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Print[Ferro-alloys.com]Reform of the taxation system will be a topic of significant importance at the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) to be held in October, according to some media sources.
The Third Session of the 11th Central Committee of the CPC held 35 years ago inaugurated China's reform and opening up. After more than 30 years, the Chinese economy now faces slower and sluggish growth. The Third Session of the 18th Central Committee of the CPC will further China's reform and opening up in light of current economic circumstances.
When the new cabinet was unveiled in March, it announced three major targets for economic reform in taxation, financial and market systems. Among them, taxation reform is considered top priority.
Wang Jun, head of the State Administration of Taxation, has repeatedly said reforming China's tax laws are vital if China is going to successfully complete transition from a dependence on investment and exports to a more consumer-oriented economy. The change from a business to a value-added tax, a major measure of the reform, began across China on August 1. Shanghai was the initial testing ground for the tax on January 1, 2012, before it was extended to another nine provinces and municipalities, including Beijing and Jiangsu and Anhui provinces.
Tax plays its part
China's auditing authority is now reviewing local government debts nationwide, a move by the Central Government to determine the financial status of local governments in preparation for further tax reforms.
During 35 years of reform and opening up, tax reform has contributed to China's economic development. At the end of the 1970s, when China first adopted its policy of reform and opening up, the Central Government began a system whereby it would delegate taxation powers to lower levels of government and receive little tax income itself, according to Gao Peiyong, Director of the National Academy of Economic Strategy at the Chinese Academy of Social Sciences.
In the early 1990s, China's reform and opening up entered a new stage, and with it came a revision of the tax code. There were three major changes in China's tax reforms of 1993. First, dividing spending from central and local budgets. Spending for national defense, diplomacy and armed forces, national level infrastructure projects, and the repayment of domestic and foreign debt to be paid for by the Central Government.
Local governments would be responsible for provincial and municipal level infrastructure development, research and development of new products by enterprises under local governments, urban construction, as well as spending for local cultural, education and healthcare programs.
Second, dividing the distribution of tax revenues between central and local governments. A dozen taxes, including tariffs, consumption and value-added taxes collected by customs, income taxes and profits paid by enterprises directly under the Central Government would all go to the Central Government.
Some 20 tax items such as business, individual income, urban land use, vehicle and stamp taxes would belong to local governments.
Several other items of tax revenue would be shared by Central and local governments, including the value-added tax, resource taxes and securities tax.
Third, establishing a system of transfer payments. According to the above divisions, 60 percent of tax revenues are designed to belong to the Central Government and 40 percent to local governments, while 60 percent of spending would fall at the hands of local governments and 40 percent at the Central Government. The 20-percent difference goes to the system of transfer payments.
The tax reform of 1993 has also been called the "tax division system" reform by economists. Gao says this tax division system enriches the Central Government's budget, and through transfer payments, China is able to balance the fiscal ability of its different regions in order to improve people's well-being and maintain sustained and rapid growth of the national economy.
New situation
Why is China reforming its tax system now?
Before China can solve the problems harassing its economic and social development, tax reform is needed. For example, to accelerate the transformation of its economic growth model away from a reliance on exports and investment and toward consumption, local governments must have a motive to do so, and reforming the tax system could do the trick. In other words, the present tax system is no longer able to provide enough impetus for economic development.
In recent years, Chinese economic growth has been declining and local governments are racked in financial difficulties. Many make investments on borrowed money to stimulate the economy. But experts say that tax revenue and spending by all levels of governments don't match. Many economists blame the Central Government for collecting too much tax and therefore putting the squeeze on local governments.
If enterprises are burdened by high taxes, the overall economy is impacted. Therefore, the government should support their development by slashing taxes. But there's a bigger problem: The structure and growth model of the Chinese economy is not sustainable. The Central Government expects to change that by reforming its tax system.
