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Fairness should be at the center of any reform to China’s personal income tax code

China’s personal income tax is so unfair that it exacerbates income inequality and social injustice

By NewsChina Updated Jun.1

For years, China’s income tax regime has come under widespread criticism for being a salary tax levied on wage earners, which is not only unfair in nature, but exacerbates various social and economic problems. 

Once past a threshold of just 3,500 yuan (US$500) of monthly earnings, China’s personal income tax code has seven bands. The marginal tax rate for an individual with a monthly salary of 80,000 yuan (US$11,600) is 45 percent. Most non-wage income is not covered by the tax code. For example, an individual’s capital gains from stock trading, regardless of how much they are, are tax-free.  

Moreover, unlike the business tax, which allows tax deduction, there is no tax deduction for the personal income tax. Every wage earner is subject to the same tax rate regardless of family size and individual circumstances, though at least no complicated annual tax filing is involved. 

During the annual National People’s Congress session held in March, income tax reform once again became a major focal point, especially after the government pledged a tax cut of $550 billion yuan (US$80bn) to boost the economy.  

On March 7, China’s Finance Minister, Xiao Jie, told reporters at a press conference that the government has been working on a reform plan, which Xiao said will increase the tax threshold, allowing “family-planning-related” tax deduction, and will include income from providing “personal services” and royalties into the calculation of personal income.  

The reform plan, if launched, is surely a step in the right direction. It has long been argued that childcare expenses and interest on mortgages for houses used as the owner’s dwellings should be made tax-deductible against income taxes, as runaway house prices have become a major public anxiety, and the decreasing birth rate has posed a major demographic challenge for Chinese society. Raising the tax threshold is also something any tax reform should include, as the current amount was enacted five years ago and has long been obsolete.  

However, if that is all the reform is about, it would be far from adequate for addressing the various problems of the personal income tax code. Moreover, considering the Finance Ministry made a similar pledge at the NPC session last year, whether such a meager reform will even materialize remains an open question.  

The government must realize the seriousness of the problems regarding personal income tax. In most countries around the world, personal income taxes are progressive and serve as a means to address income inequality and act as a form of social justice. By contrast, China’s personal income tax is so unfair that it exacerbates income inequality and social injustice.  

Therefore, any meaningful reform on personal income tax should have fairness and justice at the center. The government’s pledge to extend the income tax code to “royalties” and “personal service income” may sound like a step forward, but those affected will still be mostly the middle class, not the rich. It is ridiculous that people who work hard, either through earning wages, royalties or providing services, are subject to an aggressive rate, while board members, stock traders, and real estate speculators make fortunes without paying taxes.  

It is safe to say China’s personal income tax is intentionally made simple so that it is easy for the government to collect, as taxes can be deducted from each wage-earner’s pay packet every month. One unforeseen result is that there is no national system to collect and synchronize data on personal income from multiple sources. Therefore, a major reason that a more aggressive reform has been difficult to implement is that it will take time to establish such a system.  

If that is the case, China should temporarily suspend the implementation of the personal income law until the government has the means, capabilities and political will to have the rich pay their fair share.  

This proposal may sound extreme, but according to some economists, it is completely feasible. For example, Wang Fuzhong, a well-known economist, argues that as revenue from China’s personal income tax only accounts for about 7 percent of tax revenues (or about twice the size of the proposed tax cut this year), it can be replaced by increasing taxes on State-owned enterprises and through the larger tax revenues generated by the increase in domestic consumption that will result from the tax cut.  

In any case, it is time for China to fix its distorted personal income tax regime. The government should realize that the economic, social and political cost of an unfair tax code far exceeds its benefit for government coffers.