framework and better enforcement of laws in the economic sphere, especially those for intellectual property rights.

' A more flexible exchange rate would support a stable macroeconomic environment. While fiscal policy has been run in a stabilising fashion, the outcome of monetary policy has been considerable volatility of inflation. Greater flexibility of the exchange rate would allow the authorities to guard against any further increase in inflation in both product and asset markets, more easily adapt monetary policy to domestic concerns, and allow market forces to determine bank interest rates to a greater extent. The change in the exchange rate arrangements announced in July 2005 is a step in that direction.

'Until five years ago, lending policies led to the accumulation of a considerable quantity of bad loans. The recapitalisation of more than two-thirds of the banking system to eliminate this historical burden is almost complete and the cost to public finances of completing the exercise, while substantial, appears to be manageable. Wide-ranging reforms have improved the capacity of banks to make market-based lending decisions. Overall, these policies appear to have been successful, as new loans have been of much higher quality, even using the new, more realistic, classification system for non-performing loans. Further progress will require a continued focus on improving governance and increasing private ownership. Policies designed to expand and further deregulate capital markets would improve the allocation of capital, lower the risk of further waste of savings, and minimise systemic risk.

'Rapid growth of revenues and control of expenditure has put public finances in a sound position. As a result there is scope to move towards less discriminatory taxation of different types of companies and activities, while maintaining low marginal tax rates. Expenditure on health and education both in rural areas and for migrants in urban areas could also be strengthened, but achieving this objective may require an overhaul of fiscal relations between different levels of governments. Such spending would help reduce inequalities but would need to be complemented by further labour market reforms. Additional reductions on the restraints to migration would help to facilitate a more rapid pace of urbanisation that could help to reduce income inequalities, especially if public services are guaranteed to newcomers and if those who leave rural areas do not lose their land-use rights. Increased urbanisation would need to be accompanied by policies designed to lower the high level of pollution in an efficient, economic fashion.'

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