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  • Oct 1, 2014
  • Updated: 12:51pm

Punishing tax regime makes everyone suffer

PUBLISHED : Monday, 25 April, 2011, 12:00am
UPDATED : Monday, 25 April, 2011, 12:00am

As widely expected, the mainland tax authorities last week unveiled plans to cut taxes for low-income earners and raise them for the rich as part of the efforts to narrow a widening income gap which has contributed to social discontent.

But, unexpectedly, the National People's Congress Standing Committee decided to delay a vote on the draft amendment to the personal income tax law, citing various opinions of lawmakers and the need to solicit public feedback.

The proposed amendment would raise the minimum monthly personal income required to pay tax from 2,000 yuan (HK$2,389) to 3,000 yuan, and reduce the number of tax brackets from nine to seven. It calls for the maximum threshold for the bottom two brackets to be raised to 4,500 yuan with a tax rate of 10 per cent, while two brackets - with rates of 15 per cent and 40 per cent - would be abolished, meaning that more people would have to pay the top rate, which stands at 45 per cent.

Judging by the comments on the state media and internet forums, the biggest controversy appears to be focusing upon the proposed tax exemption threshold. Most users say it is too low and should be raised to at least 5,000 yuan if it is meant to have a real impact on helping low- and middle-income earners and narrowing the income gaps.

But few have used the opportunity to touch upon - let alone debate over - much bigger issues such as the overall direction of the mainland's tax reform and, in particular, the terrible design of the personal income tax regime and its negative implications for China's efforts to encourage entrepreneurship and upward mobility. This is too bad.

Although its economy is already the second largest in the world, the mainland is still a developing country, with more than 200 million people who live on less than US$1.25 a day, the United Nations' standard for extreme poverty. But its personal income tax regime was designed for a much developed country, with progressive tax rates up to 45 per cent. Such punishing rates have proved counterproductive, as they fail to protect the low-income earners, allow for the growth of the middle-income earners, and require the rich to pay more - the three very things a personal income tax scheme should do.

First of all, the mainland's poor earn much less than 2,000 yuan a month and therefore don't have to pay income tax. Secondly, the burgeoning middle class is the principal victim of this tax regime, as they form the largest group of taxpayers. Lastly, the filthy rich have devised various ways to avoid paying the top rate of 45 per cent, the simplest way being to pay themselves very low salaries.

The mainland's weak social security spending and the lack of transparency over how the tax dollars are spent have also contributed to widespread tax evasion.

Its current complicated progressive tax regime also means that the costs to pursue and collect taxes are already among the highest in the world.

The mainland's tax officials have a long-standing argument that cutting tax rates would only benefit the rich, singing the same verses as the US politicians that the rich should pay more. That is right in theory, but the reality is that because China lacks the US' very efficient and transparent tax-collection regime, the high rate of 45 per cent has made tax evasion rampant among the rich and the government collected very little real cash in the end. The high tax rates and worries over what tax evasion would bring have partly prompted the mainland's millionaires and billionaires to transfer their money out of the country or to emigrate.

Last year, the central government collected 483.7 billion yuan in personal income taxes, which accounted for about 6 per cent of its total tax revenue. That compares with about 8 trillion yuan in grey income, which have slipped the attention of the tax collectors.

It is time the authorities joined the rising international trend and broadened the tax base by reducing tax rates and simplifying the tax structure.

One example to show China's ridiculously high rates can be found by comparing the rates of the BRIC countries. Russia has a flat tax rate of 13 per cent, India's highest rate is 30 per cent and Brazil's, 27.5 per cent.

It is safe to assume that if Beijing lowers the top bracket to about 25 per cent or 30 per cent, it would not lead to a sharp drop in tax revenue, as the tax officials would have people believe. Instead, it is likelier to lead to a great jump, as the rich would be motivated to become law-abiding citizens and pay taxes. The tax cutting would also provide a great incentive to boost consumer spending, as the middle class would have money to spend. Moreover, it is the right thing to do.

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