Chinese Tax System In Need Of Substantial Reform, Report Suggests

by Mary Swire, Tax-News.com, Hong Kong

04 October 2002

The Chinese income tax system needs far-reaching reform if it is to contribute effectively to the country's economic development, according to an article in the Far Eastern Economic Review (FEER).

Citing rampant tax evasion and an anachronistic (despite having only existed for around 20 years) regime as problematic areas, the business weekly observed that:

'China is clearly growing nervous about taxes and for good reason. The government needs a stable source of revenue to keep a lid on stresses racking the economy - from layoffs to bad loans to pension liabilities. If left untended, these fissures in the economic system could bring China's remarkable record of economic growth to an abrupt halt.'

The report continued: 'Much is at stake. Beijing is pumping so much money into underdeveloped regions that some areas with small tax bases tap the central coffers for up to 90% of their budgets. Even more worryingly, the fiscal deficit is only part of the government's potential liabilities.'

In order to address the predicted 309 billion renminbi ($37 billion) revenue collection shortfall, the Chinese authorities have been conducting a high profile campaign to stamp out tax evasion by wealthy individuals. However, experts in the region believe that this is, at best, a partial solution, and that the entire tax system needs to be simplified and made more equitable, and the punitive top rates need to be lowered in order to remove the disincentive for declaring taxable income.

Chief China economist at Morgan Stanley, Andy Xie confirmed this, explaing to the FEER that: 'China has to simplify and lower the rates before individual taxes can be collected. I don't think it'll work otherwise. They can control employees of large enterprises, but they can't control the rest of the population. If they have 15%-20% tax rates then it can work.'

Meanwhile, uncertainty over plans to equalize the tax treatment of local and foreign firms, after years of providing incentives for the latter is making a lot of corporate taxpayers on the Chinese mainland nervous.

'It is unclear whether this [equalization] will happen next year, what the ultimate corporate tax rate will be, or what sort of exemptions existing investors will get,' the FEER article explained.

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