Commentary: China's tax reforms and Xi Jinping’s fiscal Reaganomics

Commentary: China's tax reforms and Xi Jinping’s fiscal Reaganomics

China's new tax system increases the tax burden on SMEs and micro enterprises - entities the Chinese government sees China's future productivity depending on, one observer says.

A man poses for pictures at a booth of China's President Xi Jinping books, translated in forei
A man poses for pictures at a booth of China's President Xi Jinping books, translated in foreign languages, which are on display during the China International Import Expo (CIIE), at the National Exhibition and Convention Center in Shanghai, Nov 7, 2018. (Photo: Reuters/Aly Song)

BEIJING: China’s income tax system is undergoing an administrative overhaul. 

In the ongoing opera of China’s reform, the leitmotif is again re-centralisation, the refrain is of small- and medium-sized enterprises (SMEs) and individuals driving Chinese productivity, and the bridge is meaningful fiscal administrative reform.

MIMICS REAGANOMICS

China’s State Administration of Taxation is currently overseeing a transitional period from the beginning of October until the end of 2018 to raise the tax-free threshold from 3,500 to 5,000 yuan per month (US$500 to US$700). A full transition to the new tax system will take place from January 2019.

The amendment to the Individual Income Tax Law passed by the National People’s Congress (NPC) is designed to widen the tax base and centralise tax collection. 

In widening the tax base, the NPC hopes to increase payments of social security taxes, better align tax incentives with techno-industrial policy, force more economic agents into the productive economy, and push both individuals and local governments away from property speculation.

The two main structural reforms in the amendment aim to consolidate national and local tax collection systems, and to reintegrate the collection of income tax and social security taxes. 

These were split in 1990, with the central government collecting income tax and local governments collecting the five social security taxes (for pensions, healthcare, unemployment benefits, maternity leave and workplace injury insurance). The new system re-centralises this division.

China's population stood at 1.37 billion people at the end of 2015
(Photo: AFP/-)

The new system also includes a range of incentives and disincentives to encourage more people to pay tax at the individual and SME levels. 

These include heavier taxes on property to spur more people into entering the workforce and spending their disposable incomes rather than investing in real estate.

China’s prevailing fiscal ideology mimics Reaganomics — the economic policies adopted by former US president Ronald Reagan. This tax cut and loan deleveraging mantra first appeared in 2015 as a supply-side reform to China’s industrial policy. 

Supply-side economics was the mantra of the Reagan era: Tax less, regulate less, and private enterprise will invest more and produce more goods. In turn, the aggregate in both economic output and the tax base will grow in real terms.

The added bonus of Xi’s version of Reaganomics is that the surface is amenable to Western, reform-hungry and China-exposed business. 

In the ideal world of Reaganomics, if the system is made more attractive the cowboys will come home — a lower tax-rate encourages more businesses to actually report, which translates into a wider tax base for government.

Fan is one of China's most high-profile celebrities, but the 36-year-old has since become
Fan is one of China's most high-profile celebrities, but the 36-year-old has since become embroiled in a tax evasion scandal (Photo: AFP/ALBERTO PIZZOLI)

READ: Chinese starlet Fan Bingbing’s murky tax problems show still waters run deep, a commentary

HIGHER TAX BURDEN FOR ENTERPRISES

The problem is that China’s tax reform does not deliver tax relief to the majority of taxpayers. It actually increases the tax burden on many enterprises. 

The main complaint of taxpayers is that the new system will force the collection of the five social insurances onto firms as a secondary form of taxation, avoidance of which had allowed them to grow in the first place. 

In attempting to solve a tax evasion problem, the latest reform places more pressure on the entities that it is designed to help: The SMEs and micro enterprises that the government sees China’s future productivity depending on.

The new system does have some industry-specific tax incentives though, which aim to support China’s techno-industrial policy by promoting industrial upgrading, growth of science and technology firms, and venture capitalism. 

The clearest incentives are research and development offsets. These include one-time offsets for research and development equipment, ongoing pre-tax offsets for commissioned research and development expenses, and enterprise employee education expenses.

The big winners from China’s tax reform are science and technology companies, along with start-ups and venture capital firms. 

Losers include equity fund managers, real estate developers and local governments. SMEs face short-term pain but long-term support.

File photo: A Chinese flag is seen in front of the financial district of Pudong in Shanghai
A Chinese flag is seen in front of the financial district of Pudong in Shanghai, China. (File photo: Reuters/Aly Song)

READ: Rating citizens - can China’s social credit system fix its trust deficit? A commentary

EXPECT MORE TWEAKS TO NEW SYSTEM

Yet the attempt to clean up the institutional dependencies of China’s past seem to be laying the foundations for those of the future. 

Subsidising SMEs and private enterprise will help China to transition into an innovation and techno-industrial power. But it will also create new space for subsidised enterprise behaviour that might prove difficult to budge when the inevitable reforms of the 2030s arrive.

Like many central reforms, the Chinese population sees more problems with the new tax system than the government anticipated during its drafting. 

Expect more tweaks to come as the new system rolls into operation to accommodate aspects of the tax overhaul that the government has not planned for.

Ultimately, the new system continues Beijing’s impossible friction with local governments. 

Given that most taxes had previously been collected at local levels, the real reaction to watch is that of the local tax collection agencies and the governments that they represent. It is local government more than the taxpayer whose reactions to this latest fiscal reform will matter most.

Tristan Kenderdine is Research Director at Future Risk. This commentary first appeared on East Asia Forum. Read it here.

Source: CNA/nr(sl)

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