Taxing choices for economic growth with social justice and environmental protection in the People's Republic of China.

Author:Shah, Anwar
Position:Report
 
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  1. INTRODUCTION

    Since initiating economic liberalization, and subsequent economic and fiscal reforms in support of a so-called, "socialist market economy", the Peoples' Republic of China (PRC) had experienced a sustained record of double-digit economic growth over the past three decades. This sustained growth has resulted in a record of economic growth and poverty alleviation unparalleled in the economic history of the world. In the coming decades, the PRC faces major challenges arising from global economic slowdown, ageing population, environmental degradation, fallouts from rapid urbanization, and serious income inequalities across individuals and regions and inequalities in opportunity across the nation. The reform of the fiscal system is potentially a powerful instrument to alleviate some of the emerging concerns. Since undertaking major fiscal reforms in 1994, the PRC has followed a consistent strategy of reforming the fiscal system in small but measured steps. This strategy embodies the wisdom of Chinese philosophers who argued for "feeling the stones while crossing the river". As a result of this strategy, the PRC has made significant progress in modernizing the fiscal system to cope with the demands of a dynamic economy. This modernization drive in recent years has followed the OECD model of having greater reliance on income taxes especially corporate income taxes as opposed to the PRC reliance in the past on mostly consumption taxation. This shift is likely to erode PRC's international competitiveness. Further, during the past several decades emphasis on growth led to a relative neglect of environmental and social equity concerns. Thus the tax reform agenda remains unfinished as growth, uncoordinated urban-rural development, environment and social justice concerns require a re-examination of the existing tax system to deal with these emerging concerns. This recognition was highlighted by the communique issued on 12 November 2013 at the conclusion of Third Plenum by the 18th Central Committee of Communist Party of the PRC. The communique announced establishment of leading committee on comprehensive reforms to design and implement the broad based tax and nontax reforms. This paper presents pathways to such reforms to strengthen efficiency and equity of the tax system while stimulating growth and preserving the environment.

    The paper is organized as follows. Section 2 presents an introductory overview of the PRC tax system. This is followed in section 3 by a discussion of the existing structure of central taxes and pathways to reform. Section 4 presents an analysis of local public finance. A final section provides concluding remarks.

  2. AN INTRODUCTORY OVERVIEW OF TAX SYSTEM IN THE PRC

    The Central Government's Ministry of Finance is the sole agency responsible for tax policy and the State Tax Administration is responsible for collection and administration of centralized and shared taxes through its deconcentrated offices throughout the nation. Tax collection and administration of subnational taxes and charges are the responsibility of the province and exercised by provincial and local finance bureaus. Provincial and local finance and administration bureaus have dual reporting responsibilities to central and provincial/local governments and collect taxes on behalf of all orders of governments. There is also the practice of "revenue tasks" which entail central government setting a revenue collection target for the provinces and the provinces playing a similar role for setting local government revenue targets. Since 1994, legislative powers have been centralized for all revenue sources. Thus local governments have no ability to vary the base or rate of any tax without central approval. For most local taxes, the central government does allow limited discretion in setting tax rates to local governments by specifying a permitted range for such rates. Further productive bases such as VAT, enterprise/corporate and personal income taxes have been centralized thereby creating greater fiscal space for the central government to support national objectives regarding common economic union, regional development and economic integration of lagging regions. More recent reforms integrate local business taxes with the central VAT enlarging fiscal space for the central government. Figure 1 provides a summary view of revenue disposition and direct spending by various orders of government in the PRC. The figure shows that the central government has access to greater revenues than it needs for own direct spending and vice versa for other orders of government. This is desirable for exercising the 'spending power' of the central government through fiscal transfers to lower orders to further national objectives.

    Table 1 provides an overview of tax assignment currently in vogue in the PRC. Major sources of central finance in order of importance are VAT, corporate/enterprise income tax (CIT), business tax (BT) and personal/individual income tax (PIT). Major local revenues in relative order of importance are: land lease incomes, urban maintenance tax, contract tax and vehicle use taxes (see Table 2). Overall the Central Government collected 48% and provincial-local governments collected 52% of national tax and non-tax revenues in 2012. At the present time, the PRC levies no environmental tax although several are contemplated in the near future. Further some of the existing taxes have environmental impact implications.

    2.1 Implications of the Existing Tax Assignment

    The tax sharing system introduced in 1994 significantly curtained local government access to own finances (see Figure 2). Higher level transfers on average now finance more than two-thirds of sub-prefecture expenditures. County and township governments in rural areas experienced significant further curtailment of access to own finances as a result of rural finance reforms introduced in 2002 to alleviate tax burden on farmers thereby increasing their disposable income. These reforms eliminated agricultural taxes and surcharges which until then were significant sources of their revenues. This implies that a large number of jurisdictions have inadequate levels of own financing due to a lack of fiscal capacity or not having the authority to tax newer yet unexplored sources of revenues such as environmental bads. This calls for a review of taxing powers of these local governments.

    2.1 Tax Assignment Issues and Reform Options

    Tax assignment in the PRC is broadly consistent with tax assignment principles but a few areas require examination for reassignment.

    The assignment of resource taxation requires re-examination. Resources are unequally distributed and have volatile revenue streams that are subject to external shocks and are associated with large fluctuations in prices and demand. Shocks are often persistent. Also exhaustible nature of some resources leads to depletion of wealth over time with implications for fiscal sustainability and intergenerational equity. These considerations warrant that ideally resource ownership should vest in all citizens of the nation state and all net revenues from non-renewable resources should be deposited in a heritage trust fund (Norwegian style) owned by all citizens regardless of their place of residence. The assets of this fund are held in perpetuity and could not be drawn down but capital income will be available for current use. A second best alternative is centralization of resource rent taxes (see Table 3) which are then redistributed through a central fiscal equalization program. Alternately resource rent taxes are decentralized and redistributed through inter-provincial (net) equalization program. Royalties, fees, and charges, on the hand should be assigned to provincial/local governments to meet infrastructure and resource development needs as well as to overcome any adverse environmental impacts. The PRC, however, assigns resource taxes based on offshore versus inland location with the former assigned to the center and the latter to the provinces. This distinction is fine but it may be desirable to give provincial-local government greater autonomy in setting possibly tax base and certainly rates for royalties, fees, severance, production, output and property taxes (as done in Canada--see Table 3) and piggybacking option for carbon taxes and possible devolution of energy and motor-fuel taxes.

    Further, to enhance own source revenues for local governments, consideration may be given to allowing these governments supplementary tax rates on national tax base for VAT and PIT (Personal Income Tax) and carbon taxes (when imposed) within a range defined by the central government. Further motor vehicle purchase taxes and the urban maintenance and construction tax may be considered for devolving to provincial and local governments respectively. Urban maintenance and construction tax could be integrated into broad based real property tax. In addition local governments may be given discretion in setting tax rate within a centrally defined range on nationally determined tax base for taxes that are fully retained by local governments. Local governments may also be authorized to levy congestion charges, road tolls and environmental taxes and charges. In the following section, we examine the structure of major taxes and draw their efficiency and equity implications (see also Lou and Wang, 2008).

  3. TAX REFORM: ISSUES AND OPTIONS Value-added-tax (VAT)

    Existing Structure: The PRC has a consumption based VAT which taxes domestic sales and imports of goods and provision of repairs, replacement and processing services and provides for credit for taxes paid on intermediate goods including fixed assets. The standard tax rate for VAT is 17% with a 13% rate for necessities and a 3% rate on small scale (small business) taxpayer. Most OECD countries typically levy three differential rates with the standard tax rate that varies in 2012 from a low...

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