Income tax changes in pipeline
By Jiang Yan & Zheng Caixiong (China Business Weekly)
Updated: 2005-01-02 12:17

The proposed income tax adjustment that is likely to produce immediate benefits to low-income families is widely seen as an important step in the government's efforts to bring China's tax system in line with rapid economic progress.

In a report submitted to the State Council in August, the Ministry of Finance recommended raising the personal tax exemption to 1,200 yuan (US$145) from 800 yuan (US$96.62). If approved, it will be the first increase in the income tax deductible in more than 20 years.

Since then, the ministry's proposal has been widely discussed among government planners and private-sector economists. Such a high level of interest in the topic prompted the Guangdong provincial government to establish a task force of tax officials and economists to conduct a comprehensive survey. It is expected to produce a detailed report early next year which can serve as a reference in the tax reform.

Although the impact of the proposed change seems limited, it is nevertheless part of the overall tax reform, which is considered by many economists as essential to future economic growth.

Since the Chinese economy began to enjoy rapid growth in the 1990s, many economists have called for the reform of the obsolete tax system. They noted that the existing tax system has not only failed to reflect newly gained prosperity but could also impede economic growth.

Personal income tax is a case in point. The present level of exemption was established in 1981 when China's Individual Income Tax Law was introduced. At that time, the average annual income per capita was 476 yuan (US$57.49) in urban areas and 213 yuan (US$25.72) in rural districts. These averages jumped to 8,472 yuan (US$962.73) and 2,622 yuan (US$316.67) by 2003.

A few local governments have already trying to address the issue by raising the personal tax exemption with the tacit approval of the central authorities. In Guangzhou, the personal tax deductible has been raised to 1,600 yuan (US$181.82).

"Although these adjustments in provincial levels are not in line with the nation's personal income tax law, they have not been questioned by the relevant authorities because it is accepted that they can better reflect the current economic state of affairs," said Jia Kang, director of the ministry's Institute of Fiscal Science.

Although private-sector economists agreed to the proposed change in the personal income tax, they contended that the level recommended by the ministry was too low to adequately reflect the large increase in average incomes. "Even raising it (the personal tax deductible) to 3,000 yuan (US$362.32) would not seem excessive," said Wang Yongjun, director of the Beijing-based Research Institute of Finance and Economics.

Wang and other economists said that a bigger increase than that suggested by the ministry is necessary to bring real relief to both urban and rural low-income families. "A substantial increase in the personal income tax deductible can help ease financial pressures on poorer people," said Wang Hongchen, professor of economics at Sun Yat-sen University.

Yang Zhiqing, a professor at the Central University of Economics and Finance, went one step further by suggesting the government should consider setting a scaled tax deductible system that takes into consideration regional disparities in economic growth.

These economists also said a more equitable tax code should be considered to give greater relief to people who have to support families by providing deductibles for dependents.

The tax discussion has also attracted the interest of the business sector. What business people are mostly concerned about is China's high personal income tax rates which, according to major international accounting firm Ernst & Young, are among the top five in the world.

High tax rates could indirectly hamper the development of China's high-tech industries by discouraging foreign and overseas Chinese talents from coming or returning to work in China, said Alfred Shum, a partner at Ernst & Young in Shanghai.

Simply raising the personal tax deductible is unlikely to work. Foreigners working in China already enjoy a much higher personal tax deductible of 4,000 yuan (US$483.09).

"To attract foreign talents to high-tech industries, China may need to consider lowering its personal income tax rate scale to cap at 35 per cent from 45 per cent," Shum said.

Any amendment to the tax law must be approved by the National People's Congress (NPC), China's top legislature, which is scheduled to meet in March.

Meanwhile, the tax bureau is stepping up its efforts to gather information for its recommendations to the NPC for deliberation.

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