hina’s tax offices across 36 provincial regions simultaneously unveiled new signs on June 15, marking the launch of a massive taxation reform that aims to merge the previously separate provincial and national tax offices, State media reported.
According to reform plans unveiled at the meeting of the two sessions, China’s annual legislative meetings, held in March, the reform will create a new unified taxation system which will be jointly led by the State Administration of Taxation and China’s provincial governments. Following the unveiling of new provincial taxation bureaus, municipal and county taxation bureaus are expected to be merged level by level by the end of July.
As the biggest taxation reform since 1994, the plan is widely considered an attempt to fundamentally overhaul China’s tax system and rebalance the financial relationship between central and provincial governments.
Abuse of Taxation Power
Under China’s current taxation system created in 1994, finance and taxation powers are divided between the central and provincial governments, which administer a dual taxation system. Taxes are categorized as national tax, collected by central taxation authorities, local taxes, collected by provincial and local taxation authorities, or as shared taxes, collected by central taxation authorities, though the revenue is shared between central and provincial governments.
Experts say that the dual system has become so obsolete and problematic it has started to undermine the effectiveness, efficiency, and even the legitimacy of China’s taxation system, as well as the overall health of China’s economy.
For quite a long time, a major complaint about China’s taxation system has been the arbitrary nature of the authorities’ taxation practices at the provincial and local levels, as lower levels of government often abuse their taxation power to serve the agendas of local leadership. For example, it was common practice among many provincial governments to offer tax incentives to attract investment. While the practice is sometimes a legitimate tool to boost the economy, fierce competition between provinces and cities often means that some tax incentives have become permanent, which effectively amends the national tax law at the provincial and local level.
In other cases, in areas where local governments are underfunded, local authorities often resort to aggressive and abusive taxation practices, such as forcing businesses to pay future taxes in advance, increasing the rate of some taxes or even creating new administrative “fees.”
“These practices have undermined the legitimacy of the tax law, which the central government has become increasingly concerned about,” said Liu Jianwen, director of the China Association for Fiscal and Tax Law under the China Law Society. Liu argued that establishing a unified national taxation system would create a more transparent model and a fairer business environment across the entire country.
Dual System Ambiguity
Another major problem resulting from the dual system lies in the ambiguity of the financial power of the provincial and local governments. They have a certain amount of power, but are not entirely financially independent. This leads to a situation where provincial and local governments can issue bonds to borrow money, but when they cannot pay back their debt, it is the central government’s responsibility to bail them out.
As China has adopted an investment-driven growth model and is using aggressive financial leverage to boost the economy, debt at the provincial and local levels has soared, and it now poses a major threat to China’s financial stability. By taking the taxation and financial power, and therefore the power to borrow money, away from provincial and local governments, a unified taxation system can partially address the debt crisis at these levels.
“Centralizing the power to levy taxes alone will not solve the debt problem directly, but with more balanced revenue distribution at the central level, it will help ease the debt problem in the long term,” Cao Ming, an economist at the Central University of Finance and Economics, told NewsChina.
Moreover, from the technical perspective, the institutional reform should be able to increase the effectiveness and efficiency of the taxation system. Xiong Wei, director of the Center for Taxation and Law Studies at Wuhan University, told NewsChina that the dual taxation system has incurred both a high collection cost for governments and a high compliance cost for taxpayers as they have to deal with two authorities.
In addition, as different localities adopt different standards and practices, often for the same tax, it has created tremendous difficulties for cross-regional businesses to operate. Xiong said that creating a unified and cohesive taxation system would drastically reduce the cost of taxation and help create a truly nationwide business market.
But such a prospect may be a long time coming, as the reform still faces a number of major challenges.
The immediate challenge is how to downsize the taxation system. In the past couple of years, China has launched other tax reforms which have steadily weakened the power of local tax departments. The most salient is the cancelation of the business tax in 2016, which was replaced by a value-added tax.
Since a major local tax item can account for about one-third of provincial and local governments’ revenues, cancelation of the business tax laid the foundation for the merging of the dual taxation system. It is estimated that 75 percent of all taxes are now collected by national taxation offices, which employ some 460,000 staff.
With a total staff of 410,000, provincial and local tax offices are only responsible for the remaining 25 percent. It means there needs to be a considerable downsizing program to make it as efficient as the central government promised. But so far, central authorities have shed no light on this issue.
Moreover, as provincial and local authorities hand over their taxation powers to central authorities, a key question faced by businesses is whether they will see a major jump or a cut in their payable taxes. According to Liu Jianwen, as tax incentives offered by provincial and local governments are quite common, businesses could experience a hike in their taxes.
But Liu said the central government may launch nationwide tax cuts as it has been pushing reforms to make the economy more competitive. Recently, the central government has been drafting plans to reduce personal income tax, which could be officially launched as early as October.
Consensus among experts is that the recently unveiled reform plan is just the first step toward building a unified taxation system. Given the scope of the reform, it will go beyond merging tax offices of different levels and will have a significant influence on almost all aspects of China’s economy. “There will have to be an across-the-board solution,” Liu said.