TAX PLANNING AND TAX ACCOUNTING

October 10 2012

Are Chinas individual tax rates too high?

Lien Noyens 1202010219 Introduction Taxes are necessary in every society. For example, they provide the most important revenue source for the government of China. It has also a great impact on Chinas economic and social development. One of the taxes levied in China is the Individual Income Tax (IIT). It is a form of tax you have to pay over your salary. The tax levels in China progressively increase from 3% to 45%. The progressive structure is a popular method because its considered more fair than other taxes as the tax is based on the ability to pay. Chinas tax burden For most Chinese, their tax burden seems too high. According to a research by the Central University of Finance and Economics, China's current tax burden is heavier than many middle-and upper-income countries. High tax rates or low annual IIT thresholds can have a big impact on the Chinese economy. If rates are too high, the burden on wage earners will increase and so domestic demand will drop. Raising the annual IIT threshold could be necessary due to growing publics concern over inflation and rising food prices. Even though it would reduce the governments tax revenue, it could improve the living standards of the countrys middle- and low-income earners and could help to achieve a more fair income distribution. Income distribution The Gini coefficient is commonly used as a measure of inequality of income. A Gini coefficient of zero expresses perfect equality, so where everyone has an exactly equal income. On the other hand, a Gini coefficient of one expresses maximal inequality, where only one person has all the income. A
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TAX PLANNING AND TAX ACCOUNTING

October 10 2012

score of 0,4 can be interpreted as serious inequality in a country. According to official estimates, China's Gini coefficient was slightly higher than 0.412 in 2010. Moreover, various scholarly studies suggest the gap has been widening. This is a serious matter as it will aggravate social inequality and shake social stability. Research also proved that consumption is negatively correlated to the Gini coefficient. People are more likely to save their money as the Gini coefficient increases. A way to decrease high inequality are high rates of progressive taxation. Progressive taxes attempt to reduce the tax incidence of people with a lower ability-to-pay, as they shift the incidence increasingly to those with a higher ability-to-pay. As a result, the income of the poor will go up and become wealthier in a sustainable way. Is the rate too high or too low? On the one hand, a countrys tax burden should be in line with the level of its economic development. Because of the global economic crisis, China is making a switch from the export-driven model to more consumption. As discussed before, consumption is negatively correlated to the Gini coefficient. An advantage of progressive taxing is that its an instrument for effectively dealing with income disparity, and so dealing with a high Gini coefficient. On the other hand, IIT should be linked to governmental spending on peoples livelihood (means of securing the necessities of life). Since economic reforms in 1978, the Chinese government has gradually reduced subsidies in areas such as healthcare, education and housing, where the Chinese population had previously enjoyed full coverage from the government under the planned economy. This on the contrary could be a good argument for a reduction of individual tax rates.
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