Zhang Guangtong, Vice Dean of School of Taxation at Central University of Finance and Economics, says the root cause for local government debt woes is deficit financing, or making investments on borrowed money. Local governments, Zhang suggests, should reign in their spending rather than splurge on projects to boost economic growth and look favorable in the eyes of the Central Government.
Responding to demands by enterprises for tax cuts, the Central Government has launched several measures to reduce the burden. Particularly after the global financial crisis in 2008, the Chinese Government has adopted many measures to alleviate taxes on small and micro enterprises as well as individuals.
The country thus faces a conflict: The government needs a lot of money to develop the economy, but its tax revenue keeps falling. It is a headache for underdeveloped regions. The only solution is to sell land. In some places fiscal revenue from selling land is even higher than tax revenue.
Besides land-sourced fiscal revenue, local governments are also accused of arbitrary charging or borrowing via various local financing platforms. They have borrowed a huge amount of money, and debts are growing.
"The bankruptcy of Detroit is a lesson for the Central Government. During the country's stage of rapid development, serious bubbles emerged in the economy in the form of real estate, surplus capacity and local government debts," Zhang said. "Once any of the bubbles burst, the results would be catastrophic." He adds that tax reform is needed to contain such bubbles.
How to reform?
Zhang Monan, an associate researcher with the State Information Center, says the present tax system does not give independent tax rights to local governments. Tax reforms should, she says, focus on granting certain tax rights to local governments and allow them to independently decide the size and structure of their budgetary expenditure.
"China needs to redefine the distribution of tax revenue and fiscal expenditure between central and local governments, and change the pattern with land reserves as guaranty and bank credit as a major source of capital," said Zhang. "Local governments should have new sources of income to replace land-sourced fiscal revenue."
Jia Kang, Director of the Research Institute of Fiscal Science at the Ministry of Finance, says that there are three priorities. First, the functions and purpose of lower levels of government must change to avoid grandiose and wasteful spending and increasing debt levels.
Jia says both international and Chinese experience prove that a tax division system is necessary to develop a market economy. The problems confronting China in recent years have to do with a tax division system that hasn't been fully implemented.
Second, changes in how resources are taxed is needed to promote energy saving and sustainable development. Currently, prices for basic resource and primary products are seriously distorted. Jia says resource tax reform on crude oil and natural gas has begun across the country. Reform in future will cover more resources, particularly coal, which China consumes the most.
Third, tax reform should enhance wealth distribution to promote social harmony and common prosperity.
Good prospects
The fact that the pilot program to move from a business to a value-added tax has been extended to the whole country indicates that tax reform is looking optimistic.
The pilot in Jiangsu Province began on October 1, 2012, covering sectors of transportation, technology services, information technology, culture, logistics, etc. According to Jiangsu Provincial Department of Finance, this has been largely positive. First of all, the overall tax burden has been reduced. Within the 10 months since the pilot started, 9.55 billion yuan ($1.56 billion) in taxes were cut. As the project expands, domestic demand should increase and become a driver of economic growth.
Industrial upgrading—or the way businesses operate—has also witnessed significant change. The pilot project encourages companies to separate secondary businesses from core operations and therefore promote industrial specialization. For example, XCMG Group, a leading Chinese engineering machinery builder based in Jiangsu with a business turnover of 100 billion yuan ($16.33 billion) last year, has separated its transportation and logistics businesses and established several companies specialized in logistics. The group is strengthening its core business and expanding the scale of secondary dealings.
More importantly, the shift to a value-added tax both promotes the upgrading of traditional manufacturing technologies and encourages companies to innovate and purchase more advanced equipment, which is evident in the purchase rise of more sophisticated equipment during the pilot period in Jiangsu.
Changes likely coming to China's tax system will have a lasting impact on the country as a whole.
"From a strategic point of view, reform of China's tax system not only aims to reduce corporate taxes and improve the overall way taxes are collected, but more importantly promote the transformation of China's economic growth model, said Jia.
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