Aravind Yelery, Associate Fellow, Institute of Chinese Studies.
China’s ‘new normal’ rate of economic growth also means fall in revenues and possible uncontrolled expenditure patterns in China. In this situation “deepening the reform of the tax system [and] establishment of a modern financial system” become important. The leadership is under overwhelming pressure to revamp its tax system to suit changing fiscal dynamics. The People’s Bank of China (PBoC) is planning to reduce the tax burden on Chinese businesses and raise hopes of economic growth. Since April 2016, the PBoC has convened a series of meetings of its various departments in Beijing to discuss the way forward and plan the ground for the upcoming 13th five year plan and tax reforms were flagged as the top priority. The closed-door meeting called for tax cuts and a gradual expansion of tax bases. This signals a willingness of leadership to take new and concrete steps toward reducing business taxes in China, streamlining the tax system and integrating various tax-related laws in 2016.
China’s current tax structure is based on indirect taxes. Hence, the reforms have to take care of balancing the indirect and direct taxes by gradually increasing the proportion of direct taxes. The increase in direct taxes would mean raising the proportion of personal income tax revenue and at the same time introducing other direct taxes. In 2012, the government started phasing in a business-friendly programme that would replace business taxes with VAT, with the goal of full implementation by 2015 but this has not happened. It was expected that the shift to VAT from business taxes alone would reduce total tax collections by at least RMB900 billion. By June 2015, according to the state taxation office, the total tax revenues were reduced by RMB485 billion. A more comprehensive reform plan for property taxes, resource taxes and streamlining of the system for distributing tax revenues among local and central governments was introduced in 2014, and is supposed to be completed by the end of 2016. This plan too seems unlikely to be completed in time.
It is surprising for a country like China, which is fiscally and administratively centralised, to miss deadlines and it seems that the government purposely missed its goal for shifting from the business tax to VAT in order to shore up its revenue stream. So far, the shift has yet to affect building construction companies, financial services firms and other businesses in the service sector. The same story was witnessed when the property taxes were introduced as direct taxes to deal with the inflation in real estate and cut the burden on property developers. The tax was initially introduced in select cities (Chongqing and Shanghai for instance) but the plans to phase in property taxes were never fully realised. One of the government’s reasons for such hesitation was explained in April 2015 when the Finance Minister, Lou Jiwei, made a statement that changing the system for taxing property owners and construction businesses would hurt government revenues.
So what can we expect in 2016 in terms of tax reforms? The fiscal reforms, which were set in motion in 2014, proposed six broad tax reforms, namely, business tax reform in the form of VAT, resource or rare earth tax, consumption tax, real estate tax, environmental tax and personal income tax. The business tax is still to be fully adopted under the new VAT regime as it has still not been implemented optimally in the test cities. As far as the resource tax – ad valorem – is concerned (levied against only certain minerals, and not rare earth materials hitherto), it is expected to solve the long-standing problem of lack of revenue from the rare earths industry. The government is also trying to rectify the imbalance in the consumption taxes by introducing taxes on high energy consumption, high pollution and high-end consumer goods. The most challenging part of tax reforms is the real estate tax or the property tax, which remains highly contested and it could need thorough debate before being adopted by the provinces. The individual housing property tax collection is far more difficult than collecting personal income tax. Since individual housing does not always generate cash flow, citizens are reluctant to pay the housing taxes using their personal incomes.
As the government plans to implement the new tax regime, there seems to be a growing confusion in the country. For example, because of the complexity of reforms and given the uncertain time schedule for a complete business tax-to-VAT conversion, authorities are applying different VAT rates, ranging from zero to 17 percent, to different kinds of businesses. The basic flaw lies in the foundation of taxation in China – reforms in taxation need to follow certain frameworks to gradually establish and improve the rules, including the constitution, tax law (general tax), substantive tax law (law on VAT, income tax, profits of legal entities and others, etc.), tax penalties, tax relief and other tax laws and regulations. The tax reforms will not be fruitful if standardization of law enforcement activities by tax authorities is not carried out efficiently.