How China’s Income Tax Became a Levy on the Poor
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2017-02-22 05:36:41

At the top of the agenda for lawmakers at the March plenary session of the National People’s Congress (NPC) — China’s version of parliament — will be the considerable challenge of reworking the country’s personal income tax law. More than 36 years after it was first enforced, the law has gone from a Robin Hood-esque levy on business owners and high-income groups to what is effectively a tax on the poor

Official Communist Party decrees to tax income were first prepared in 1950, but never came into force due to the Soviet-style centralized ration system that took hold over the following decades. The first real effort to tax income did not occur until 1980, when the government’s market-oriented reforms primarily began to target a new influx of foreigners coming to work in China.

Under the 1980 law, people who earned less than 800 yuan per month — then around $523 — were exempt from income tax. At around 13 times higher than the average industrial worker’s salary at the time, this was an extraordinarily high figure, and it meant that, astonishingly, only 15 Chinese citizens had their incomes deducted in the first year after the law was enacted.

Curiously, that tax threshold remained intact for nearly two decades. This was mainly due to the fact that as late as 1993, only 1 percent of all Chinese employees made over 800 yuan a month (an amount that by this point had devalued to a paltry $93).

Despite the continual rise in food prices — a strong indicator of inflation — China’s tax threshold has risen only three times since 1993. First, in 2005, the government doubled it to 1,600 yuan per month. Two years later, it put it up to 2,000 yuan. In 2011, it hiked it up once more, this time to 3,500 yuan. Today, despite wage rises, inflation is running far ahead of the tax system: In cities like Shanghai, where median disposable income stood at around 4,400 yuan last year, it is the working-class poor who are coughing up the largest proportions of their salaries for the taxman.

I find it ludicrous that China predominantly taxes salaries as opposed to other sources of wealth. In the United States, those who earn more than $100,000 per year — around 5 percent of the population — generate more than 60 percent of the country’s income tax. In China, the opposite has happened: Nearly two-thirds of the country’s income tax now comes from those who earn less than 120,000 yuan (around $17,400) per year, up to 64 percent in 2014 from 43 percent in 2010.

Income growth in this group has soared over the last few years, propelling many who were formerly exempt from tax into the lowest payment bracket. China’s tax regulations, however, indicate that the government is more concerned with balancing its budget than narrowing the country’s yawning wealth gap. Last year, the state took more than 1 trillion yuan in individual income tax, up 17 percent from 2015.

I find it ludicrous that China predominantly taxes salaries as opposed to other sources of wealth.

Put simply, tax authorities choose to impose high income tax on the salaries of the poor because they are easier to police. By law, employers have to automatically deduct tax from the paychecks of salaried employees and send the proceeds to the state. In contrast, taxing the broader, more diversified wealth of the rich is fraught with difficulty.

There is now a consensus to raise the bottom rung of the tax ladder to at least 8,000 yuan per month as a key means to bridge the rich-poor divide. A rise in personal tax-free income allowance is likely to take place this spring, although official timetables and policy details remain remarkably thin on the ground. Given that personal income tax only accounts for roughly 6 percent of total tax revenue in China (as opposed to around a third of the American federal budget), raising the threshold would ease the pressure on low-earners concerned about the rising cost of food, housing, education, welfare, and medical care.

Individual income tax must work on the principle of taking from the rich in order to help the poor. The government will soon have the opportunity to reaffirm this belief through its long-awaited overhaul of the tax regime. By doing so, it would show that it is serious about closing the country’s wealth gap and strengthening social justice. Now that all bank deposits, equity transactions, share dividends, property rights, marital statuses, and tax declarations have to be filled out under a single personal identity, the ready-made excuse that wealth is hard to trace will no longer check out.

For tax collectors, however, there is a difference between identifying the wealthy and taxing them proportionately. In addition to lobbying against changes to existing income tax regulations, the rich are also more able to avoid paying tax. Entrepreneurs routinely employ tax advisers to create so-called shell companies in Pacific or Caribbean tax havens, to which profits from their businesses are transferred. And these transactions are completely legal, as they merely exploit existing regulatory loopholes.

Others invest in unit trust or art collections in order to launder money or move assets abroad. High-income foreign business executives ensure that they are out of the country — either for one 30-day stretch or for 90 days cumulatively per year — allowing them to avoid tax responsibilities in China. In the hope of staying “good for business,” the government is reluctant to squeeze them too hard and risk escalating capital flight to other countries.

I am confident that revising the income tax law will not shrink the state’s tax pool. First, as I have mentioned above, personal income only accounts for a negligible proportion of national tax revenues. Second, taxing the rich properly will offset those at the bottom of the pyramid who suddenly find themselves exempt. Third, new taxes on property or inheritance can provide alternative revenue streams for the government. Property taxes, for one, have already been trialed in a number of Chinese cities.

The final aim of the March talks should be to reform the impenetrable system of progressive taxation in which levies range from 3 percent to 45 percent, depending on specific circumstances. In reality, only the lower tiers are ever effectively enforced. It is time for China to transition to a simpler, clearer tax model allowing stronger policing at all levels of the pyramid. Other, more radical forms — such as taxing household income over personal income, or providing exemptions to large mortgage-paying families — should also be on the table.

In the end, the success of tax reform hinges on the conviction of tax authorities to strengthen enforcement and collection, as well as on their willingness to treat equity transfers, property sales, interest on savings, and share dividends as viable alternative sources of tax, thereby taking the pressure off the have-nots, whose salaries alone represent their primary taxable assets. Creativity in levying tax is vital, but so is a crackdown on tax evasion and avoidance. It is time to act on our unfair tax system and make sure that the rich pay their fair share.

(Header image: A worker cleans windows in a building opposite Shanghai’s central business district, Sept. 21, 2015. Liu Xingzhe for Sixth Tone)