Tax reforms are more than a numbers game
The Ministry of Finance's call for reforms to China's personal income tax system is an indication of a comprehensive overhaul yet to come. Proposals discussed in the past few months have ranged from the introduction of a withholding tax, to raising the amount people can earn before they have to start paying tax and lowering tax rates.
The backdrop to these calls for change includes an effort to stem widespread tax evasion on the part of the country's highest earners. The government's pursuit of tycoons like Yang Bin is well known but, just as importantly, officials have been going after others less famous. Last year, they identified nearly a million new corporate and individual taxpayers and collected more than 35 billion yuan in extra revenue. Then there is the widening gap between rich and poor. The credo of the past decade of economic reforms has been to allow some people to get rich first. Now it is evident that leaders fear the social instability that would result from the impression that the richest are amassing wealth through unfair or illegal means.
The ministry proposes raising the tax-free allowance from 800 yuan a month to at least 1,200 yuan and lowering rates for other income brackets. This would leave more money in consumers' pockets and stimulate domestic spending, something China needs in order to keep economic growth on track. If these new policies also encourage citizens who were not paying taxes before to come in from the cold - and thereby boost government revenues at a time of growing deficits - so much the better. For maximum effect, the new tax code would also need to simplify the system drastically and close many loopholes.
Details of the changes have yet to be revealed, but it is evident the ministry and other policymakers see the tax regime as more than just a means of raising funds. In any jurisdiction, whether city, state or country, taxation is an extension of social policy. In some northern European countries, higher tax rates are accepted by a public that also benefits from a comprehensive social safety net, while other countries use taxation to spur growth by keeping capital gains and income tax rates low in even the highest brackets.
As China moves away from an economy dominated by state-owned enterprises and the cradle-to-grave social security they provided, it needs to decide what role its evolving tax system will play in an economy where growth is driven by the private sector and the markets. How progressive or redistributive should the system be? How much of their income will high earners be allowed to keep? And what incentives and safeguards will be put in place to make sure compliance is a matter of course, rather than an option? Comprehensive reforms that take these questions into account will lay the groundwork for further growth and for continued social harmony.