China's income tax reform seek growth boost and poverty relief

China's income tax reform seek growth boost and poverty relief

China’s government is about to introduce a long-discussed cut in individual income tax

As promised by Prime Minister Li Keqiang in his 2018 Government Work Report, the Standing Committee of the National People’s Congress has passed on August 31 an amendment to China’s individual income tax. It slashes tax for low-income and middle-income earners, in an effort to keep up with the rapid increase in living costs and better redistribute wealth in one of the most unequal countries in the world, with a Gini coefficient for income of about 0.40.

What next

The new law will increase the disposable incomes of millions of low-income and middle-income earners, to reduce inequalities and boost household consumption. However, it fails to shift the tax burden towards wealthy non-income earning individuals. There will not be a major impact on the government’s overall fiscal position.

Subsidiary Impacts

  • Recent comments by the Constitution and Law Committee signal that the law may soon be amended again.

  • Important changes to residency rules will have an impact on foreign nationals living in China
  • New tax residence and anti-avoidance rules will eliminate loopholes and allow for a more efficient tax collection

Analysis


The reform will take effect on January 1, 2019.
The final amendment does not significantly differ from the draft released in late June, which had prompted contentious debates. Many experts and officials argued that the reforms were too limited. As a result, the law passed with an unusually high number of abstentions (eleven) and dissenting votes (two) among the members of the roughly 150-seat committee.

Tax cuts across the board


This reform adds to other tax cuts granted by the Xi administration since 2017. This year the State Council announced corporate tax cuts by more than 45 billion renminbi (6.6 billion dollars).


Together, these tax cuts are expected to boost domestic demand and stimulate consumption, while responding to China’s escalating trade war with the United States and tax cuts passed there by the Trump administration.

Minimum threshold

Previous amendments to the Individual Income Tax Law had raised the minimum threshold above which one has to pay taxes from 800 renminbi per month to 1,600 in 2005, 2,000 renminbi in 2007, and 3,500 renminbi in 2011. The new amendment further raises the threshold to 5,000 renminbi per month, or 60,000 renminbi per year.
This exempts a significant part of the low-income population from paying individual income tax.

Criticisms


Even the 43% increase of the minimum threshold fails to keep up with larger increases in per capita disposable income (67% from 2011 to 2017) and consumer price index (an average of about 2% annual increase since 2012).

Many public intellectuals and high-level government officials (including, for example, Wang Xiaolu, deputy director of the National Economic Research Institute) advocated a higher threshold, suggesting raising it to 8,000 or 10,000 renminbi per month.

Critics also recommended the establishment of mechanisms for dynamically adjusting the threshold by tying it to the evolution of income, expenditure and price levels.

Others argued that it should vary geographically across China, given the disparity in regional economic development. Yet other experts suggested calculating taxable income on household income rather than individual income.

The final amendment includes none of these propositions. However, the legislature’s Constitution and Law Committee signalled on the day the law was passed that the amendment was only a first step towards more comprehensive reform. Several of the suggestions above may become the basis of later reforms.

Simplifying categories

The amendment has simplified the categories of income subject to income tax:

  • A new broad category called ‘comprehensive income’ includes wages, labour services, author’s remuneration and royalties.

  • The latter three will be subject to the seven-bracket progressive rates that now apply to wages, instead of the current flat proportional rate of 20%.

  • The ‘comprehensive income’ category will be calculated annually, as opposed to monthly under the current law.
Small concessions were made in the final draft:
  • Taxpayers are allowed to pay taxes on only 80% of their income from labour service payments, author’s remunerations and royalties.

  • Income from author’s remunerations will be further discounted by 30%.
Nonetheless, this reform will likely add up to a higher taxable income base for some individuals, especially in intellectual and creative professions.

Going easy on the rich


Other categories, including income from interest, dividends and bonuses, and income from lease or transfer of property, were left untouched. They will remain subject to a flat proportional rate of 20%.


In 2014, tax revenue from wages and salaries accounted for 65.3% of the total individual income tax revenue, while being comparatively light on very rich individuals who do not need to work.

Widened income bands


Changes to the taxable income bands and the expenses taxpayers can deduct from taxable income further lighten the burden on low-income and middle-income taxpayers. China has a progressive personal income tax system, with seven rates ranging from 3% to 45%. 


The new law will not fundamentally rebalance the structure of tax revenue in China

To the dismay of many critics, the highest tax rate of 45% was not reduced. However, the amendment significantly expands the three lowest income bands (3%, 10% and 20%).

Fiscal impact

The tax cut will not do much to weaken the government’s fiscal position because individual income taxes contribute a relatively small share of government revenue in China (around 8% last year, see China’s fiscal system will adapt as economy transforms).

Moreover, rapid household income growth means that the tax base is growing, offsetting the impact of the tax cut.

There will not be a major hit to fiscal revenue

Demographic goals

In addition to the deductions of social insurance contributions that were already available, the amendments introduce several ‘special expense deductions’, for expenses including children’s education, continuing education, treatment for serious diseases, housing loan interest and housing rent.

These measures respond to growing concerns regarding China’s ageing population. Deductions for education, in particular, are expected to encouraging families to have more children, as China shifts away from the one-child policy.

Eliminating loopholes

The amendment lowers the threshold for tax residency from one year to 183 days, in line with international practices. This will subject foreign nationals who live in China for 183 days or more in a year to pay Chinese tax on their worldwide income, as opposed to five years previously. This eliminates loopholes: under the previous law, expatriates could leave China for a period of more than 30 days consecutively or 90 days cumulatively, to avoid becoming a resident for tax purposes.

Last, the amendment includes a series of new anti-tax avoidance rules, similar to some of the rules in the Enterprise Income Tax Law. These measures will allow Chinese tax authorities to fight more actively against rampant tax avoidance.

This article was first written for the Oxford Analytica Daily Brief, which is the copyright holder.